Bernanke says Fed's hands were tied on Libor

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke defended the U.S. central bank on Tuesday from accusations it did not move aggressively enough to address problems with the setting of the global lending benchmark rate Libor, saying it was in the hands of a private banking group.

The reliability of the London interbank offered rate, a benchmark that underpins transactions worth trillions of dollars, has been shaken with revelations that bankers manipulated the rate to profit on trades and hide their own borrowing costs during the 2007-09 financial crisis.

To compile Libor, the British Bankers' Association polls a panel of banks, which submit estimates of how much they believe they have to pay to borrow from each other.

Bernanke called the process "structurally flawed" and said he wanted to see changes. "I would like to see additional reforms to the Libor process, assuming that Libor will continue to be a benchmark for financial contracts," he told the Senate Banking Committee.

Dozens of big banks, including JPMorgan Chase & Co and Deutsche Bank, are under investigation in the rate-rigging scandal, and Barclays Plc has already settled with U.S. and UK regulators, agreeing to pay a $453 million penalty.

Barclays alerted the New York Federal Reserve Bank as early as August 2007 of concerns that banks were under-reporting their borrowing costs, according to documents released last week by the Fed.

At the hearing, lawmakers pressed Bernanke to explain why so many years could pass without an overhaul of the system.

"Why have we allowed it to go on the old way when we know it was flawed for the last four years?," asked Republican Senator Pat Toomey.

Fellow Republican David Vitter suggested that U.S. regulators were weak given that the central bank still did not know whether U.S. banks were also guilty of rigging the rate.

"If we don't know that, it seems like somebody dropped that ball, the fact that we're four years later and we don't know that," Vitter said.

Bernanke noted that Treasury Secretary Timothy Geithner, then the head of the New York Fed, emailed Bank of England Governor Mervyn King in 2008 with recommendations on how to boost the credibility of Libor, but he said the Fed's hands were largely tied.

"We are and need to continue advocating for reforms to the Libor process. It is constructed by private organization in the UK, and so our direct ability to influence that is limited," he said.

Bernanke said the early warning signals had only been picked up by junior employees at the New York Fed, and he cited one Fed document that he said showed one of those employees clearly did not know what Libor was or how it was constructed.

The Fed chief offered two ways to address the problems with Libor that have been uncovered.

He said the process for setting the rate could be overhauled to reduce the ability of any given bank or trader to influence it, while increasing the monitoring of the reporting process.

The other approach would be to replace it with an observable market rate. "There are a number of possible candidates that have been advanced that might ultimately replace Libor," Bernanke said.

However, he admitted it would be hard to move away from Libor given that the rate is used for $550 trillion of interest rate derivatives contracts and influences a wide array of financial products from mortgages to credit cards.

At a separate hearing, Commodity Futures Trading Commission Chairman Gary Gensler said the CFTC would "continue vigorously to use our enforcement and regulatory authorities" to ensure that benchmark rates such as Libor are free of manipulation.

(Additional reporting by Sarah N. Lynch in Washington and Jonathan Spicer in New York; Editing by James Dalgleish, Tim Ahmann and Tim Dobbyn)

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