After being rigged by some of the world's biggest financialinstitutions, the London interbank offered rate, the benchmark formore than $300 trillion of securities and loans, is nowincreasingly being set by a smaller group of banks.

Bank of America Corp., Citigroup Inc. (C), Bank of TokyoMitsubishi UFJ Ltd., Royal Bank of Canada, Sumitomo MitsuiFinancial Group Inc. and Lloyds Banking Group Plc (LLOY)'ssubmissions have been used in setting the rate on an almost dailybasis in the past four months, data compiled by Bloomberg show. Twoyears ago, none of the 18 designated lenders made it into everyfixing of the measure, which excludes outliers by stripping out thefour highest and lowest contributions.

“You have a core group setting the rate and that's a majorconcern,” said Bret Barker, a money manager at Los Angeles- basedTCW Group Inc., which oversees $128 billion. “It's going to be verytough to fix that and very tough to replace Libor.”

While Libor is supposed to represent the interest rates bankspay each other for short-term loans, the dominance of a smallergroup shows the measure is failing to accurately reflect the truehealth of the financial system and borrowing costs.

The U.K.'s Financial Services Authority recommended Sept. 28that Libor have a broader group of contributors, whileacknowledging that developing an alternative would be toodisruptive to borrowers around the world because the rate is soembedded in the financial system. Libor's use stretches from U.S.adjustable-rate mortgages and floating-rate bonds to over-the-counter derivatives including interest-rate swaps.

Traders have said for years that Libor was being rigged. Thosesuspicions were confirmed in June, when Barclays Plc (BARC),Britain's second-biggest lender by assets, paid a record 290million-pound ($468 million) fine for manipulating the benchmark.Bloomberg News has found that at least a dozen banks are beingprobed by regulators worldwide for allegedly colluding on Liborsubmissions to profit from bets on derivatives.

“With Libor being such an intrinsic part of the financialsystem, restoring trust in it is an important step towards thebroader task of rebuilding confidence in banking,” Matthew Fell,the director for competitive markets at the Confederation ofBritish Industry, said in an e-mail on Sept. 28 after the FSA andManaging Director Martin Wheatley released their findings of aninvestigation into the benchmark.

Small Group

Libor is calculated by Thomson Reuters Corp. on behalf of theBritish Bankers' Association, with rates published daily for 10currencies over 15 maturities. Compilers discard the four highestand lowest quotes and average out the remaining 10.

Three-month dollar Libor, the most commonly used of the ratesoverseen by the BBA, ended last week at 0.35125 percent, down from0.58250 percent at the start of the year.

Submissions by Bank of America, Citigroup, BTM and RBC were usedin all 87 of the fixings in the four months since June 6, datacompiled by Bloomberg show. Sumitomo's were used on all but oneday, and Lloyds's on all bar two, both last week.

Citigroup kept its estimate unchanged at 0.45 percent until theend of July, when it began reducing it to 0.34 percent as of Oct.5. BTM held its submission at 0.46 percent until July 27, beforereducing it to 0.35 percent by last week, while Bank of Americadidn't move its estimate from 0.47 percent until Aug. 2. Itsubmitted a rate of 0.39 percent on Oct. 5.

Victoria Garrod, a spokeswoman for Bank of America in London,declined to comment, as did Jeffrey French at Citigroup Lloyds is“assisting various regulators in their on-going investigations,”London-based spokeswoman Nicole Sharp said.

HSBC Holdings Plc held its submissions for three-month dollarLibor at 0.25 percent since Sept. 14, and after offering the lowestestimates since August 2011 hasn't been included in the calculationat all over that period, data compiled by Bloomberg show.

At the top end of the submissions, French lenders SocieteGenerale SA (GLE), which quotes borrowing costs of 0.46 percent,and Credit Agricole SA (ACA) at 0.495 percent, haven't beenincluded in the past four months.

Brendan McNamara, a spokesman at HSBC in London, declined tocomment. Nathalie Boschat, a spokeswoman for SocGen, andAnne-Sophie Gentil at Credit Agricole, both in Paris, also wouldn'tcomment.

Drying Up

Unsecured lending between banks — the activity Libor is designedto reflect — has dried up as institutions increasingly demandcollateral before money changes hands or go to central banks forfunds. As a result, banks' reported borrowing costs have diverged,meaning the same group of lenders is dominating the middle groundwhere the benchmark is set.

The gap between the highest and lowest submissions has widenedfrom before the scandal, reaching an average 0.32 percentage pointin the past four months, compared with 0.1 percentage point in thesame period of 2011, data compiled by Bloomberg show.

The century-old BBA, which represents more than 200 banks andlobbies policy makers and regulators on their behalf, helpedintroduce Libor in January 1986 to cement London's dominance in themarkets for syndicated loans and interest-rate swaps.

Speculation rose at the height of the financial crisis in 2008that some panel members were submitting inaccurate information forLibor to mask their true borrowing costs and avoid being viewed astroubled.

Proposed alternatives have failed to gain traction. ICAP Plc(IAP), the largest broker of transactions between banks,discontinued its daily survey of New York unsecured funding ratesin August after consistently receiving insufficientsubmissions.

Dan Doctoroff, President and Chief Executive Officer ofBloomberg LP, has offered a measure dubbed the Bloomberg InterbankOffered Rate, or Blibor. It would use data from a variety offinancial transactions in an effort to better reflect participatingbanks' real cost of credit. Bloomberg LP is the parent of BloombergNews.

The BBA should be stripped of the responsibility for managingthe rate and other organizations invited to replace it, Wheatleysaid in unveiling the results of his report on Sept. 28. Herecommended a code of conduct backed by criminal penalties for howlenders contribute to the benchmark.

Other measures proposed include encouraging more firms to put inquotes and allowing the FSA to force uncooperative banks to makesubmissions.

'Completely Failed'

“Governance of Libor has completely failed,” Wheatley said.“This problem has been exacerbated by a lack of regulation and acomprehensive mechanism to punish those who manipulate thesystem.”

Financial Secretary to the U.K. Treasury Greg Clark said thegovernment will move at the “maximum possible pace” to overhauloversight of Libor and will give a formal response next week.

The BBA is focusing on the “ongoing regulatory and governmentalinvestigations and inquiries,” said Brian Mairs, a spokesman forthe lobby group. The priority “is to ensure the provision of areliable benchmark which has the confidence and support of allusers, contributors and global regulators,” he said.

“We just might get a better process with less room forsubjectivity,” said Paul Smillie, a global banks analyst inSingapore at Threadneedle Asset Management, which oversees about$45 billion of fixed-income assets.

Elsewhere in credit markets, a gauge of U.S. corporate creditrisk fell every day last week as a better-than-forecast joblessreport boosted optimism about the world's largest economy, whileGeneral Electric Co. (GE) led a 27 percent rise in corporate bondsales.

The Markit CDX North America Investment Grade Index, acredit-default swaps benchmark that investors use to hedge againstlosses or to speculate on creditworthiness, declined 3.9 basispoints in the week to a mid-price of 95.2 basis points, accordingto prices compiled by Bloomberg.

The Markit iTraxx Europe Index of 125 companies withinvestment-grade ratings climbed 1.5 basis points to 128 at 9:55a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asiaindex of 40 investment-grade borrowers outside Japan rose 1 to130.

First Sale

The indexes typically fall as investor confidence improves andrise as it deteriorates. The contracts pay the buyer face value ifa borrower fails to meet its obligations, less the value of thedefaulted debt. A basis point equals $1,000 annually on a contractprotecting $10 million of debt.

GE, the biggest maker of power-generation equipment, issued $7billion of bonds in its first offering in almost five years throughthe Fairfield, Connecticut-based parent company, according to datacompiled by Bloomberg. Hospital chain Tenet Healthcare Corp. (THC)sold $800 million of high-yield bonds as part of a four-point planthat includes share buybacks.

Telefonica SA (TEF), Spain's biggest phone company, and Italy'sMediobanca SpA tapped European bond markets amid renewed investorappetite for securities from the continent's most indebtedcountries.

Corporate bond yields tumbled to a record, with the Bank ofAmerica Merrill Lynch U.S. Corporate & High Yield Master indexdropping to 3.676 percent before paring its decline to end the weekat 3.7 percent.

Labor Department figures on Oct. 5 showed the U.S. unemploymentrate fell to 7.8 percent in September, the lowest since PresidentBarack Obama took office and down from 8.1 percent in August.

The U.S. two-year interest-rate swap spread, a measure ofdebt-market stress, rose for a third week, increasing 0.31 basispoint to 13.69 basis points. The gauge, which reached a 2 1/2-yearlow of 12.31 on Sept. 14, widens when investors seek the perceivedsafety of government securities and tightens when they favor assetssuch as company debentures.

Bloomberg News