Question:
Consider the libor scandal 2014 which many banks of the uk banks were involved in .explore the causes of this scandal and evaluate the impact?
Libor stands for the London Interbank Offered Rate. It is the rate at which banks can borrow funds from each other. Previously it was known as BBA Libor (for British Banker’s Association). Libor is generally defined as a benchmark interest rate through which banks can lend unsecured funds to each other. This rate is also published by the British Bankers Association. Libor is calculated against ten different currencies and fifteen different maturities that is why Libor is considered as a global benchmark to lend short term interest rates. Eighteen banks participated for the US Dollar Libor.
The Libor rate being a global benchmark, it is used for giving mortgages, loans and other financial products traded around the world. Therefore an attempt was made to make the current market in favor of labor rate. That led to increase in the profits and it made an advantage over others. The labor Scandal arose with the fact that banks started getting aware about lending loans to one another and this cause led to increasing Libor rate. The higher the rate that they were charged to borrow, the more likely a bank was to collapse.
Libor rate affected the global borrowing because many banks used Libor as a base rate against interest rates on corporate and consumer loans. According to US Commodities Future Trading Commission, hundreds of trillions of dollars were linked to Libor which included auto and home loans. It was also important to note that banks involved with securities business were more likely to fail. From facts it was seen that 5000 banks failed in the 1920s.During the Great Depression more than 25% banks failed and even some were closed down.
The American banks those were included as the panel for fixing US dollars was The Bank of America, JP Morgan Chase and Citibank, NA.
Apart from this 16 other non- US banks were involved in the US dollar fixing in London. These banks are:
HSBC, Bank of Tokyo-Mitsubishi UFJ Ltd, and of Nova Scotia, BNP Paribas, Barclays, Deutsche Bank, Credit Agricole CIB, Credit Suisse, Rabobank, Royal bank of Canada, Lloyds TSB Bank plc, UBS AG, The Royal bank of Scotland group, The Norinchukin Bank, Sumitomo Mitsui Banking Corporation (Hou, 2015).
The LIBOR Scandal was brought in by the GFC so that Barclays could maintain its creditworthiness in the market. It was also found out that the manipulation was not just restricted to the managers and traders in Barclays, but also catered to other banks in US as well over the years.
The LIBOR scandal was caused by the regulators and rogue employees who even pose a stop to the government as well. This scandal was considered as a form of price fixing. The answer to the cause of this issue was suspecticious because of the presence of political parties and issues. There were no standard operating procedures and they did not abide by the law (https://www.clpuk.co.uk, 2015).
There was a controversy with this scandal that manipulations was done by Barclays in the cost submissions that lead to downsizing of their financial health and therefore they could not make any profit out of it. It was also pointed out that traders were placed in between with direct communication and this made the bankers to be affected. This brought an insight by the traders to set the labor rates as per convenience (Claudio, 2014).
LIBOR had following impact on the financings in the US. Libor decides on the rate of interest that can be adjusted along with residential mortgages used such as collateral for derivative securities which are sold both in the private and public market places. It also sets the rate of interest for the next period by which floating bonds can be sold within or outside US. The outstanding bonds are necessarily to be redeemed as and when the international financings are issued. All the proceedings of the bonds are directed of the issuer in Guaranteed Investment Contracts (GICs). This was a part of the investment offered by financial service institutions.
There were two main forms of manipulation that were discovered. Firstly traders were acknowledged to ask Barclays employees to change their rates. Secondly initiatives were taken to improve the fiscal health manipulating the rates downward. It was projected that the new rate calculation will be based on increasing rates of interest rate in the market. It was also proposed to make the rates transparent in the market for international use (LBC, 2015).
Certain amount of fine was imposed against manipulation of the Libor rates. Barclays Bank was fined $200 million by the Commodity Futures trading Commission, the United States Department of Justice fined $160 million and 59.5 Euros by the Financial Services Authority. During the global financial crisis of 2007-2012, the interest rates were made lower (When the “Bollinger” bankers’ bubbles burst, 2013).
There was a need of labor rate manipulation that was reported by the Wall Street Journal in 2011. It was necessary for the government to make necessary changes in form of amendments to the Parliament or Banking Reform Bill. The government wanted to control the credibility of LIBOR by officially replacing British Banking Association as operational administrator and this also restore the reputation of LIBOR in market (Horton, 2012).
The process of fixing or setting the LIBOR rates is transparent and simple according to the BBA LIBOR 2013. Certain questions were raised in the market according to which the business was to be conducted. It was also necessary to specify the rate at which funds could be borrowed which is prior to the market size as well. All the contribution from the banks involved are taken into the account for producing the final Libor rate in the market within each currency. These final official rates are then published by Thomson Reutors who is considered as the designated distributor of these rates. After that it is made available to thousands of banks around the world (Voxeu.org, 2015).
The official LIBOR rates are used by the banks itself as benchmarks not only for the customers but it also helps in the settlement of contracts. For example maturing interest rate contracts on derivatives exchanges. Therefore Libor rate is considered as an integral element of the international financial system of world.
The next step is to make avail these rates to be monitored and examined by the Foreign Exchange and Money Market Committee. The sub committees play a crucial role in determining and solving necessary issues related to the disciplinary actions and LIBOR submission process as well. It was determined that there was a transparent calculation mechanism that was widely used and considered as strength for over-the-counter derivatives.
The role played by the LIBOR rate was mainly to serve as a benchmark rate for financing of loans and funds across the world. The rate was used as a debt instrument to the corporate bonds and government, credit cards, loans given to the students, and also as a derivative to other financial products. It also helps to calculate the current state of the banking system that is being operated in the world (Yeung, 2013).
Libor rate became a focus of significance in determining the credit policies. It poses a level of confidence that banks have on one another. The rate at which banks charge on loans and mortgages depends on the ability at which banks can raise money as well. If there is a certain increase in the percentage of pounds it can add to hundreds of households. If banks can borrow more cheaply then there is no need to offer good returns. For example if the base rate was 2 percent then Libor would be 2.1 percent (BBC News, 2013). It is very essential for a consumer to know which rates are tied up with Libor. Consumers must know the original terms and conditions for it.
The Libor rate also affected the financial markets as well. It was necessary for the banks to know to know about the actual borrowing and lending rates. The central bank should have monitored the rates accordingly as Libor does. The new contractors wanted a transaction based benchmark for the Libor mechanism to work along with the existing contractors as well.
Libor was now considered as an instrument to check how healthy a bank is and it also depicts which banks are deemed with poor financial health (Gatarek, Bachert and Maksymiuk, 2006).
Conclusion:
It can be concluded that recommendations needed to be given for improving the rates imposed by the Libor rate that can be implemented in UK in the near future. The Libor Scandal controversy reduced the circumstances of the market activity and this led to swapping of index overnight. This helped banks to make short term transactions. It was also necessary to ensure a more reliable benchmarking system that would enhance the funding costs of the banks. This also enabled to provide a legal aspect to make it more transparent and open to the financial industry.
References
BBC News, (2013). Timeline: Libor-fixing scandal. [online] Available at: https://www.bbc.com/news/business-18671255 [Accessed 27 Feb. 2015].
Council on Foreign Relations, (2015). Understanding the Libor Scandal. [online] Available at: https://www.cfr.org/united-kingdom/understanding-libor-scandal/p28729 [Accessed 27 Feb. 2015].
Gatarek, D., Bachert, P. and Maksymiuk, R. (2006). The LIBOR market model in practice. Chichester, England: John Wiley & Sons.
Global Research, (2015). Two Years after the Libor Scandal, Banks Get Token Fines for Rigging Global Foreign Exchange Rates. [online] Available at: https://www.globalresearch.ca/banks-get-token-fines-for-rigging-global-foreign-exchange-rates/5413850 [Accessed 27 Feb. 2015].
Hou, D. (2015). LIBOR: Origins, Economics, Crisis, Scandal, and Reform. 1st ed. [ebook] Available at: https://www.newyorkfed.org/research/staff_reports/sr667.pdf [Accessed 27 Feb. 2015].
Hou, D. and Skeie, D. (n.d.). LIBOR: Origins, Economics, Crisis, Scandal, and Reform. SSRN Journal.
https://www.clpuk.co.uk, F. (2015). Interest Rate Swaps – Interest Rate, LIBOR Rates, Base Rates, Euribor Rates, Gilt Rates, Historic Rates and Trends. [online] Swap-rates.com. Available at: https://www.swap-rates.com/BBALiborrates.html [Accessed 27 Feb. 2015].
Insider, B. (2012). The LIBOR Scandal Explained in One Simple Infographic – DailyFinance. [online] DailyFinance.com. Available at: https://www.dailyfinance.com/2012/07/11/the-libor-scandal-explained-in-one-simple-infographic/ [Accessed 27 Feb. 2015].
Karacadag, C., Sundararajan, V. and Elliott, J. (2003). Managing risks in financial market development. [Washington, D.C.]: International Monetary Fund, Monetary and Financial Systems Dept.
Kawai, M. and Prasad, E. (2011). Financial market regulation and reforms in emerging markets. Washington, D.C.: Brookings Institution Press.
Kelley, M. (2012). INFOGRAPHIC: The LIBOR Scandal Explained. [online] Business Insider. Available at: https://www.businessinsider.com/infographic-the-libor-scandal-explained-2012-7?IR=T [Accessed 27 Feb. 2015].
Konchar, S. (2014). The 2012 LIBOR Scandal: an Analysis of the Lack of Institutional Oversight and Incentives to Deter Manipulation of the World’s Most “Important Number”.
Lawdeb.us, (2013). “The Libor Scandal, its Implications, and Effect on the Corporate Trust Industry” by Romano I. Peluso. [online] Available at: https://www.lawdeb.us/our-history/blog/2013/January/Libor%20by%20Romano%20I%20Peluso [Accessed 27 Feb. 2015].
LBC, (2015). What Is The Barclays Libor Rigging Scandal. [online] Available at: https://www.lbc.co.uk/the-barclays-libor-rigging-scandal-explained-56812 [Accessed 27 Feb. 2015].
Taylor, J. and Williams, J. (2008). A black swan in the money market. Cambridge, Mass.: National Bureau of Economic Research.
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Voxeu.org, (2015). The LIBOR scandal and reform | VOX, CEPR’s Policy Portal. [online] Available at: https://www.voxeu.org/article/libor-scandal-and-reform [Accessed 27 Feb. 2015].
Yeung, T. (2013). From LIBOR to HIBOR. Hong Kong: Centre for Financial Regulation and Economic Development, The Chinese University of Hong Kong.
Claudio, L. (2014). From Scandalous Politics to Public Scandal: Corruption, Media, and the Collapse of the Estrada Regime in the Philippines. Asian Politics & Policy, 6(4), pp.539-554.
Horton, R. (2012). Offline: The scandal of device regulation in the UK. The Lancet, 379(9812), p.204.
When the “Bollinger” bankers’ bubbles burst. (2013). Strategic Direction, 29(2), pp.13-16.
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