FED seeks LIBOR Alternative!

On September 4 2014 Federal Reserve governor Jerome Powell announced that the FED is looking for an alternative to LIBOR…any thoughts and ideas for a suitable replacement?

The LIBOR (London InterBank Offered Rate) - initialized in 1986 as the ‘benchmark interest rate’ for futures contracts and hedging against risk is one of the key determinants of interest rates in ‘floating rate loans’.

Every day between GMT 1100 and 1110 hours, 18 banks submit interbank borrowing rates for loans over 15 different borrowing terms (ranging from overnight to one year).

The information is then used for calculating borrowing across ten currencies. Thompson Reuters processes this information evaluates the ‘trimmed mean’ (mean calculated by excluding the extreme observations at the top and bottom tails of the distribution) for different exchange rate and borrowing term combinations and publishes 150 'benchmark' rates every day.

From financial transactions to credit card APRs (Annual Percentage Rate) its impact is wide felt. At present, there are $150 trillion outstanding U.S dollar LIBOR contracts in addition to $150 trillion worth of financial contracts traded using different currencies.

The past decade has witnessed various fraudulent practices in reporting rates which eventually feed into calculating the trimmed means’. Evidences leading to the ‘LIBOR scandal’ was first reported as early as 2005 with the major melt down happening in 2012 when clear evidence was presented against Barclays Capital for manipulating the rate for profit purposes.

On September 4 2014 Federal Reserve Governor Jerome Powell stated that the FED is looking for a LIBOR alternative. The sheer volume of U.S. dollar Libor contracts puts the system in great risk in case the widely accepted benchmark collapses amidst the scandal it is surrounded by.

Perhaps the officials are thinking something along the lines of a PRIME rate (the rate at which US banks lend to its most favourable customers) equivalent for the derivative industry.

So what are your thoughts?

For more details on how the LIBOR is calculated click here.

For more details on the press release on Jerome Powell’s announcement click here.

The content for this blog has been sourced using: Explaining the Libor interest rate mess , ft/fandd/2012/12/basics.htm">Back to Basics: What Is LIBOR? , Timeline: Libor-fixing scandal .