European banking plan to rival London’s Libor

London dominates the $5-trillion-a-day foreign exchange market, trading twice as many dollars as the United States and more than twice as many euros as the entire euro zone, according to TheCityUK study.

A European banking group will this week test a new price benchmark to set the cost of interbank and corporate lending, challenging the London Interbank Offered Rate (Libor) pricing scheme and paving the way for a stronger role for continental European banks in money markets.

The European Banking Federation (EBF) is the driving force behind the project, which will complement an existing benchmark in euros, Euribor, decided upon daily by a committee of 44 banks.

The new project, called 'US Dollar Euribor', is set to establish a global benchmark in the American currency in direct competition with the USD Libor benchmark. The USD Euribor is attempting to bring together 24 banks, mostly from continental Europe, but also from Japan, the US, China and Canada. One British bank is also part of the project, according to a source close to the operation.

Libor relies instead on a survey of roughly 16 banks and is decided upon by British Bankers' Association (BBA).

"This week we will launch a testing exercise which will last a month or two," Cedric Quemener, the EBF manager in charge of the project, told EURACTIV. "If everything goes according to plan, the launch of the new benchmark is foreseen in September," he added.

The plan originates from concerns among continental European banks about what they see as a dominant position by investment banks and other big lenders from the City of London, which have a hold on the price-setting process that dictates the cost of trillions of dollars of bank and company borrowing.

"We believe that the new benchmark is set to be much more representative of the reality in Europe," Quemener said. Having a bigger say in the definition of the benchmark for interest rates is also crucial to decrease uncertainty in the markets, he added.

Libor troubles

The European challenge to Libor comes at a time when the group backing the British benchmark is in the midst of turmoil over the possible role it played in manipulating Libor rates to cool the financial crisis.

Regulators are probing whether a handful of major banks manipulated the global benchmark. The Bank of America, Barclays, Citigroup, WestLB and UBS are among the targets of the ongoing investigation by regulators in Britain, Japan and the United States.

The investigation is aimed at verifying whether banks understated Libor to reduce their borrowing costs and downplay investor panic during the financial crisis.

About $350 trillion worth of financial products all over the world reference Libor, and lower levels for the rate could have robbed lenders and investors of significant amounts of interest income. Borrowers, on the other hand, would have benefited from the move.

Libor rates spiked during the financial crisis but were widely criticised at the time for not having risen enough to reflect market pricing.

Italian banks remain cautious

The USD Euribor appears to have broad support in continental Europe, although the names of the banks involved are not yet public.

German and French banks are among the strongest forces behind the project. But the plan is missing a key partner at the moment: Italian banks.

None of the three Italian banks that are members of the Euribor steering committee (Unicredit, Intesa San Paolo and Monte dei Paschi) have thus far shown an interest in joining the USD Euribor.

The Italians' cautiousness is most likely linked to the primarily European nature of the top Italian banks, and their consequent lack of interest in participating in a global benchmark.

Their very prudent approach proved successful during the financial turmoil. They were among the few credit institutions in Europe not to find themselves in need of public aid. Prudence might be the prevailing attitude on this occasion too.

Euribor and Libor are reference rates based on average interest rates charged by banks on their borrowing and lending activities.

Euribor is the benchmark for euro-denominated operations, while Libor is the current reference for financial instruments denominated in sterling and US dollars.

These benchmarks proved an important measurement during the financial crisis by showing oscillations of interbank interest rates, thereby taking the pulse of the economic situation. 

  • Sept. 2011: Possible launch of USD Euribor.

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