Well the speculations seem to be over and it is now almost
true that London Inter Bank Offer Rate (LIBOR) got cheated and with it the
entire world that relies so much on this indicator. Top officials (CEO, COO,
and a Chairman) at Barclays resigned this week as an admission of guilt while
the Bank agreed to pay a penalty of $453 million[i]
to US and UK regulators.
At a time when the distrust is high with regard to
everything related to finance and banking reforms are underway in most developed
nations this development is likely to further increase the resentment of the
layman and the non-finance industry about the ailments in the banking industry.
Here we give you a lowdown on the importance of LIBOR, how
it gets determined, and how it got manipulated.
Why LIBOR is
important:
It wouldn’t be incorrect to say that each one of us could
have been individually impacted by what the LIBOR could be on any given day. LIBOR
indicates the rates in terms of ten currencies[ii]
and fifteen maturities at which banks
can borrow unsecured money in the market so as to further lend to businesses,
government, or households. So the mortgage rates or the education loan rates you
are charged do get determined by what the LIBOR is. In macro terms LIBOR serves
as “.....the benchmark for $360 trillion
of global securities.”[iii]
How LIBOR is
determined:
British Bank Association (BBA) publishes the LIBOR each day.
The LIBOR, however, is not based on some sophisticated, scientific calculations
but on the rates submissions by a panel of leading banks for each of the ten
currencies for which the currency is published.
The panel of banks that submits its borrowing rates for GBP
for example includes - Abbey National plc, Bank of Tokyo-Mitsubishi UFJ Ltd, Barclays
Bank plc, BNP Paribas, Citibank NA, Credit Agricole CIB, Deutsche Bank AG,
HSBC, JP Morgan Chase, Lloyds Banking Group, Mizuho Corporate Bank, Rabobank,
Royal Bank of Canada, The Royal Bank of Scotland Group, Société Générale, and UBS
AG.
What went wrong?
A number of banks allegedly colluded to rig the LIBOR.
Barclays has already been found guilty while a number of others are being
investigated.
The accused banks deliberately reported lower borrowing
costs during the financial crisis to avoid suggesting to the markets that they
were struggling and facing tight credit markets. This practice was also found
to be commonly used for the benefits of the banks’ traders.
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