Friday, July 13, 2012

Libor rigging: what is it all about?

Libor manipulation scandal dominating the news lately is one more example of corporate greed and unethical ways of  profit hungry banks.  This latest financial scandal is another blow to already ailing banking industry.  So what's it all about?

What is LIBOR?
Banks borrow / lend regularly amongst themselves  to manage their balance sheet.  Libor or the London Interbank Offered Rate  is the benchmark rate for this borrowing / lending.  A panel of banks publish the interest rate at which they are willing to borrow everyday for different maturity;  this is collated, the top & bottom 4 quotes are eliminated and the average of the rest is published by BBA (British Bankers Association) everyday, before midday UK time. This rate is then used to fix the interest liability on borrowings of corporate, credit cards, mortgages, car leases, bank deposits and such.  Libor is published everyday for 10 currencies and 15 maturities (ranging from overnight to one year) for each currency.

Barclays' doing?
It is reported that between 2005 and 2009, Barclays traders influenced the pricing of these rates.  Initially, apparently a small number of individual traders submitted an overstated interest rate, to boost profit of their desk. During credit crisis period of 2007 and 2008, Barclays lowered its libor submission in order to protect the reputation of the bank from (1) negative speculation which arose as a result of its earlier overstating came under scrutiny and (2) also to make the bank look healthier and therefore able to borrow at lower rates

The bank has been slapped a fine of  over US$ 450 million by the UK and US regulators and gained huge public and political attention.  Barclays Plc decided to offer its Chairman Marcus Agius (married into Rothschild dynasty, incidentally) as a sacrificial lamb; but for once the authorities were quick to act and get appropriate guys to pay the price.  Bob Diamond and Jerry Del Missier who were at the helm of affairs at Barclays Capital at the time of libor scandal (till recently, the CEO and COO of Barclays group) have both resigned under duress.  One can't be heading a top investment bank and look to get away saying  "I had no clue of what a bunch of my traders were doing" or "every bank did it" or "most days no requests (to rig) were made" .  The Economist which generally is never out of line observes "this was rather like an adulterer saying that he was faithful on most days".

The exact amount of detriment caused by Barclays' rate manipulation is hard to assess. It is being argued that it only made a few basis points difference (one basis point is one hundredth of a percentage); in the context of enormous financial market there is no "just a little".   Global derivative market is estimated to be $350 trillion; assuming libor was manipulated by one basis point, the financial implication is $35 billion a year.  We are neither putting a number to the magnitude of manipulation nor suggesting that all gains went to Barclays.  However whether they overstated or understated libor, it affected  financial market end users viz. savers or borrowers.

What's more?
Barclays has been the first to be assessed by the regulators.  What is worse is that we are probably going to find out that most major banks have been involved in this scam. There will be a huge wave of lawsuits because of this scandal and that will drag on for decades.  At a time when confidence in global financial markets is already declining, this certainly is no good news. Barclays and its partners in crime have completely destroyed the legitimacy and trust which are the very basic fabrics of financial intermediation.