Saturday, July 18, 2015

LIBOR Rigging.

LIBOR- Benchmark Interest rate

The LIBOR, which essentially mean London Interbank Offered Rate, is a benchmark interest rate based on the rates at which banks lend unsecured funds to each other on the London interbank market. It is published daily by the British Bankers' Association (BBA), and was first used in financial markets in 1986. The LIBOR rate determination comprises of a process whereby each day about 40 banks submit their interest rates - at which they plan and decide to lend to the trade organizations in their region. Then, aligning to the middle averaged quartiles, the high and the low bids are essentially discarded. It ought to be more out of a risk into its assessment as it in turn reveals the real cost of money of the bank. The Libor rates serves as a reference rate for mortgages, student loans, Financial Derivatives, and other financial products.

LIBOR Scandal

Many banks worldwide use Libor as a base rate for setting interest rates on consumer and corporate loans. When Libor rises, rates and payments on loans often increase; likewise, they fall when Libor goes down.
Major banks showcased to be healthier than they actually were during the financial crisis and made substantial profits (purging Libor interest-linked portfolios) by suppressing their funding costs and manipulating the rates through a setting process which proved to be opaque. This resulted in the International rate-rigging scandal. 

Profits and Prophets- The Cost of Capital for Alternative Investments

The Parties which were involved were traders and the managers at the major banks which included Barclays, Citigroup, UBS, RBS, BOA, JP Morgan, HSBC, Deutsche Bank and Credit Suisse – all of which are undergoing an investigation and might be fined further. The breach showcases that the banks deliberately tried to skew the Libor rate to make windfall gains on their large Libor interest-linked portfolios. The Regulators are trying to determine whether the banks submitted inaccurate data during the financial crisis. 

Tan Chi Min, a trader with RBS in a conversation with other traders said this in the year 2007, 

“It’s just amazing how Libor fixing can make you that much money or lose if opposite. It’s a cartel now in London”

Effect on the Markets worldwide

The pressure from the Libor rate setting scandal led to loss of ground for the Pound and the British currency against the Dollar and the Yen. The LIBOR incident adversely affected the European markets and is turning out to be among the largest financial frauds in history (Including mortgages, bonds and consumer loans). The significant negative effects are on European Financial Markets and consumers worldwide. LIBOR rigging and the Greece crisis made investing in the US markets a safe haven strategy which is evident from the recent rally. 

Fines for manipulation

Following reflects a list of banks that were penalized for this deed:
1. Barclays Bank was fined
$200 million by the Commodity Futures Trading Commission
$160 million by the United States Department of Justice
£59.5 million by the Financial Services Authority

2. The Royal Bank of Scotland was fined €260 million,
3. Deutsche Bank €259 million,
4. JPMorgan €80 million and
5. Broker RP Martin €247 thousand.

Survey by Members of CFA institute

A survey taken by CFA Institute Members about LIBOR resulted in the following.

Survey Results:

As per the survey:

56 % of members believe that an average rate based on actual interbank transactions would be the best methodology to set for LIBOR.

49 % believe that if the interbank market becomes very illiquid, using estimated rates would be acceptable. Herein, a higher proportion of those in APAC (62%) than in AMER (45 %) agreed.
55 % of members believe that industry bodies with regulatory oversight on top should administer and oversee the LIBOR. 

26% believe that bank regulators should administer and oversee the LIBOR. Also, a higher proportion of members in AMER than those in APAC and EMEA think that industry bodies should administer and oversee the LIBOR, though this method is the preferred one to administer and oversee it for 11% of all the members, globally.

As we analyze the results of various official investigations, it becomes increasingly apparent that not only were a large majority of financial institutions engaged in fraudulent manipulation of the benchmark LIBOR to their own advantage, but also that bank management and regulators were completely unable to effectively monitor the activity of institutions. That was because they were too big to manage and too big to regulate. One would think that the obvious conclusion here is that structural changes are needed to effectively regulate, something which has been proposed on numerous occasions by the Levy Economics Institute. Rather unfortunately, discussion in the media and political circles have turned to whether the problem was the result of the failure of central bank officials and government regulators to respond to repeated suggestions of manipulation, and to stop the fraudulent activities. This is a classic case of ‘Can’t see the wood for the trees' and thereby not addressing the real issue.

Groups Negatively Affected by LIBOR Manipulation:

Institutional investors
Consumers (borrowers and savers)
Global Financial markets

The way forward

It is high time the European banks fasten their seat belts by having more stringent rules and regulations implemented to end the anti-competitive practices and should be used within the broader context to preserve the exclusive dealing and to limit conflicts of interest. There should be better supervision by the compliance officers and they should be made accountable for the lapses. 


This article is written by Juhi Ramani. Follow her on Facebook here