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.