How to set Libor in a post-Barclays age

Time for the banks to have some skin in the game

The Libor-fixing scandal is obviously problematic for a number of reasons, but one of the biggest ones is that it isn't entirely clear how to prevent it happening again. The only reason we know for sure the rates were artificially set are the (still astonishing) internal emails from Barclays requesting that.

The issue is that, certainly at the height of the financial crisis, and even now, Libor relies on self-reported rates. Banks rarely actually borrow in large quantities from the inter-bank market any more, so rather than reporting what they are borrowing at, they are forced to report what they think they could report at. The problem then is that unless you have cast-iron evidence that there is an ulterior motive, its hard to distinguish rate-fixing from just not really guesstimating your rates very well.

Some have responded to this by arguing that the replacement to Libor should be based on actual borrowing. If a bank isn't borrowing on the inter-bank market, they report some other similar cost of capital; if they aren't borrowing at all, they don't submit. But in the FT today, Frank Partnoy comes up with another, more ingenious solution:

The teeth of the new regulation would be a rule requiring the bank that submitted the lowest Libor estimate to lend a significant amount of money, say $1bn, to the Libor Trust at its submitted low rate. Conversely, the bank submitting the highest Libor estimate would be required to borrow the same amount from the Libor Trust, in the relevant currency for the specified period of time, at its submitted high rate.

So if Barclays under-reports its rate by 1 per cent and finds itself the lowest reporting bank, it suddenly loses out on $10m over the course of a year. And the same problem if it over-reports. If, meanwhile, RBS over-reports by 1 per cent, it loses out on the same; and the trust in charge of setting the rates pockets the $20m difference (which could then go towards running costs, into the Treasury, or some other noble cause).

If there is a problem with that, it's that it may not be entirely painless to be forced to borrow $1bn even at accurately reported rates. But that seems like a small price to pay for regenerating trust in a system which has suffered a severe blow.

Barclays. Rates up, up, up? Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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New Digital Editor: Serena Kutchinsky

The New Statesman appoints Serena Kutchinsky as Digital Editor.

Serena Kutchinsky is to join the New Statesman as digital editor in September. She will lead the expansion of the New Statesman across a variety of digital platforms.

Serena has over a decade of experience working in digital media and is currently the digital editor of Newsweek Europe. Since she joined the title, traffic to the website has increased by almost 250 per cent. Previously, Serena was the digital editor of Prospect magazine and also the assistant digital editor of the Sunday Times - part of the team which launched the Sunday Times website and tablet editions.

Jason Cowley, New Statesman editor, said: “Serena joins us at a great time for the New Statesman, and, building on the excellent work of recent years, she has just the skills and experience we need to help lead the next stage of our expansion as a print-digital hybrid.”

Serena Kutchinsky said: “I am delighted to be joining the New Statesman team and to have the opportunity to drive forward its digital strategy. The website is already established as the home of free-thinking journalism online in the UK and I look forward to leading our expansion and growing the global readership of this historic title.

In June, the New Statesman website recorded record traffic figures when more than four million unique users read more than 27 million pages. The circulation of the weekly magazine is growing steadily and now stands at 33,400, the highest it has been since the early 1980s.