The scandal-hit and “manipulated” Libor interest rate may be difficult to replace, with Bank of International Settlements economic adviser Hyon Song Shin arguing that a “toolbox with a separate screwdriver and saw could be better suited to serve the financial system than a Swiss army knife”.

The BIS, commonly known as the central banker’s central bank, has said that multiple benchmarks could be needed, with the challenges stemming from the fact that a reference rate has to satisfy several criteria, with the “foremost” requirement being that it should not be “susceptible to manipulation”.

The bank said a single replacement could put a squeeze on bank funding, with customers then having to endure additional costs.

Libor is being phased out by regulators by the end of 2021.

A number of alternative overnight risk-free rates (RFR) have been developed, with the US’ Sofr and the UK’s Sonia. However, Shin noted that banks borrowing to lend could also see their margins squeezed under the RFRs, resulting in additional benchmarks being needed.

“A sudden spike in their short-term borrowing rates can pull the rug from under their feet during episodes of financial stringency, squeeze their margins, and subject the system as a whole to broader stress. Banks could be exposed to basis risk in periods when their marginal funding costs diverge from interest rates earned on those of their assets benchmarked to the new RFRs, resulting in a margin squeeze,” the economist added.

As a result of this, Shin argued that a “pragmatic and tailored approach” may be required.

“For instance, RFRs could be complemented with some forms of credit-sensitive benchmark, an approach undertaken in some jurisdictions. The eventual outcome could well feature the coexistence of multiple benchmarks.”

Banks have been encouraged by regulators to find an alternative reference after the Libor-rigging scandal, which saw global banks fined billions for manipulating the rate for profit and a reduction in transactions.

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