May 28, 2016    3 minute read

The Libor Rigging Saga and Potential Bubble

   May 28, 2016    3 minute read

The Libor Rigging Saga and Potential Bubble

When banks start operating purely for profit purposes, then any sort of manipulation may yield to serious results where the customers face colossal losses and a loss of investors’ confidence. Recently, LIBOR manipulation has had severe ramifications on big banks, shaking investor confidence.

The big banks include Bank of America, JP Morgan Chase and Citigroup. While the first rigging case was brought to light in 2012, the scandal dates back to as early as 2007-2008. Ironically, this was the time when the nation was going through its worst financial turmoil.

The year of 2012 saw one of the biggest scandals in the international banking industry that went unnoticed and was less talked about amidst the Eurozone crisis. The reason this was big and needed immediate attention was because it was the beginning of a ‘LIBOR Scandal.’

LIBOR is the London Interbank Offered Rate which is set as an average value (stripped of the highest and lowest rates) of the rates at which banks are prepared to lend to each other. If a balance sheet of a bank has a mismatch, they are usually reckoned by borrowing from (in the scarcity of cash) or lending to (in excess of cash) other banks. In such cases, LIBOR measures the cost of this inter-bank lending setting out the average rate banks pay to borrow from one another. It has a broad impact involving key currency rates, business loans,mortgages and even student loans.

So basically, the riskier a bank appears (higher chances of default), the higher interest rate it will pay showing less confidence in the borrowing bank. In short, LIBOR shows the strength of a certain bank and any manipulation with it by the bank can have a huge loss of a huge customer base and a crash in markets.LIBOR is checked by British Bankers Association (BBA) and lately, it lost its role and responsibility to theIntercontinental Exchange (known as ICE).

The switch was in line with the recommendation in the Wheatley report of LIBOR. According to the Wheatley Review;

The BBA should transfer responsibility for LIBOR to a new administrator, who will be responsible for compiling and distributing the rate, as well as providing credible internal governance and oversight. This should be achieved through a tender process to be run by an independent committee convened by the regulatory authorities.

According to the BBA, LIBOR ‘acts as a barometer of how global markets are reacting to the prevailing conditions.’ Complex derivative products used by professional traders in the bond and currency markets are commonly priced using LIBOR. During US sub-prime mortgage crisis, Libor soared because of the loss of investor confidence in the international banking industry. According to BBC, the value of deals determined by LIBOR was revised down from $800 trillion to $450 trillion following the Wheatley report in 2012.

Barclays and UBS were just some of the banks that manipulated the LIBOR and admitted to this scandal. The banks in this scandal are not only big UK banks but also involve American banks like Bank of America, JPMorgan Chase.

In 2016, the regulatory authorities have become vigilant of financial crimes committed by the financial industry in 2008. Yet, very few face criminal convictions. The multi-billion dollar industry chooses to settle charges by paying huge fines. The banking scandals continue to unfold and not only tarnish the reputation of the banks involved but  have negative repercussions on the entire economy.

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