If the U.S. Federal Reserve doesn’t come up quickly with a practical alternative to Libor (London Interbank Offered Rate), then what could transpire, if the current system falls apart, would be a “horrible mess.”
In remarks prepared for a New York University financial conference, Jerome Powell, Federal Reserve governor, said this doomsday scenario must be avoided considering that there are currently “$150 trillion in outstanding U.S. dollar Libor contracts,” according to a Reuters story. To end Libor, a benchmark lending rate used for everything from mortgages to interest-rate swaps, would be a “protracted, expensive and uncertain process,” warned Powell.
In addition to the contracts, Libor is also used as a “reference rate to another $150 trillion in contracts denominated in other currencies,” says Reuters.
After the 2012 Libor scandal in which a number of banks, such as Barclays, were found to have manipulated the interest rate for profit (and were later hit with more than $6 billion in fines), the issue still hits a raw nerve in the financial community.
Although the rate has been revised since then, Powell noted that it’s still imperative “to find an alternative that is based on transactions in credit markets that are large and robust enough to reflect actual lending conditions, such as the U.S. Treasury market,” reports Reuters.
At the same time, Libor’s importance should be scaled down in the global finance world, says Powell.
Until an alternative is developed, an effort should be made to strengthen the rate “so that it can continue to be used, perhaps by basing it on actual transactions among a larger group of institutions, instead of the current method of basing it on banks’ estimates of what they would be charged for borrowing from other banks,” says Reuters.