Banks may be understating key lending rate: report

NEW YORK (Reuters) - Major banks may have understated Libor, a crucial global interbank lending benchmark, masking weakness in the global financial system, according to a Wall Street Journal analysis.

Libor has indicated that the banking system was stronger than it actually was at critical junctures in the financial crisis, the paper reported.

The paper reported Thursday that its analysis indicates Citigroup Inc (C.N), WestLB WDLGgb.F, HBOS Plc HBOS.L, JPMorgan Chase & Co. (JPM.N) and UBS AG (UBSN.VX) are among the banks that have been reporting significantly lower borrowing costs for the London interbank offered rate, or Libor, than what another market measure suggests they should be.

The five banks are members of a 16-bank panel that reports rates used to calculate Libor, which is supposed to reflect an average rate at which banks lend to each other.

Trillions of dollars of corporate, household and financial derivatives contracts are tied to Libor.

Rates jumped on Thursday, with the overnight dollar-denominated Libor rate rising to 2.5875 percent, more than 58 basis points above the fed funds target rate, the benchmark short-term lending rate set by the U.S. central bank.

The British Bankers' Association, which oversees Libor, is scheduled on Friday to release recommendations to address criticisms from traders and analysts about Libor's reliability during the current credit crunch.

Rising Libor rates this week may reflect interbank market participants anticipation that the BBA may issue recommendations that will result in higher official Libor fixings, analysts said.

"I guess the fear is the BBA will say this is the new Libor rate and it will be materially higher," said Ray Stone, economist with Stone & McCarthy Research Associates, in Princeton, New Jersey.

"At the end of the day the BBA will want the Libor setting to be as indicative as possible of the underlying borrowing cost," said Stone.

To assess the borrowing rates reported by the 16 banks, the Journal reviewed another market that can help assess the financial health of banks: the default-insurance market.

Beginning in late January in tandem with concern about banks, the two measures began to diverge, with reported Libor rates failing to reflect rising default-insurance costs, according to the Journal's analysis.

The paper reported that the gap between the two measures was wider for Citigroup, Germany's WestLB, Britain's HBOS, JPMorgan Chase & Co. and Switzerland's UBS than for the other 11 banks. The Journal said one possible explanation for the gap is that banks understated their borrowing rates.

The banks contested that explanation.

"We continue to submit our Libor rates at levels that accurately reflect our perception of the market," a Citigroup spokesman said.

"For HBOS, we believe our Libor fixings are a genuine and realistic indication of our average cost of funding. Our postings are on the whole in line with the market," said an HBOS spokesman in Edinburgh via email.

JPMorgan's London office declined comment on the story.

A UBS spokesman in New York was not immediately available for comment.

A WestLB spokesman said the bank provides accurate data.

The difficulties that U.S. banks are having accessing cheap short-term financing may less pressing than the Journal article suggested, said Stone.

"U.S. banks can get dollars from the Fed, they can go to the discount window where they have a backstop source of funding," he said. The U.S. discount rate is currently at 2.25 percent.

Analysts also questioned the Journal's methodology for determining that banks may be understating interbank lending rates.

"The methodology is based on too high a risk-free rate which produces a large upward bias in the Journal's measure of bank borrowing costs," wrote Terry Belton, head of global fixed-income strategy at JPMorgan in an email note on Thursday.

In mid-April, for instance, the Journal calculated a Libor rate that would have been 25 basis points higher than the actual reported Libor. However, if a range of other market rates were taken into account in calculating this data, "the Journal article might have concluded that BBA Libor is fixing 25 or 50 basis points too high rather than too low," Belton wrote.

(Reporting by John Parry, Dan Wilchins and Ed Tobin, Editing by Tom Hals)