July 18, 2012 / By Paul Hannon, WSJ
 

LONDON—The Governor of the Bank of England has asked the heads of the world's leading central banks to come up with proposals to reform the hugely influential London interbank offered rate, which is used as a reference interest rate for $800 trillion in securities and loans.
 

Mervyn King has written a letter sent Wednesday to members of the Economic Consultative Committee, which he heads, suggesting a dinner on Sept. 9 in Basel, Switzerland, as the forum for exchanging ideas on how to deal with Libor's shortcomings, according to a central bank source who is familiar with the contents of the letter.
 

Mr. King's letter follows revelations three weeks ago that officials at Barclays BARC.LN +0.72% PLC attempted to tamper with the rate. The Barclays chief executive and chief operating officer were among the bank officials who resigned in the wake of a scandal that has damaged London's reputation as a trustworthy financial center and cast doubt on the Bank of England and government regulators.
 

The letter follows increased pressure from U.S. financial regulators to revamp how the interbank lending rate is set and regulated. It also coincides with U.S. Treasury Secretary Timothy Geithner saying Wednesday that the U.S. also will participate in a global initiative to bring in changes to prevent abuse.
 

Mr. King has told other governors that it is now "very clear that radical reforms of the Libor system are needed," said the source, who is familiar with the contents of the letter, Libor was set up in 1986 by the British Bankers Association as a measure of what banks pay each other for short-term loans, and is based on submissions of claimed borrowing rates by between six and 18 banks. More than $800 trillion in securities, derivatives and loans are linked to the Libor, including $350 trillion in swaps and $10 trillion in loans, including auto and home loans.
 

Probes by regulators in the U.S. and the U.K. uncovered evidence that a number of banks tried to manipulate Libor over a period between 2005 and 2009. From 2007, that manipulation revolved increasingly around attempts to disguise high funding costs during the financial crisis. Even small movements--or inaccuracies--in Libor affect investment returns and borrowing costs, for individuals, companies and professional investors.
 

In his letter, Mr. King has told his fellow central bank governors that the problems with Libor "go deeper" that the fact that it is based on self-reported borrowing rates, according to the person familiar with the contents. More fundamentally, Mr. King argues that there are times when there is no lending between banks at certain maturities.
 

In those circumstances, the declared Libor rate would therefore be largely fictitious and based on banks' best guess as to the cost of their borrowing if there were any lenders.
 

Mr. King's letter marks an effort by the BOE to reassure investors that it is taking steps to address problems at the heart of the global financial system that the U.S. and U.K. probes have revealed. Mr. King came under fresh pressure from U.K. lawmakers Tuesday over the central bank's failure to catch efforts by Barclays and others to manipulate the interest rate.
 

The scandal over Libor comes as Mr. King enters his final years as governor of the BOE. But Libor has never been regulated, and Mr. King Tuesday said the central bank is "not an investigating body."
 

The Economic Consultative Committee includes all members of the Bank for International Settlement's board of directors, among whom are Federal Reserve Chairman Ben Bernanke, European Central Bank President Mario Draghi and Peoples Bank of China Governor Zhou Xiaochuan. It also includes the central bank governors of India and Brazil.
 

Mr. Bernanke raised questions Tuesday about the accuracy and even the future of Libor, while facing lawmakers' questions about why they didn't move sooner to halt alleged bank manipulation of the rate.
 

Speaking to the Senate Banking Committee, Mr. Bernanke said Libor is "structurally flawed." He said U.K. officials who oversee the rate's integrity did little to implement recommended improvements that the central bank passed along in 2008.
 

He said alternatives to replace Libor "will be seriously considered unless, of course, measures are taken to restore confidence."
 

Mr. Geithner on Wednesday defended the U.S. reaction to concerns over Libor, saying officials acted quickly and forcefully to confront potential manipulation of the key interest rate.
 

"The U.S. to its credit set in motion a very powerful enforcement response, the first results of which you have now seen," Mr. Geithner said in an interview with CNBC.
 

Also, the Treasury secretary, who was head of the Federal Reserve Bank of New York when concerns first arose, said there is now a broader global effort to change the Libor system.
 

"The British will obviously be central to that but we're not going to leave it completely to the British," Mr. Geithner said.
 

ECB Governing Council member Ewald Nowotny Tuesday said the revelations about manipulation showed a need for "stronger and more publicly monitored procedure: more supervision and the involvement of the central bank."
 

"It's inconceivable that the most renowned banks in the world are involved, and that reference data turn out to be unreliable," Nowotny said in an interview with the Austrian newspaper Der Standard. "It shows that the English authorities are wrong to rely on the market regulating itself."

Write to Paul Hannon at paul.hannon@dowjones.com