23 November 2012

Bundesbank/Dombret: Statement on Libor

1. Importance of money market benchmark rates for financial stability and monetary policy

The integrity of money market benchmark interest rates is fundamentally important both for the correct pricing of numerous financial instruments, such as interest rate swaps and forward rate agreements, and for a large number of loan agreements that use these interest rates as a benchmark. Manipulations of these interest rates can cause considerable damage to both the real economy and the financial industry. Moreover, such manipulations can potentially impair the confidence placed in participants in the benchmark process and in the financial system as a whole. It is therefore vital, for reasons of financial stability, that benchmark interest rates are set using robust procedures.

Meaningful money market rates are useful from a monetary policy perspective as well: understanding the monetary transmission process and analysing the state of the money market are fundamentally important for monetary policy decisions. Analysing the effect of monetary stimulus is traditionally also based on unsecured money market rates such as Euribor, which is Libor’s counterpart in the euro area.

2. Supervisory measures for reducing vulnerability to manipulation

The competent supervisory authorities (e.g. IOSCO, ESMA, EBA, BaFin), in particular, are currently considering numerous measures designed to reduce the risk of benchmark interest rates being manipulated. One measure being discussed is whether basing the calculation of benchmark interest rates to a greater extent on actual transactions might serve this objective. On the one hand, transaction data would be less vulnerable to manipulation and could be used by supervisory authorities as a starting point for reviewing the reported interest rates. On the other hand, non-transaction-based benchmark interest rates might be preferable as they can also be calculated in periods when there are few transactions or none at all, in the underlying market segment, which can be the case in crisis situations.

Given that even a reformed model, e.g. one based on transactions, probably cannot fully disincentivise manipulations, it will be of prime importance to install appropriate governance and supervisory structures both at the level of banks (appropriate risk classification of the process, meaningful segregation of functions etc.) and at the level of the institution that calculates the benchmark in question. In addition, it must be ensured that the institution that aggregates the data submitted by panel banks can actually accomplish its task in an independent manner. In principle, increasing the size of the panel of banks involved in setting the benchmark interest rates might also help to mitigate the risk of manipulation, as a broader group of banks would make it more difficult to manipulate interest rates. Furthermore, one primary objective of any reform of the benchmark interest rate system should be the prevention of potential conflicts of interest.

3. Further options for reform from a central bank perspective

In parallel with the supervisory initiatives stated above, central banks are also discussing possible options for reform. The Bundesbank is a participant in these discussions. As part of the European Commission’s public consultation on a possible framework for the regulation of the production and use of indices serving as benchmarks in financial and other contracts, the Eurosystem central banks have put forward proposals for Euribor reform which primarily recommend a more robust governance process and consider reliance on transaction-based figures. As part of this public consultation, the European System Risk Board, again with Deutsche Bundesbank involvement, has also submitted an opinion on macro-prudential aspects of a reform of benchmark indices. Furthermore, a group of senior officials set up by the central bank governors represented in the Bank for International Settlements’ Economic Consultative Committee, is currently addressing medium- to long-term policy options for benchmark interest rates in the money market.

In the medium to long term, the use of alternative interest rates as benchmark rates is an option worth considering. The pros and cons of such proposals should therefore be given very careful consideration. In addition, the choice of appropriate benchmark interest rates is a matter for the private sector. Any transition to different benchmark interest rates should be at the discretion of the markets and not forced from above by legislators. Forcing actors to adopt a new system would constitute an intervention in the freedom of contract for which, in Deutsche Bundesbank's opinion, there is no justification at this juncture.

Press notice

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