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What is the controversy over LIBOR and why are some experts suggesting that banks replace it with a different index?

LIBOR is the”most significant”benchmark index for short-term loans in the world, but over the past few weeks questions have been raised by the Wall Street Journal (“Study Casts Doubt on Key Rate“), Moody’s Economy.com and others whether it is set artificially low. The implication is that lenders reported lower than actual results to ease concerns about their own financial health. The impact is significant: if LIBOR is set too low, borrowers receive a windfall while bank earnings are reduced.

This is not just an issue for corporate lending. LIBOR is a key index for many consumer loans, and is an important measure for determining ALCO strategy.

How is LIBOR set? What are the implications for lenders? Should US banks peg their loans to LIBOR, and if not, what index should they use? The Wharton School at the University of Pennsylvania does an excellent job of explaining these issues: see “Why Finance Experts Are Rethinking LIBOR

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