Libor Process Under Review

The process for setting one of the world's most important interest rates veered toward a shake-up when the U.K. banking group responsible for the rate asked government officials to intervene.

"We will now be asking the authorities to consider in what manner the Libor setting mechanism should be regulated in the future," the British Bankers' Association said Thursday.

The move came a day after the announcement that Barclays BARC.LN +2.17%PLC agreed to pay $453 million in fines and admitted that traders and executives tried to manipulate two interest rates, including the London Interbank Offered Rate.

Set every day under the auspices of the BBA, Libor is one of the most widely used interest rates, affecting the cost of everything from business-account overdrafts to credit cards to mortgages. Libor rates are calculated for different currencies each day using quotes submitted by banks on a panel, based on the banks' estimated borrowing costs.

The BBA's announcement marked a significant acceleration of the trade group's efforts to reform the Libor rate-setting process in response to the ongoing two-year probe of several banks for alleged interest-rate rigging.

In a statement, the BBA said it was "shocked" by the revelations of three settlements between Barclays and regulators in the U.S. and U.K. The deal is expected to result in agreements with other banks that ultimately could total billions of dollars, people close to the investigation have said.

"I don't think even in your wildest dreams you could have thought [the outcome of initial concerns about Libor] was going to be like that," Angela Knight, BBA's chief executive, said in an interview.

It isn't clear how or when outside oversight of Libor might be toughened, but the U.K. Financial Services Authority and the Bank of England might become more directly involved in supervising the rate-setting process. Under one option being considered by the U.K. government, regulators would join banks on a new Libor supervisory committee, according to a person familiar with the discussions.

U.S. regulators suggested in a regulatory filing Wednesday that BBA officials failed to respond decisively to signs that Libor was being manipulated. In 2007, a senior Barclays executive told the BBA in a phone call that he believed the U.K. bank and other financial institutions involved in the rate-setting process were submitting artificially low rates, according to the Commodity Futures Trading Commission filing.

The Barclays executive urged the BBA to "react and be heavy handed" by throwing any banks that broke the rules off the Libor panel, the CFTC said in the filing.

U.S. regulators said the U.K. banking group responded by asking the banks themselves if they thought there was a problem. The BBA sent an email to its steering committee, which included Barclays, asking if the rates seemed lower than they should have been.

On Thursday, a BBA spokesman said the group now is investigating the CFTC's description of events. Ms. Knight said that the banks that set the rate are monitored by industry regulators, not the BBA.

Ms. Knight, who is in the process of stepping down as the BBA's top executive, has pushed for the government to play a larger role in overseeing Libor, but she faced resistance from inside the trade group, according to people familiar with the trade group. Ms. Knight declined to comment on the matter.

In Thursday's interview, she said BBA officials started considering changes to the Libor process in 2008. The group sought outside advice and formed a committee that oversaw the panels in charge of daily rate-setting. The trade group has repeatedly refused to identify the banks on the oversight committee. "We do not release the names…as we do not wish members to be opened up to any risk of individual lobbying," a spokesman said in April.

As the world-wide investigation deepened, the BBA in March established a separate review panel to recommend possible changes to Libor. Its members include Barclays, BARC.LN +2.17%Credit Suisse Group AG, CSGN.VX +5.31%HSBC Holdings HBC -2.04%PLC, Lloyds Banking Group LLOY.LN +4.09%PLC and Royal Bank of Scotland Group PLC.

The Barclays admission deepened longstanding criticism of how Libor and other interest rates are set. British lawmakers Thursday joined a growing chorus of demands for an overhaul. Alistair Darling, a former U.K. Treasury chief, denounced Libor as "a work of fiction."

But the damaged credibility of Libor hasn't resulted in consensus on an alternative. Libor remains "entrenched" partly because it remains one of the best ways to protect against interest-rate risk, investment bank Keefe Bruyette & Woods Inc. said in a report in April. The report added that U.S. banks could reduce their dependence on Libor for commercial lending over time.

Barclays admitted that some derivatives traders tried to increase their profits by rigging the bank's submissions. The U.S. Justice Department said the quote-rigging affected Libor rates "on some occasions."

Barclays said it also submitted artificially low quotes to the U.S. dollar Libor panel during the financial crisis to try to protect the bank's reputation. Executives at the bank were concerned the submissions, which are published, would be seen as a sign of weakness if they were much higher than rival banks, regulators said.

·        1. By 11:10 a.m. London time, the banks on the Libor panels submit to Thomson Reuters, as an agent for the British Bankers' Association, their estimated borrowing rates.

·        2. Thomson Reuters discardsthe highest and lowest submissions. The remaining 50% of the submitted quotes are averaged to work out the Libor rate.

·        3. By about 11:30 a.m. London time, Libor rates are published.