What would happen if banks abandoned Libor? The Barclays scandal has prompted lenders to rethink their role in setting interest rates. A mass boycott of the London Interbank Offered Rate could throw markets into a tailspin. Regulators need to decide urgently how the benchmark for hundreds of trillions of dollars of contracts should be reformed.
No banks have withdrawn from Libor in the wake of the political firestorm that followed Barclays’ admission of rate-rigging. But a growing number of institutions are pulling out of arrangements used to determine lesser-known benchmark rates from Dubai to Tokyo. And Paul Tucker, the Bank of England’s deputy governor, last week suggested regulators were making contingency plans to deal with a Libor boycott.
There’s nothing to stop banks from pulling out. Libor is fixed each day when banks submit the rates at which they would be able to borrow for a range of currencies and maturities. Participation in the panels is voluntary, and changes are not unusual. West LB, the German lender that is undergoing a severe restructuring, recently withdrew from the panel that sets dollar Libor rates.
Moreover, the $453-million fine imposed on Barclays for rigging Libor shows involvement in setting the rates is anything but risk-free. Dozens of other banks are still under investigation. And the US Department of Justice’s launch of criminal investigations suggests banks and their employees could yet face even tougher sanctions.
Unlike Libor, rates like Tokyo’s interbank rate, Tibor, Singapore’s Sibor and Dubai’s Eibor are unlikely to hurt markets or the banks that turn their backs on them. With the downside so low and the legal liability soaring, shunning these “little” Libors is a no-brainer. Besides, banks may have sound business reasons for pulling out: RBS, for example, is scaling back its operations in Asia.
A Libor boycott could be disastrous. Despite its flaws, the rate is crucial for pricing hundreds of trillions of dollars of loans and derivatives. Avoiding market disruption may be sufficient to prompt banks to overcome their legal concerns and stick with the Libor-setting process for now. But regulators can help by clearly setting out how the Libor benchmark can be reformed or replaced. They need to get on with it.