that libor behaved quite differently from rates with no credit risk embedded in them, such as risk - free rates. libor is a less - than - ideal rate for most derivatives contracts and secured borrowing because movements in the credit risk component do not reflect well the underlying risks of the actual question asks banks only about transactions of “ reasonable market size ”. this size is not defined and is left to banks ’ judgment. bis central bankers ’ speeches those contracts. however, libor ’ s pervasiveness has become self - reinforcing. firms use libor in contracts, even when it is less than ideal, because they know they can hedge the resulting risk using highly liquid, libor - based interest rate swaps or other derivatives contracts. and those derivatives markets are so liquid because most market participants use libor as the reference rate in their financial contracts. because of the progression of this dynamic over time, and not because of some careful design, libor has spread well beyond its intended uses and become an important pillar of the global financial system – perhaps too important. in recent years, two separate developments have called into question the wisdom of that arrangement. i have already mentioned the first one – the emergence of a pervasive pattern of attempted manipulation of libor dating back many years. this misconduct was designed either to increase the potential profit of the submitting firms or to convey a misleading picture of the relative health of such firms. since 2012, seven financial institutions have settled related charges with the u. s. commodity futures trading commission and the u. s. department of justice, and the cumulative penalties and fines paid in the united states now stand at more than $ 3 billion. 8 global penalties paid related to benchmark misconduct exceed $ 6 billion as investigations into reference rate manipulation continue. although these penalties and fines are themselves substantial, to my mind the longer - term damage to the public ’ s trust represents the greater cost of this misconduct. a second problem is that unsecured interbank borrowing has been in a secular decline that predates the global financial crisis. changes in bank behavior following the crisis exacerbated the decline and further weakened the foundation of libor. the result is a scarcity, or outright absence in longer tenors, of actual transactions that banks can use to estimate their daily submission to libor. ongoing regulatory reforms and the shift away from unsecured funding raise the possibility that unsecured interbank borrowing transactions may become even more infrequent in

daniel k tarullo : the international agenda for financial regulation speech by mr daniel k tarullo, member of the board of governors of the federal reserve system, at the american bar association banking law committee fall meeting, washington dc, 4 november 2011. * * * long before the recent financial crisis, banking regulation had acquired an important international dimension. the crisis renewed attention to the interconnectedness among national financial markets. in its aftermath, accordingly, the international focus on banking regulation has grown even more extensive. today i will discuss three subjects germane to the increasingly significant international regulatory agenda. first are the steps needed to complete the reform agenda on capital and liquidity standards, including some implementation issues in the united states. second are areas that i believe should be priorities for international work in 2012 – cross - border resolution of financial firms, wholesale funding markets, and over - the - counter ( otc ) derivatives reform. and third are some institutional changes that will be required in the relevant international bodies to assure that they fulfill their promise of promoting a safe and efficient international financial system. before turning to these topics, i think it important to state the goals that should inform u. s. involvement in international financial regulatory efforts. in recognition of the fact that financial distress can quickly and dramatically cross national borders, we seek to protect our own financial system by promoting the adoption of strong, common regulatory standards and effective supervisory practices for large financial firms and important financial market infrastructures around the world. such standards and practices can also help prevent major competitive disadvantage for u. s. firms. completing the agenda on minimum capital and liquidity standards strong capital and liquidity standards are central to these goals and to the overall reform agenda for financial regulation. the crisis showed that liquidity problems can be an independent source of severe stress, perhaps even for firms that might otherwise have remained solvent. but it also confirmed that capital standards themselves had been wholly inadequate in a number of respects : required capital levels were much too low, particularly trading book capital requirements. in evaluating the condition of financial firms at the height of the crisis, markets focused on common equity ratios and virtually ignored the tier 1 ratio enshrined by basel i and basel ii. moreover, markets and supervisors both used a much more forward - looking capital calculation than under prevailing regulatory requirements – subtracting losses that they estimated would be sustained in an adverse scenario to determine whether firms would have enough capital to remain viable financial intermediaries. finally, the significant interconnectedness