Financial regulators on both sides of the Atlantic are pushing to transform Libor by bringing more transparency to one of the world's most important interest rates.
But those efforts to use actual market transactions, rather than unverified figures supplied by financial institutions, is expected to run up against strong opposition from banks, say observers.
Central bankers have called a meeting in early September to reform Libor, or the London Interbank Offered Rate, amid a growing scandal over rate-fixing by some of the world's largest banks.
Libor, which is set using information provided by banks based on what they say are their costs for borrowing between each other, is used to set rates on trillions of dollars of other financial products, from credit cards and mortgages, to bonds and corporate loans.
After Barclays Bank PLC agreed to pay $453-million (U.S.) in fines to settle allegations its staff conspired to fix rates by submitting false information to Libor process, the credibility of the benchmark has come into question, and its future is now in doubt.
U.S. Federal Reserve chairman Ben Bernanke and Bank of Canada Governor Mark Carney, who also heads up the global Financial Stability Board, have both said in recent days that the Libor process needs to be overhauled, or replaced by another financial measuring stick altogether.
Even though British financial authorities see Libor as a process that falls under their purview, U.S. Treasury Secretary Timothy Geithner has sent a stern warning that reforms won't be "left to the British" without other countries playing a role.
The preference of North American and other European central bankers appears to be replacing Libor with something that represents actual transactions in the market, since both Mr. Carney and Mr. Bernanke have indicated a key weakness in Libor is the lack of transparency.
Ultimately it could come down to the FSB, under the guidance of Mr. Carney, to devise a new Libor, which some observers say could be based on a system where the banks report their actual borrowing costs with data supported by recent transactions in confidence to their own central bank. That central bank then passes along that data in confidence to an international body, such as the Bank for International Settlements, which sets the rate and discloses the data publicly without the names of actual banks attached to it.
"The way Libor is set, it depends on what people [at banks] say rather than what they do. There are no records of actual trades and where they take place, where banks actually borrow," said Michael King, a former senior economist at the Bank of Canada and the Bank of International Settlements in Basel, Switzerland, and now an assistant finance professor at the Richard Ivey School of Business at the University of Western Ontario.
"And so it's set up in a non-transparent way so that the players involved can move the quotes in their favour. I would require banks to report where they actually borrow every day amongst themselves."
The Libor scandal now hits at the heart of the FSB's mandate, after the organization said it wanted to fill data gaps that hurt transparency of the financial system. But Mr. Carney could face considerable opposition from the dozens of banks involved in setting Libor in a variety of currencies. Financial institutions would prefer to keep those numbers secret, fearing that divulging too much detail about their own financing costs would give their competitors too much information about the state of their activities, and could put them at a weakness.
In recent days a number of replacements for Libor have been proposed. Mr. Bernanke has suggested using Overnight Index Swaps, treasury markets or the market for repurchase agreements to help set interest rates. Another rate, Eonia (an overnight lending rate used to track inflation and set by the European Central Bank) is also considered a potential replacement to Libor. Like Libor, it is set by averaging data supplied by a panel of banks. However, it is derived using actual transactions instead of estimates.
Documents made public in Washington two weeks ago show that U.S. authorities tried to push for changes to Libor as far back as 2008 amid reports from traders in New York that several banks had been understating their Libor submissions to distort the market, and make the financial positions of their respective financial institutions appear stronger.
In April 2008, the New York Federal Reserve Bank says in documents, it discovered Barclays was intentionally low-balling rates. Mr. Geithner, who headed the New York Fed at the time, proposed changes to the Libor process, including a new "credit reporting procedure." But the Bank of England didn't follow through and believed the problem "might go away with time," the documents suggest.