The warning is revealed in 80 pages of emails from 2008 released by the Bank of England on Friday as part of its attempt to deflect criticism by MPs that it had been warned by regulators in New York about problems with the rate setting process.
Libor is set by a panel of banks which are asked the price at which they think they might be able to borrow on the markets, rather than the actual price at which they could borrow. One email, dated 21 May 2008, appears to show that Angela Knight, the chief executive of the BBA, was aware of the potential for banks to submit rates not reflecting the price at which they though they might borrow. She refers to the issue in an email sent to Paul Tucker, deputy governor of the Bank of England, as they discuss potential changes to the way the rate is set.
An internal email at the Bank of England, sent by an employee whose name has been redacted, also tells Tucker of the "longstanding perception that Libor by virtue of the manner in which it is set is open to distortion".
The memo, dated 22 May 2008, goes on: "Panel banks have no obligation to trade or to have traded at rates that they submit so it is at least plausible that these are influenced by commercial incentives."
The memo, sent during the credit crunch when banks were reluctant to lend to each other, describes confidence in Libor as "fragile" and mentions the "powerful incentive" for banks to "avoid the stigma" of submitting high rates which might demonstrate they were in financial difficulty. It is copied to other Bank officials.
The £290m fine levelled on Barclays last month for trying to manipulate the level of Libor has sparked controversy about what the Bank of England, the Financial Services Authority (FSA) and the BBA knew about problems with the rate, particularly because the Federal Reserve in New York was also concerned about Libor.
Seven other financial firms are being investigated by the FSA and even more by regulators elsewhere, which has led to speculation that the industry wants to agree a mass settlement with regulators.
The latest emails cover the part of the Barclays fine which relates to the depths of the financial crisis, when it was reducing Libor submissions. But they do not cover an earlier period dating to 2005 when it was altering its inputs to Libor at the instruction of derivatives traders.
The emails also show the etiquette inside the Bank, where the governor Sir Mervyn King is referred to as "G". His handwriting is shown in comments written on email printouts, and he addresses the recipients as "Mr" rather than by their first names.
In one response, in May 2008, King describes proposals put forward by the BBA as "wholly inadequate … What should we do". By July 2008, King says discussions sound "quite constructive".
The BBA's warning in April 2008 followed a report in the Wall Street Journal that banks were reducing submissions "for fear of looking desperate for cash".
The BBA said: "In its emails the British Bankers' Association was drawing the attention of the Bank of England to the need for strong governance being a feature of the BBA's Libor consultation and the BBA's desire that the Bank of England should play a formal role in the process going forward … The Bank declined and we understood that they had discussed this issue with other authorities as well. At their request this reference was therefore removed from the document."
The BBA is not currently recruiting for a full-time director of its Libor panel after John Ewan left last week to take up a new job.
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