Libor Surges After Scrutiny Does, Too

Banks May Be Reacting
As BBA Speeds Probe;
Impact on Borrowers

By CARRICK MOLLENKAMP
April 18, 2008; Page C1

LONDON -- The world's most widely used interest rate took its largest jump since the advent of the credit crisis in a sign that banks could be responding to increasing concerns that the rate doesn't reflect their actual borrowing costs.

Thursday's sudden jump in the dollar-denominated London interbank offered rate, or Libor, comes after a decision Wednesday by the British Bankers' Association to speed up an inquiry into the daily borrowing rates that banks provide to establish the Libor rate.

The move by the BBA, which oversees Libor, came amid concerns among bankers that their rivals were not reporting the high rates they were paying for short-term loans for fear of appearing desperate for cash.

In a note to clients Thursday, UBS AG strategist William O'Donnell suggested that banks were responding to the heightened scrutiny, saying that the BBA's announcement of its inquiry was an attempt "to bring publicly posted rates back into line with the shadow interbank money rate market."

If sustained, the jump could mean higher debt payments for homeowners, companies and others. Libor serves as the basis for interest rates on trillions of dollars in floating-rate corporate loans and mortgage loans. Libor rates are also used in hundreds of trillions of dollars in derivatives contracts, such as the interest-rate swaps companies and investors use to protect themselves against sudden shifts in the relationship between short-term and long-term interest rates.

Some expect Libor to increase further. William Porter, credit strategist at Credit Suisse, said he believes the three-month dollar rate is 0.4 percentage point below where it should be. That echoes the view of Scott Peng, a Citigroup Inc. analyst who said that Libor understated banks' true borrowing costs by as much as 0.3 percentage points.

The benchmark dollar Libor rate for three-month borrowing hit 2.8175% Thursday, or about .08 percentage point more than the 2.7335% rate set on Wednesday. That was the biggest increase since the three-month rate rose 0.12 percentage point on Aug. 9. At that time, news that French bank BNP Paribas had suspended withdrawals from three investment funds set off global concerns about banks' financial health. The three-month rate is now at its highest level since March 13, when markets were preoccupied with problems at Bear Stearns Co.

A spokesman for the BBA declined to comment. On Wednesday, the BBA said a review of the data banks provide to Thomson Reuters Corp. -- initially planned for June -- was already under way. The disclosure that a review had been fast-tracked came after a Wednesday article in The Wall Street Journal highlighted bankers' concerns about Libor.

The problems with Libor have attracted the attention of policy makers in the U.S. "This is a new development," Federal Reserve Bank of Dallas President Richard Fisher said during an appearance in Chicago. "I need to learn more."

Other lending rates for other currencies fell or remained relatively flat. That could be a sign that banks' demand for dollar loans has made the dollar Libor rate one of the more susceptible to inaccuracies. The three-month sterling rate fell to 5.90625% from 5.92438% Wednesday, while the three-month euro Libor rate edged up to 4.78% from 4.775%.

Every morning, banks submit to Thomson Reuters what it would cost them to borrow money across 10 currencies -- the U.S. dollar to the Swedish krona -- and 15 maturities, ranging from overnight to a year. In recent months, dollar rates submitted by banks have not varied markedly, nor have they increased or decreased sharply.

Thursday was a different story. The highest quote of the morning was submitted by U.K. lender HBOS PLC, which submitted a 2.86% rate for a three-month loan. That was up 0.10 percentage point from Wednesday. HSBC Holdings PLC posted a rate of 2.85%, up 0.12 percentage point from Wednesday. Bank of America Corp. submitted the lowest rate of 2.77%, up from 2.75% on Wednesday.

HBOS spokesman Shane O'Riordain said the bank had changed the rate to reflect similar moves in U.S. futures markets. "We always err on the side of caution," he said. An HSBC spokesman and a Bank of America spokeswoman declined to comment.