Bank of England considering alternative to LIBOR

The Bank of England will clarify how markets will adopt the proposed alternative interest rate benchmark after banks were fined billions of dollars for trying to rig the London Interbank Offered Rate (LIBOR).

Chris Salmon, the Bank of England’s Executive Director for markets, has said LIBOR, which is the benchmark for interest rates that banks charge each other, remains too prevalent.

LIBOR was previously overseen by the British Bankers’ Association (BBA), and LIBOR rates have come under scrutiny after traders were accused of rigging the rate. The rates are calculated through an ‘honour system’, in which a panel of banks report their estimated costs of borrowing from one another in different currencies over a specified time period [1].

The Bank of England has been working on an alternative reference rate for the past year. Salmon has said the aim of this is to “transition a significant portion of new derivatives contracts to the alternative reference rate, moving to a world where LIBOR is used when it is appropriate to account for bank credit risk, but not otherwise” [1].

Treasurers will then decide whether to adapt their use of reference rates, once the transition is underway.

Salmon has warned that companies who seek to raise money on fixed income markets may find this harder, given the potential of an increase in volatility.

[1] Reuters UK. ‘BoE says will map out move to Libor alternative in 2016’.