Reference is made to the letter from the Ministry of Finance to Finanstilsynet (Financial Supervisory Authority of Norway) of 14 December 2012 with a copy to Norges Bank. The Ministry of Finance requests Finanstilsynet to assess benchmark interest rates in Norwegian financial markets in consultation with Norges Bank. The Ministry also refers to measures proposed by Finanstilsynet to strengthen the existing system for the calculation of the NIBOR rate and requests that the measures be implemented as soon as possible.

As there are currently no viable alternative benchmark rates, it is important that NIBOR is calculated in a way that instils confidence among all market participants. This is the background for the initiative taken by the Bank in 2010 towards the establishment of rules for the calculation of NIBOR. After the rules were established and came into effect in August 2011, the Bank highlighted the need for guidelines to avoid conflicts of interest in the calculation of NIBOR in its letter to the Ministry of Finance of 12 January 2012. On 1 February 2013, Finance Norway, the trade organisation for banks, expanded the NIBOR rules to include a requirement for each panel bank to have clear guidelines for identifying and dealing with any conflicts of interest that may arise as a result of the bank's own interests in markets where NIBOR is used as a benchmark.

The authorities in a number of countries have found evidence of manipulation of international benchmark interest rates and some large international banks have been fined. Norges Bank has received enquiries from market participants abroad suggesting NIBOR might also have been calculated on a faulty basis. Norges Bank informed Finanstilsynet about these enquiries in its letter of 16 August 2012, emphasising that Norges Bank had no reason to assume that NIBOR was being manipulated but calling attention to the need for measures to strengthen confidence in NIBOR.

In the attachment to this letter, the calculation of the NIBOR rate is discussed in the light of ongoing international efforts to improve confidence in benchmark rates such as LIBOR, EURIBOR, STIBOR and CIBOR. The measures proposed by Finance Norway in its letter to Finanstilsynet of 8 February 2013, with a copy to Norges Bank, have also been considered. Although several of these measures are in line with Norges Bank's assessment, the Bank's view is that the measures should go somewhat further than proposed by Finance Norway.

In the attachment, we note that although NIBOR is a NOK rate, it is nonetheless calculated as a USD rate swapped into a NOK rate in the forward exchange market. Because of the mechanical connection to the forward premium, NIBOR volatility is higher than for benchmark rates in other countries. In the Bank's opinion, this volatility makes NIBOR more unpredictable than other countries' benchmark rates and more open to suspicion of manipulation. Confidence in Norwegian financial markets can be impaired if non-panel participants do not understand the factors underlying changes in benchmark rates from one day to the next. It is therefore Norges Bank's view that banks should calculate NIBOR in such a way as to reduce volatility. Panel banks should report the interest rate they would charge on lending in NOK, as described in the definition of NIBOR. In the absence of actual unsecured interbank lending transactions, each panel bank must set its contribution based on judgement. Judgement should be based on the broadest possible range of price information, not only from one particular dollar rate and the forward exchange market, in line with international recommendations such as in Sweden and Denmark. Banks should be able to present documentation of their exercise of judgement when requested. This will bring practice in Norway with regard to benchmark rate contributions more into line with recommendations in other countries.

The financial sector should focus on developing an OIS market ^[1] in Norway. An OIS reflects an expected overnight rate. OIS rates with different maturities provide a virtually risk-free yield curve. OIS can be traded in the market and would be an important cross bearing for NIBOR. An OIS market will provide a clearer indication of the factors underlying changes in NIBOR and thus contribute to greater transparency and confidence. There is an OIS market in all comparable countries.

In Norges Bank's view, further clarification of the rules is needed in order to avoid conflicts of interest in banks contributing to NIBOR. The UK Wheatley Review, which discusses LIBOR submissions, recommends that contributors to a benchmark rate should be kept separate from banks engaged in derivatives trading: ...Specifically, LIBOR submitters should be physically separated from interest rate derivatives traders...^[2] In order to generate confidence in NIBOR submissions, the Bank holds the view that this process must be completely protected from employees with individual mandates to take risk, i.e. employees taking active positions in instruments for which NIBOR is the benchmark and whose own interests may be served (for example via bonuses) by NIBOR movements in one or the other direction.

In its review of STIBOR, the Riksbank conducted interviews of STIBOR panel banks and states the following in its report: ...It becomes apparent that the responsibility for making each individual bank's daily Stibor submissions lies primarily with the banks' treasury departments, which are responsible for the banks' funding. One important reason for this allocation of responsibility is that the Stibor submissions should reflect a bank's cost of borrowing money. Another is that the bank's treasury departments are often separate from the other operations in the bank, such as, for example, trading on behalf of customers and to some extent the bank's own financial assets. By separating these functions, there is less incentive for individual traders' or the bank's own net trading positions to influence which submissions the bank makes when setting Stibor...^[3]

Norges Bank shares this view and emphasises that confidence in NIBOR submissions may be critically dependent on the knowledge that individuals setting a bank's submission cannot at the same time serve their own interests.

Norges Bank welcomes the plans to strengthen public supervision of NIBOR and Finanstilsynet's intention to monitor panel banks with a particular focus on information management and conflicts of interest, cf. the finance minister's response in the Storting to parliamentary question no. 740 on 8 February 2013.

Norges Bank will not have a role in the actual calculation of NIBOR or its supervision. Involving the Bank could generate uncertainty as to its role as the central bank. As NIBOR is important for the conduct of monetary policy and for financial stability, however, Norges Bank should be informed about how Finance Norway and the relevant supervisory authorities supervise the calculation of NIBOR and how any complaints related to NIBOR are assessed.

Yours sincerely,

Kristin Gulbrandsen

Anders Svor

• Attachment:  "Calculation of the NIBOR rate" (pdf, 455 kB)

Footnotes

[1] OIS – Overnight Index Swap

[2] Cf. The Wheatley Review of LIBOR: final report, Section 4.2.1, see Wheatley (2012).

[3] Cf. Riksbanken (2012), pp. 19-20.