London: The benchmark interest rate for $62 trillion of credit derivatives and mortgages for 6 million US homeowners faces its biggest shake-up in a decade as lawmakers question if banks are understating borrowing costs.

For the first time since 1998, the British Bankers’ Association is considering changing the way it sets the London interbank offered rate, according to chief executive officer Angela Knight, who appeared before a parliamentary committee in London on Tuesday. “We’ve put Libor under review,’’ Knight said in an interview.

While she declined to discuss specifics, the BBA will announce changes May 30, she said.

The BBA, an unregulated London-based trade group, sets Libor by polling 16 banks each day on the rates they pay for loans in dollars, British pounds, euros and eight other currencies.

The association is under pressure to show the rates are reliable following complaints by investors that financial institutions weren’t telling the truth after the collapse of subprime mortgages nine months ago contaminated credit markets and drove up borrowing costs.

While the BBA set the one-month dollar Libor rate at 2.72% on April 7, the Federal Reserve said banks paid 2.82% for secured loans later that day.

Secured loans typically yield less than unsecured debt.

“The Libor numbers that banks reported to the BBA were a lie,’’ said Tim Bond, head of global asset allocation at Barclays Capital in London.

“They had been all the way along. The BBA has been trying to investigate them and that’s why banks have started to report the right numbers.’’

Libor rates jumped after the BBA said April 16 that any member banks found to be misquoting rates will be banned. The cost of borrowing in dollars for three months rose 18 basis points to 2.91% in the following two days, the biggest increase since the start of the credit squeeze last August.

The cost of borrowing in dollars for three months should be as much as 30 basis points, or 0.30 percentage point, higher than the current rate, Citigroup Inc said in a report last month.

Banks are understating borrowing costs on concern they will be perceived as “weakened’’ by the credit turmoil that forced banks to record $323 billion of losses and credit-markets writedowns, said Peter Hahn, a fellow at the London-based Cass Business School.

“Since the credit crunch, it’s something that appears to have been manipulated,’’ said Hahn, a former managing director at Citigroup.

“We are in an extraordinarily delicate confidence time where a small event can shatter things quite easily.’’

The BBA accelerated its annual review of Libor to assess if there’s a fault with how the rate is computed, if it reflects “difficult markets’’ or is “giving the right answer, just one that people don’t want to hear,’’ Knight said on Monday.

“Libor has stood the test of two decades,’’ she said at Tuesday’s parliamentary committee hearing.

While the association has contacted all the member banks to investigate Libor “volatility,’’ the swings in the rate are “hardly surprising’’ amid the credit turmoil, Knight said.

“We have not run away or hidden from the need for reform or the need for review’’ of “serious’’ issues in the UK financial-services industry, Knight said.

The BBA has submitted a report based on discussions with member banks to its independent Foreign Exchange and Money Market Committee, which is carrying out the review of Libor, said Brian Mairs, a spokesman for the BBA in London.

Bank representatives contacted by Bloomberg were either not immediately available for comment, or declined to say what recommendations they are making to change Libor.

Source : DNA