Management Strategy: An Analysis of the LIBOR Crisis of 2012
One year has lapsed since the regulatory report that fined British Banking Association (BBA) for the alleged London Interbank Offered Rate (LIBOR) scandal in 2012 (Szilárd and Zoltán 23). LIBOR entails a yardstick of interest rates administered by the BBA. LIBOR calculates the interest rates based on the borrowing periods. This serves as a benchmark to the average cost of banks in their unsecured borrowing for a certain period. In the past, the BBA has been performing its role of lobbying and overseeing LIBOR while unregulated. LIBOR has a vast number of transactions in use reaching an estimated value of more than $300 trillion (Szilárd and Zoltán 23). This has severely damaged the benchmark and these calls for immediate replacement to limit the interruption of the financial markets. To reform the LIBOR there must be a comprehensive program and to provide a transition to the financial unstable benchmark. The recent crisis demonstrates lack of credibility of LIBOR by the market participants. Most market participants respond positively to the whole scale replacement of the LIBOR.
The LIBOR entails a set of indices that detail the current prevailing interest in the money markets in London that dominate various currencies annually. LIBOR began in 1986 as a simple indicator of interbank lending in the London money market (Edwards et al. 831). The BBA implements the LIBOR and Reuters publishes day-to-day business activities. Reuter publishes at least 10 different currencies for different borrowing periods. Each day has a publication of 150 different LIBOR reports (Edwards et al. 831). Before publishing the report, Thompson Reuters has to check the validity of the submissions and discards the highest and the lowest quartiles. Presently, LIBOR is a crucial benchmark for the global interest rates with more than $ 800 trillion financial instruments (Szilárd and Zoltán 24). This is due to global presence in handling most of the interest rates. Some of the financial derivatives engaged with LIBOR include corporate debt, mortgages, interest rate and currency swaps. Every type of bank in Britain with the exclusion of commercial banks has its own trading association. Frequently, LIBOR identifies the base for the variable-rate loans. LIBOR is influential to impact on the financial transactions. For example, LIBOR determines the floating portion of transactions in most of the interest rate swaps traded in the money market. The BBA does business for the banks in more than 60 countries and gives indication of the average rate (Edwards et al. 832). LIBOR makes a representation of the lowest cost of borrowing. The LIBOR rates indicate the currency of the active banks base on the submission of bank panels. The Reuter report tabulates the interest rates in proper documentation and standard derivatives. LIBOR uses the Capital Allocation Pricing Model to calculate the financial derivatives. In this calculation, any risky portfolio demands a higher spread from the risk-free rate. LIBOR can also measure the strain of money in the markets as well as make predictions to the central bank’s interest rate in future. LIBOR establishes contract with the global derivatives and other financial instruments as well as the mortgages. LIBOR acts as a point of reference to other rates. In this case, LIBOR gauges the health of the banking sector. LIBOR has to check rates charged by the banks and cites the risk rates. The increase of LIBOR displays banks habit of lending each other occasioned by the rising stress in the financial market. The reduction of LIBOR makes indication on the financial stability of the money markets. The market analyst checks on the tread of the spread the highs and the lows.
In the past, LIBOR was impenetrate able due to the apparent deviations. Submitters within the LIBOR bank panel would make submissions on the charge to borrow capital. Banks began submission of the beneficial rates due to lack of regulation.
The LIBOR Scandal
There is plentiful of evidence that display banks involvement with the LIBOR crisis. The damage escalates to billions of dollars. Bank executives made observation on the artificially low LIBOR in 2007 (Isaac 54).This signaled that some banks understated the cost of borrowing. The BBA assured the executives of the rigorous quality measures in the LIBOR to mitigate any scandal. After the Wall Street financial crisis, BBA sent memos to banks and cautioned them to submit accurate rates. LIBOR had already emerged as a big organization prone to manageability problems. There were apparent flaws in the regulation of LIBOR and some of the bank executives largely benefited in the financial swindle. Isaac (54) cites that the major banks in Britain contributed to the inconsistent behavior of the LIBOR. According to Edwards et al. (831) Citigroup and JP Morgan Chase significantly reports low borrowing costs for LIBOR than the market measures. The misstatement in the report affects the international banking system. The misstatement led to the financial crisis in 2008 since the report made contrary reports to the actual situation in the financial sector (Edwards et al 833).
In July 2012, Barclays Bank plc began manipulating the interest rates immediately after the restoration of the financial crisis (Leising 38). Barclays did this to put a false image that the bank was stable and withstood the global financial crisis. Leising et al. (38) states that the reports submitted by Barclays to Thomson Reuters had misstatements and stood to benefit the trading position of the financial institution. In this light, Barclays manipulated the rates of LIBOR. The downward manipulation of the LIBOR rates forces a rise on the bonds price that appears on the balance sheet. Some of the internal emails of Barclays made revelation that the LIBOR rate manipulation stood to benefit the banks close to 10 million dollars. Additionally, any investor or trader dealing with the bank could also benefit due to a lower LIBOR rate.
Barclays Bank PLC admits the fraud of low LIBOR rates and is subject to a $453 million penalty by the Department of Justice (DOJ). This penalty seeks to resolve the pending situation of the LIBOR. Barclays accepts responsibility of the misconduct submissions. Edwards (833) says that Barclays had earlier in 2012 made false submissions and took an improper trading position in the LIBOR. Isaac (54) says that Barclays signs agreements with the Commodities Futures Trading Commission (CFTC) and the DOJ. The statement details the intentional misrepresentation perpetrated by Barclay’s employees. The employees made false submission to Thomson Reuters at a rate that saw the bank borrow from other banks in London. Some of the Barclays investors requested the LIBOR submitters to submit false rates to the Thompson Reuters. This would ensure they reap immense benefit from the manipulated LIBOR rates. The bank executives had also requested the LIBOR submitters to present false submission to the publishing company. This would ensure the banks image in relation to other banks appear financial stable and attract more customers in the business community. During the financial crisis, the bank indeed appeared prosperous due to a false submission of the LIBOR rate. Barclays Bank PLC traders’ collaborated with other banks to manipulate the LIBOR submissions and this had a tremendous impact on the financial sector.
In some instances, the Barclays LIBOR submitters made false reports to manipulate the banks cost of funds. In addition, the UBS Swiss bank also pleads guilty to making false submissions to the LIBOR. In effect, the Justice Department imposes a penalty of $1.5 billion (Proctor 844). According to Proctor (844), some of the traders in UBS boast of enormous profits due to the malpractice. Most of the UBS workers rigged the LIBOR to reinforce their profits as well as falsely display the bank as healthy.
The LIBOR reporting system is subject to manipulation due to making unregulated self-reporting that has no basis on the market transactions. The manipulation of LIBOR rates ensures the gain of one party and the eventual los of another party. The manipulation of the LIBOR rates ensures that the lenders receive cash at a lower rate than they should have. In the same instance, the savers and the owner of pension funds could lose a share of their portfolio due to the financial fraud. The investors of equities suffer occasioned by the deduction of the spread and the risk-free rate that leads to a lower absolute return.
In August 2012, The Financial Service Authority makes inquests to the regulation and calculations of the LIBOR (Proctor 840). According to Proctor (840), the director of FSA makes investigation in the LIBOR crisis and cites that the structure of the system deserves overhaul. The probe of Barclays scandal displays that bank employees can manipulate the rates.
The Future Legal Implication of LIBOR Scandal
Regulators and policymakers discovered the manipulation of LIBOR rates as detail in the misreporting. Edwards et al. (835) cites that market intelligence coupled with concrete information on the LIBOR rates demonstrates possibility of manipulation. The Federal Reserve offers that the under-reporting of the rates is in line to avoid the notion of appearing weak of the banks.
Once a bank submits low LIBOR rates, the bank clients will receive small payments in their financial contacts. This is because the LIBOR rates determine the costs of financial instruments globally. The artificial push down of the LIBOR rate involves winners and losers in equal measure. Banks have the task of proving the reason for artificial pull down of the LIBOR rates for an extended period. LIBOR rates entail a theoretical judgment of the bank and this can make the plaintiffs suits hard to win. This can occur when the banks decide not to settle the litigation. The antitrust laws make it difficult to sue the banks. Some of the complex financial derivatives do not receive much scrutiny and regulation as the stocks and bonds in the money market. It has been alleged that the banks collaborate to artificially lower the LIBOR rates to the detriment of the financial institution. In this case, banks fraudulently misrepresent the rates in the knowledge that the investor will incur losses due to reliance of false rates. The court has empowerment to determine whether a scandal is that of purposeful price-fixation in the antitrust law.
The LIBOR scandal has the capacity to undermine public confidence on the money markets. In the light of the presence of LIBOR around the globe, the scandal has to face future litigation. This is because LIBOR is widely used as point of reference. For, instance Morgan Stanley faces a $6 billion litigation bill that includes caveats and lower liability subject to the claimants proof. The LIBOR lawsuits can claim damages as held in the antitrust laws (Isaac 55).
Reforms to Mitigate LIBOR
The self-reporting borrowing rates is hypothetical and has little oversight. Flaws in the LIBOR structure negate a culture of fraud that the banks do so with impunity. Leising (39) says that banks have to put reform structures that will reduce the future manipulation of LIBOR. There is need to have a secure internal process where the banks employees cannot report the banks cost of funds. Barclays has adopted reforms that ensure that the employees do not manipulate LIBOR. This was stipulated in the CFTC agreement. Barclays has to construct and promote good structures to set the benchmark interest rates. The interest rates should entail honesty without any conflict of interest. Banks must perform third-party audits in their LIBOR submissions. Banks have to check the LIBOR submitters are honest people. The regulators must create firewalls to deter communication between the LIBOR submitters and the bank employees. All banks participating in the LIBOR must adopt the reforms to ensure overall integrity. According to Isaac (55) there is need to reduce the number of LIBOR reports, increase the number of contributing banks, and specify the transaction size. According to Proctor (846), the LIBOR scandal calls for additional financial regulation. There is need for effective and efficient enforcement of the antitrust laws. There is also need for reforms in the internal and external reporting process. Proctor (846) cites that LIBOR is subject to amendment rather than replacement in the future. There is need for an independent administrator to oversee the operations of LIBOR other than BBA. There is need for a new code of conduct for the participating banks as well as statutory regulation.
Works Cited
"Szilárd Erhart, Imre Ligeti and Zoltán Molnár: Reasons for the LI BOR Review and Its Effects on International Interbank Reference Rate Quotations." MNB Occasional Papers (2013): 23-34.
Edwards, Christine A., et al. "Implications for Commercial Organizations of the Global Investigations into Libor." Banking Law Journal 129.9 (2012): 831-837.
Isaac, Peter. "Long Reach Of The Libor Scandal." Chartered Accountants Journal 91.8 (2012): 54-55.
Leising, Matthew, Lindsay Fortado, and Jim Brunsden. "Here Comes The Libor Scandal's Sequel." Bloomberg Businessweek 4326 (2013): 38-39.
Proctor, Charles. "Libor: The Wheatley Review." Banking Law Journal 129.9 (2012): 838-846.
