Understanding the LIBOR scam
LIBOR – the London Inter Bank Lending Rate, is considered to be one of the most important lending rates in the financial market. It is nothing but the average of all the interest rates estimated by each of the lending banks in London. This is the rate to be charged by the banks, had it to borrow from other banks. It is also the primary benchmark, along with Euribor, for short term interest rates around the world.
Libor rates are calculated for five currencies and seven borrowing periods ranging from overnight to one year. Many financial institutions, lenders and credit card agencies all over the world set their rates relative to the Libor rate.
As well as being used to decide the rate of other transactions, the Libor rate is also used as a measure of trust in the financial system and is a reflection of the utterly strong confidence that banks have in each other’s financial health.
Talking about the way these rates are set, banks don’t just lend money to each other whenever they like. Every day, a group of leading banks submits its interest rates to Libor; these are the rates at which the banks are willing to lend money to each other. The rates are suggested in ten different currencies, covering fifteen different lengths of loan, ranging from overnight to twelve months.
The most important rate is the there-month dollar Libor.
However, in June 2012, Libor came across with one of the biggest scandals the financial markets have ever seen. And owing to the fact, that so many agencies and financial systems and organizations are connected to this rate, the consequences of the scam were pretty huge.
In June 2012, multiple criminal settlements by Barclays Bank revealed significant fraud and collusion by member banks connected to the rate submissions that finally led to the Libor scam. The effect of this scam was such that the British Bankers’ Association in September 2012 said that it would transfer over sight of Libor to UK regulators, as proposed by the managing director of the Financial Services Authority. This review and statement also recommended that all the banks submitting their rates to Libor must base their rates on actual inter-bank deposit market transactions and keep record of all these transactions. It was also proposed that individual banks’ Libor submissions should be published after three months, while criminal sanctions were also recommended specifically for the manipulation of the benchmark interest rates.
The value of the total deals as determined by Libor at this point of time revised down from $800 trillion to $450 trillion!
Since the rates submitted are estimates, not actual transactions, it has been suggested that banks could have submitted false figures, which is extremely easy to do. It was alleged that traders at several banks merged into a conspiracy and influenced the final average rates that eventually led to a manipulated Libor rate. The false rates submitted by the banks were either higher or lower than the actual rates.
During the past three years, many reputed banks such as Barclays Bank, Deutsche Bank, JP Morgan, Swiss Bank, Bank of Scotland etc. have all been fined by financial regulators for being a part of such practice and indulging in fraud. This is seen as a serious act of market manipulation and corrosive t trust in the financial markets. For instance, in August 2015, former city trader Tom Hayes was also convicted of conspiracy to defraud for manipulating the Libor rate. His punishment was decided as a 14 year jail sentence which was later reduced to 11 years.
After such allegations came to light, the government commissioned a major review of Libor and the process by which the interest rate was set. The function of overseeing the regulation of the rate was passed on from the British Association to the Intercontinental Exchange – ICE.
Following this, it was then decided that rates will be based only on those actual transactions for which record are kept. Another key change that came into the picture was the setting up of specific criminal sanctions that would lead to the imposition of punishment in case there is any manipulation in interest rates done by any individual or organization.
Besides this, there was also a call for alterations or alternatives to Libor asked for by the International Finance Law Review. Interestingly, 90% of the attorneys polled by the publication said that the incident should mark the end of the Libor rate or its acceptance as a benchmark rate.
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