Among the most important benchmarks used in the global financial market stands the London Interbank Offered Rate (LIBOR). Initially, LIBOR was conceived by the British Bankers Association (BBA) as a standardized interest rate in order to facilitate interest rate calculations among banks in the United Kingdom. However, since its launch in the 1980s, LIBOR “has evolved and has come to serve both as an indicator on interest rates at which banks are willing to lend each other money on a short-term basis and as a leading benchmark against a variety of other interest rates” (Invesco, 2012). Today LIBOR is considered one of the most important indexes in the world of finance, which is why news of banks fixing their LIBOR rates quickly escalated into a full blown scandal.
In attempting to explain the effects that such a discovery has on the global financial markets, the first thing that must be explained is its obvious reputational repercussions on banks all over the world. First of all, after having learned about the fixing of the LIBOR rates, lenders and other stakeholders in the banking industry have started to wonder whether or not they have been defrauded by their banks. On this point, it is worth noting that “LIBOR interest rates impact the settlement of nearly $800 trillion in financial instruments globally—including corporate debt, mortgages, student loans, interest rate and currency swaps, and other derivatives” (Joint Economic Committee, 2012). Naturally, if foul play was conducted by banks in presenting their LIBOR reports to the market, lenders could very easily have been forced to make payments much higher than what they should have paid. Adding on to this, it is equally worth noting that in the future, households will be overzealous when thinking about doing business with banks (and financial institutions in general).
From the beginning it is clear that the scandal that broke out due to the fraudulent management of the LIBOR rate constituted a devastating hit for the financial sector’s reputation. Moreover, it becomes clear that the economic ramifications will be significant, as it is highly likely that towards the future the market demand for financial services will decrease due to low levels of perceived reliability. Continuing with the analysis of the economic impact that the scandal had on the financial sector, there needs to be a differentiation between the banks that fixed their LIBOR ratings and those that did not. LIBOR rates are used as a means of analyzing and evaluating the risk of lending funds to a particular bank (or any other organization for that matter). Furthermore, “the fundamental cost of lending the money is the cost of acquiring the funds to lend; on the margin, the cost of acquiring funds is the interest rate needed to procure funds from another bank.” (Demos, 2012). Based on this, it follows it is important for LIBOR to be a reliable index insomuch as it ultimately determines what the financial costs of lending money are (to banks, organizations, and individuals alike).
LIBOR, apart from dictating what the financial costs of lending money are, also dictates what the risks of lending money are. LIBOR serves also as a credit rating that banks can use to evaluate the risk of lending amongst each other. For example, if a bank were to have a relatively high LIBOR rating, it could be interpreted by other banks that lending funds to that bank is highly risky (and they might choose not to lend funds). Conversely, a low LIBOR rating would be interpreted as low-level risk, and so banks would be more inclined to lend funds. Barclays, one of the banks involved in the scandal, “was fined a total of £290 million ($455 million) for illegally manipulating its daily LIBOR submissions between 2005 and 2009” (Stevens, 2012). Barclays submitted inflated and deflated ratings. In other words, the bank altered their numbers in order to produce higher LIBOR ratings, but they also altered them so that lower ratings would be produced (depending on what they tried to accomplish).
“Quite quickly, two separate aspects of this scandal emerged”
The first was that banks seemed to have been manipulating the rates that are used to calculate LIBOR so that their derivative positions on LIBOR contracts would show higher trading profits. The second was that, at the height of the financial crisis, Barclays bank seems to have reduced its LIBOR submissions to the British Bankers’ Association in order to give the impression to the market that others were willing to lend to Barclays at lower interest rates than was actually the case” (The Institute of Economic Affairs, 2012).
By tampering with its financial reports in order to produce higher/lower LIBOR submissions, Barclays wished to appear stronger (financially speaking) than it truly was. Evidently, the bank’s management feared that after the economic crunch of 2008, the bank would suffer significant losses, and in an attempt to mitigate such losses, they chose to forge their LIBOR ratings. In the end, the market (as well as the authorities) got wind of Barclays’ wrongdoings and punished the bank by levying the aforementioned fine. However, the economic implications that this scandal will bring to Barclays will be much higher; the market will surely punish the bank, which is now unreliable (and therefore constitutes a high risk).
Barclays, however, was not alone; other banks appear to have also indulged in manipulating their LIBOR submissions; “investigations by regulators in several countries, including Canada, America, Japan, the EU, Switzerland and Britain, are looking into allegations that LIBOR and similar rates were rigged by large numbers of banks” (The Economist, 2012). As well, it was announced last week “that New York-based Berkshire Bank is suing 21 banks including Bank of America, Barclays and Citigroup for damages over alleged Libor manipulation” (Stevens, 2012). Clearly, the LIBOR scandal did more than simply hurt the banking sector’s reputation and finances; the internal environment also suffers as those who upheld laws and regulations feel that LIBOR manipulation has had a detrimental impact on their financial resources (which derive from interest payments).
The financial market’s image has been negatively affected by the scandal; banks will surely become unreliable in the eyes of the public, and this will imply serious financial problems towards the future. The significance of the scandal’s economic ramifications is incontestable, but there are other effects that must be addressed as well. Specifically, it is necessary to consider the legal/regulatory ramifications of the LIBOR scandal. As government investigations continue (in the United States, the United Kingdom, and abroad), it is to be expected that other banks will follow Berkshire Bank’s example and sue those banks which they might feel defrauded them of their financial resources (by manipulating interest rates via the LIBOR index). In case other banks are proven to be guilty of tampering with their LIBOR submissions, governments will have to intervene as this will be clear evidence of collusion (which goes directly against the spirit of free competition that laws intend to foment).
As soon as the scandal broke out, various sectors have started making propositions as to how best deal with the problem (from a legal point of view). Some believe that in order to effectively stop such fraudulent practices in the financial markets, newer laws and regulations must be enacted. Conversely, there are those who believe that governments should simply apply existing laws swiftly and efficiently. In the United States, for example, it is widely believed that “the federal government should efficiently and effectively enforce the existing antitrust and securities laws that already made Barclays’ and its employees’ actions illegal” (Joint Economic Committee, 2012).
As well, much criticism has been made to the way in which the BBA handles and computes the LIBOR index. It appears that the time for changing the way in which the LIBOR rating is compounded must change so as to avoid such happenings from taking place in the future. Undoubtedly, change will occur; the market simply cannot afford for any such situations to become the norm, especially now that the credit boom appears to have reached its end and the market is only slowly recuperating after the 2008 crunch. Finally, what happened with LIBOR has led some to question whether or not the market will continue following the same trend. After decades of continued growth in credit, it appears that it is no longer possible to secure profits and financial security by pursuing this approach. Today, “the economic growth ‘borrowed’ during the credit boom, has been replaced with a new period of austerity” (Williams, 2012). If this is the case (which it certainly appears to be), consumers will soon find themselves searching for safe investments that yield sustained returns in the long term (instead of attempting to speculate with stockholdings). Only time will tell what the future of the market will be. The only thing that is for sure at the moment is that the LIBOR scandal will serve as a catalyst for significant change given its commercial, economic, legal, and regulatory implications.