Problems Inherent in LIBOR/EURIBOR/SHIBOR, 'Netting', the Liquidity Coverage Ratio; And New Recommendations for US FSOC's Processes, and LIBOR/SHIBOR/EURIBOR Rate-Setting Processes

37 Pages Posted: 26 Nov 2013

Date Written: August 1, 2013

Abstract

The LIBOR rate-setting scandal of 2012-2013 illustrated weaknesses inherent in LIBOR and similar benchmarks such as the Euro Interbank Offered Rate (“EURIBOR” - the analogous benchmark rate for interbank lending in Euros) and the Shanghai Interbank Offer Rate (“SHIBOR” - the analogous benchmark rate for interbank lending in Reminbi). LIBOR, EURIBOR and SHIBOR are key benchmarks that determine interest rates for more than US $450 trillion of transactions and financial instruments around the world. Thus, even small errors in the rate-setting processes for these benchmarks can have substantial effects on monetary policies, on the profitability of financial institutions and regular companies; and on household finances. The problems inherent in the rate-setting processes for key benchmark interest rates (eg. LIBOR, EURIBOR and SHIBOR) are pervasive, structural and cannot be solved by either existing or proposed rate-setting mechanisms. However, the principles and rate-setting mechanisms introduced in this article can serve as foundations for further research on rate-setting mechanisms.

The US FSOC’s Criteria for identifying SIFIs are inaccurate and are likely to result in false positives and false negatives. Similarly, the Basel Committee on Banking Supervision’s (BCBS) criteria for identifying systemically important financial companies and banks are inaccurate and limited (the five categories of risk importance are interconnectedness; size; complexity; cross-jurisdictional activity; substitutability/financial institution infrastructure).

Most forms of “Netting” of derivatives are highly inaccurate and misleading. Netting was a primary cause of the Global Financial Crisis because it lead to gross misstatements of the true risks of many derivatives. Similarly, the Liquidity Coverage Ratio is misleading.

Suggested Citation

Nwogugu, Michael C. I., Problems Inherent in LIBOR/EURIBOR/SHIBOR, 'Netting', the Liquidity Coverage Ratio; And New Recommendations for US FSOC's Processes, and LIBOR/SHIBOR/EURIBOR Rate-Setting Processes (August 1, 2013). Available at SSRN: https://ssrn.com/abstract=2359835 or http://dx.doi.org/10.2139/ssrn.2359835

Michael C. I. Nwogugu (Contact Author)

Independent ( email )

P. O. Box 11104
Enugu 400007, Enugu State 400007
Nigeria
2348149062100 (Phone)

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