May 30, 2008
What if Libor is Wrong?
Posted by Julie Hill

Is something fishy is going on with dollar Libor (London interbank offered rate)? Libor is supposed to approximate the average rate that banks lend unsecured funds to one another. To calculate the dollar Libor rate, the British Bankers’ Association (the BBA), has a panel of 16 banks report their borrowing costs. Some believe that these banks may be submitting artificially low borrowing costs in order to avoid appearing cash strapped. Amid this criticism, the BBA announced today that it “will be strengthening the oversight of BBA Libor. The details will be published in due course.” The BBA, however, did not change the make-up of the 16 bank panel.

Does this mean legal trouble for the many, many contracts that rely on Libor as a financial benchmark? Well for past payments or obligations, it probably will have little effect. In my experience, most contracts rely on Libor as quoted by a particular source, at a particular time. For example:

"LIBOR Rate" means … the rate offered from time to time for U.S. Dollar deposits for the Interest Period selected, as quoted by Telerate News Services as of 11:00 A.M. London setting time … on the first Eurodollar business day of the Interest Period, provided, that if two or more of such offered rates appear on Telerate …, the "LIBOR Rate" shall be the highest of the two quoted.

To me this suggests that the parties decided that, rather than debate about what rate or rate quote might best reflect current conditions, they would instead rely on a particular source’s quote even if that quote might later turn out to be “wrong.” Of course, those hurt by low Libor rates are likely to put pressure on the BBA to ensure that going forward banks are accurately reporting their borrowing cost. Those hurt may even turn to tort law seeking redress from BBA or banks on the panel. More long-term, if people lose confidence in the reliability of Libor, future contracts will simply rely on another benchmark.

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