Badly behaved banks

The Libor scandal holds lessons for governments and regulators across the world

Published: July 30, 2012 3:47:08 am

It is a truth cynically acknowledged in Britain that if there is a class of people the electorate distrusts more than its politicians,it is bankers. A slew of allegations around the fixing of Libor (the London interbank offered rate),a key reference rate relied on by global financial institutions,has only served to confirm this adage. Amid tension,a parliamentary review into the scandal is underway in Britain. The latest installation of the saga has resulted in correspondence released by the Bank of England to ward off criticism that it had been clearly warned by regulators in New York several years ago about questionable practices.

Nonetheless,this is far from being a uniquely British scandal. Its ramifications extend well beyond its shores. In an inter-connected market,the issues raised by this episode and its lessons should be of deep interest to governments and regulators elsewhere too.

At the moment,the Libor affair seems to swirl around a single bank in Britain. Barclays has been fined £290 million by regulators in Britain and the US for its attempts to manipulate Libor. Bob Diamond,its chief executive,has had to resign. Still,some may wonder why the manipulation of an esoteric financial rate appears to be generating such hullaballoo. This is important because Libor — the daily money market rate at which banks in London are able to borrow funds from each other — is a key rate that influences what companies and individuals across the globe pay to borrow money or to receive for their hard-earned savings. It is used as a benchmark to set payment thresholds on a range of financial obligations and instruments.

If it turns out that institutions were able to rig this rate,it may open the door to a waterfall of lawsuits from investors and debtors. Ironically,Barclays found itself in the public glare only because it was the first institution to cooperate fully with regulators. It is unlikely to be the only institution to have indulged in such practices. Regulatory investigations into the fixing of Libor and other reference rates are also underway in the US,Canada and the EU. It dents the reputation of a sector already struggling to cope with the ongoing global economic slowdown.

With this investigation,two different strands of manipulation have emerged. The first surrounds traders attempting to enhance profit or reduce losses. Dating back to 2005,it involved Barclays traders coopting their money market desks to submit inaccurate estimates for Libor. Such traders were also in touch with counterparts in other institutions,exchanging requests to forward on to their submitters. What this suggests is an unsavoury collusion akin to a price-fixing cartel. The second strand of rigging can be traced to the credit crunch in 2007 and presents a moral conundrum. At the peak of the credit crunch,a high Libor submission from an institution,reflecting the costs of its borrowing,would have been interpreted as a sign of weak financial health. Barclays lowered its submission to fit into the median range that other institutions were in. Allegedly,it was tacitly nudged into doing so by the central bank.

Part of the problem with Libor was that it was based on estimated borrowing costs submitted by a panel of institutions under the auspices of a trade body. That made the submissions more susceptible to “accidental or deliberate misreporting”. As a way forward Libor ought to be set on the basis of actual borrowing costs submitted by a larger panel with stringent oversight. Yet,after a flurry of scandals (like a US Senate report into HSBC’s money laundering),the larger exercise lies in conducting a review of the banking sector with a view to promoting transparency,curbing excessive risk-taking and retaining public confidence.

The integrity of a free market depends on a culture of transparency and responsibility. If this scandal leads to a move in such a direction,that will not be such a bad outcome.

Rishabh Bhandari is a lawyer based in London

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