May 30 (Bloomberg) -- The group that sets the London interbank offered rate can restore its credibility by following the example of Australia and New Zealand, said Morgan Stanley. Or, the British Bankers' Association could look to the U.S., according to UBS AG and Credit Suisse Group.

The loss of confidence in the benchmark rate for $350 trillion in derivatives and corporate bonds and 6 million U.S. mortgages spurred the world's biggest banks to recommend fixes, though they reached no consensus. The BBA plans to announce after 5 p.m. today the first changes to Libor in 10 years after the Basel-based Bank for International Settlements suggested in March that some lenders were misstating borrowing costs to avoid speculation that they were in financial straits.

``The BBA clearly needs to fix Libor as it's not functioning as it should,'' said Jan Misch, a money-market trader in Stuttgart at Landesbank Baden-Wuerttemberg, Germany's biggest state-owned bank. ``How exactly they go about doing that I don't know.''

Morgan Stanley, the second-biggest U.S. securities firm by market value, says Libor should be based on trades rather than a survey. Credit Suisse, Switzerland's No. 2 bank, suggests increasing the number of U.S. participants. Zurich-based UBS, the world's largest wealth manager, advocates calculating the rate later in the day, while Barclays Capital says rates should be based on anonymous quotes.

Published Rates

The BBA, an unregulated trade group, asks 16 member banks each day how much it would cost them to borrow from each other for 15 periods ranging from overnight to one year, in currencies including dollars, euros and yen. It calculates averages, throwing out the four highest and lowest quotes, and publishes them at about 11:30 a.m. in London. Individual bank rates are also published.

``Most interesting would be to initiate a system similar to that in the Australian and New Zealand dollar markets, where the fixings are preceded by a brief period of trading in bank bills,'' a London-based Morgan Stanley team led by Michelle Bradley wrote in a report yesterday. ``This could improve the transparency and credibility of the fixings to some degree.''

Libor `Lie'

Basing rates on transactions is only part of the solution, said Tim Bond, head of asset allocation strategy in London at Barclays Capital, a unit of Barclays Plc. Libor would be more reliable if banks offered rates anonymously, allowing them to avoid being penalized by investors if their borrowing costs stick out from the average, said Bond, who has described Libor as ``a lie.''

Discrepancies in the rates that banks quote began to appear as financial institutions racked up losses during the collapse of the subprime-mortgage market. In the first four months of 2007, the difference between the highest and lowest rates for three- month Libor didn't exceed 0.02 percentage point, according to JPMorgan Chase & Co. In the same period this year, it was as wide as 0.17 percentage point.

When the BBA threatened on April 16 to ban banks that misquoted rates, the cost of borrowing in dollars for three months jumped 18 basis points in the next two days, its biggest increase since before the start of the credit squeeze in August, BBA data show. A basis point is 0.01 percentage point.

Skewed Toward Europe

Libor would be more representative of bank funding costs if it wasn't skewed toward Europe, Eric Liverance, head of derivatives strategy at UBS Securities LLC in Stamford, Connecticut, wrote in report dated May 27.

The BBA should expand the number of American banks and set the dollar rate when the U.S. market is open, he said. Citigroup Inc., Bank of America Corp. and JPMorgan are the three U.S. banks on the panel that sets dollar Libor.

``Stresses on dollar funding from banks in Europe may be creating a distortion of domestic funding costs in the U.S.,'' Liverance wrote.

UBS, which recorded $38 billion of writedowns and losses between July and April, quoted dollar-borrowing costs that were lower than its rivals on 85 percent of the days during that period, according to data compiled by Bloomberg. By contrast, the U.K.'s Lloyds TSB Group Plc, which wrote down $1.4 billion, quoted rates that averaged less than 1 basis point above Libor.

``They need to make sure the way in which Libor is being fixed has credibility in the marketplace,'' said Terry Belton, head of fixed-income strategy at JPMorgan in New York. ``They are aware of the controversy going on and will take steps to improve credibility, but at the end of the day those will be small steps that won't move Libor one way or the other.''

The BBA may decide to avoid sweeping changes because Libor is so engrained in the global financial system, according to BNP Paribas, France's second-biggest bank.

``It is unclear whether the BBA will decide on anything dramatic as the Libor setting is fundamental for many existing contracts,'' Nathalie Fillet, a senior interest-rate strategist in London at BNP, wrote in a report yesterday.

To contact the reporters on this story: Gavin Finch in London at gfinch@bloomberg.net; Ben Livesey in London blivesey@bloomberg.net.

Last Updated: May 30, 2008 06:30 EDT