A report into the Libor rate-rigging scandal says the system is broken and suggests its complete overhaul, including criminal prosecutions for those who try to manipulate it.
Its author, regulator Martin Wheatley, told the BBC that bankers guilty of fixing Libor in future could be jailed.
"Society has lost confidence in banks... and we need to restore that."
Libor is used as a benchmark for millions of transactions and determines some loan and mortgage rates.
Mr Wheatley, managing director of the Financial Services Authority, said that society wanted people who committed these sorts of acts to "pay the price, and if that includes jail for the most extreme fraud in the system, then that's what should happen".
Libor - the London Inter-bank Offered Rate - is calculated from banks' estimates of how much it costs them to borrow from other banks, and is then used as a reference rate to determine the interest charged on loans to companies and individuals.
His report also said the banking association that supervises Libor, the British Bankers' Association (BBA), had "no further role" in the setting of Libor.
His main recommendations include:
- Introducing a new regulatory structure for Libor, including criminal sanctions for those who attempt to manipulate it
- Inviting other groups to apply to take over the BBA's role, which will include drawing up a code of conduct and carrying out regular audits
- Encouraging banks not part of the current group of 20 rate-setters to submit rates to Libor to make it more representative
- Basing Libor calculations on actual rates being used, rather than estimates currently provided by banks
- Cutting the number of Libor daily fixings from 150 to just 20 and reducing the number of currencies looked at to better reflect the most-used rates
The review suggested the Financial Services Act, which is currently passing through parliament, be amended to allow the FSA to investigate and prosecute future Libor manipulation.
Regulation of the UK's financial system is itself being overhauled. Responsibility for overseeing financial firms, including overseeing any new Libor-setting body, will be shifted to the FSA's replacement, the Financial Conduct Authority, which Mr Wheatley will lead.
The Financial Secretary to the Treasury, Greg Clark, strongly welcomed the report, which he said was a "credible blueprint for the future", adding that the government supported the "broad thrust" of the recommendations which would be debated when parliament resumes.
He added that the banking industry should not wait for changes to be imposed, but should "begin immediately to put its house in order".
Labour's shadow treasury minister, Chris Leslie, said: "Reforming Libor so that it is based on real 'and independently verifiable' trade data is the least that should be done.
"But surely the wider lesson is that a whole array of benchmark indices, across commodity markets and other traded products, are too easily prone to manipulation."
In the longer term, Mr Wheatley said that UK authorities should work with other international bodies to examine whether Libor should remain the market benchmark.
The governor of the Bank of England, Mervyn King, said the proposals should be introduced swiftly.
But he also said more work needed to be done to find a safe method of pricing market transactions that are currently linked to the 130 Libor rates that Mr Wheatley wants scrapped.
"Over the medium to long term, further thinking will be needed to meet the challenge of benchmarks based on thinly-traded markets, especially when they are quote-based."
A group of large banks submit daily estimates of the rates they are paying to borrow money. On the basis of the submissions, financial firm Thomson Reuters calculates the Libor rate on behalf of the BBA, and it is released to the financial markets.
Libor sets a benchmark for more than $300 trillion (£185tn) worth of loans and transactions. Mr Wheatley said it was "the most important figure in finance".
In June, Barclays was fined £290m because its traders tried to rig Libor.
Following the scandal, and revelations that other banks were implicated, Chancellor George Osborne asked Mr Wheatley to review Libor.
"The disturbing events we have uncovered in the manipulation of Libor have severely damaged our confidence and our trust - it has torn the very fabric that our financial system is built on," Mr Wheatley said.
In a stinging criticism of the BBA, Mr Wheatley said it was "careless" in its approach to policing Libor and put too much trust in a system that "did not have the right level of checks and balances in place".
Libor could impact traders' bonuses, he said, so they had an interest in pushing the rate up or down. "They were allowed to do this freely with no oversight," Mr Wheatley said.
At the height of the financial crisis when bank finances were weak, there was an incentive to submit a low Libor figure. A high figure might call into question a bank's creditworthiness.
The BBA said the review was an "essential step" towards reforming Libor and signalled it would accept Mr Wheatley's recommendation that oversight be handed to another body.
The BBA said it would work closely with the government and regulatory bodies towards this.
Mr Wheatley said that Libor rigging had been across the board: "We are not talking about a few rogue individuals here, but a systemic problem. In the case of Barclays, for example, there was a web of traders that worked together to try and manipulate Libor to benefit one another."
Barclays is the only bank to have been fined so far, but it is understood at least 15 banks globally are being investigated for possible Libor manipulation.