Libor Lied. Here’s Why Replacing It Isn’t Easy: QuickTake Q&A

The scandal-ridden London interbank offered rate, or Libor, may be on its last legs. After more than two years of study, a U.S. Federal Reserve-sponsored group on June 22 recommended replacing the interest-rate benchmark with one based on the bustling Treasury repurchase, or repo, market. That’s where banks overnight exchange their U.S. Treasury bonds for cash, then buy the securities back the next day. The new rate eventually could be the benchmark for pricing some $300 trillion of U.S. derivatives, student loans, home mortgages and many other types of credit. It could take years to transition to the new rate from Libor, an integral part of the global financial system for decades but that turned out to have numerous vulnerabilities.

Lots. It was set up by the London-based British Bankers Association in 1986 as a way to price syndicated loans and interest-rate swaps. The rate was determined by a daily poll, which asked banks to estimate how much it would cost to borrow from each other without putting up collateral. Because fewer banks make such unsecured loans, Libor doesn’t always reflect actual practice. And because it doesn’t always reflect actual transactions, either, it’s prone to manipulation. Regulators and prosecutors, after the 2008 financial crisis, found that dozens of firms worldwide had colluded to set the benchmark at levels that would benefit their own Libor-linked portfolios. Large European and U.S. banks paid billions of dollars to settle rigging and other charges.