Commerce and trading are essential for the world economy and both are intrinsically dependent on money transfers and currency swap; not only, from one country to another, but also from one financial institution to another. The glue that allows this efficient funneling of funds is the rate that both the borrower and lenders agree to pay. However, the rate per se is not useful if it does not trustworthy. That is why it is so important to count on with an interest rate whose fixing and utilization be clean of any spot of misrepresentation and manipulation from its authors. There are a handful of such as rates in the current international financing market: Tibor, Libor, Sibor and Euribor. Nevertheless, by far the main interest rate utilized is LIBOR (London Inter-Banking Offered Rate). The total financial impact varies from nearly $554 trillion in OTC Interest rate Derivatives and €316 trillion in Short term Interest (Garcia, 2012, p. 1) to $360 trillion in financial products in different currencies (Scheiner & Broda, 2012, p. 1).
Unfortunately, since 2007 to 2009 there were reports and investigations containing evidence that the LIBOR rate had been artificially manipulated. The scheme was to benefit a selected group of banks which were in charge of providing the Thomson Reuter (the LIBOR fixing rate agency) with quotes used as a raw material to estimate the final published LIBOR rate.
In 1984 the BBA (British Bank Association) began the standardization of Interest Swap…it became the reference rate of numerous securities such as: syndicated loans, futures, contracts, and forward agreement rates. In the process the BBA choose 16 banks that provide daily rate appraisals to estimate the LIBOR. Those banks are designated based on their reputation, size of market activity, and perceive expertize in a specific currency. Thomson Reuter is the agency that estimates the LIBOR after excluding 25% of both highest and lowest quote submitted (Scheiner & Broda, 2012, p. 1). The BBA would eliminate the higher and the lowest quote and any outliers and would only average the center quartile (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 137).
Origen of the crisis
On May 29, 2008 one article published in the Wall Street Journal opened the Pandora Box when purported that there has been an artificial reduction of the LIBOR (London Inter-Bank Offered Rates) rates submitted by the banks members of the panel of contributing banks (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 136). Then three probing reports form The Financial Services Authority, the Commodity Future trading Commission, and the Department of Justice (USA) containing evidence that several banks colluded to influence and pervert their quotes to estimate the LIBOR BBA. (Kregel 2012. p. 1).
One of the elements that could have caused the underrating of the submitted quotes is that after the crisis shock in 2007 the inter-bank market was almost frozen. Therefore, there were not real interbank rates to be submitted by the individual institutions. The Barkley had been submitting higher quotes that the rest of the banks and the BBA asked it to decrease them, in case it was no experimenting funding problems. Otherwise, the British government would force to accept financial assistance. Barkley replied that its situation was strong and that it believes that were the other banks the ones that were quoting lower than effective interbank borrowing cost rates (Kregel 2012. p. 2-4).
The main victim of this manipulation would have been the competitiveness in the financial markets; as this scheme would unfavorably influence the efficient distribution of capitals and cause distortion of prices, i.e. the mortgage prices would decreased and therefore the amount of houses sold would increase dramatically as well as related assets; such as: furniture, construction materials, etc. while depressing others. The (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 138). The free market principles were breached and the impact was staggering as the Libor is the main benchmark for short-term Interest rates, a negligible distortion on LIBOR would lead to huge capital transference from lenders to borrowers in an immoral way (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 1).
Maybe the very same process to estimate the LIBOR rate propitiated the manipulation scheme. The BBA select 16 banks that submit quotes based on their effective funding costs. This open the possibility that even 5 of the 16 banks could collude to influence the LIBOR rates. The type of banks selected could also be a factor to try to influence the LIBOR, i. e. If they are lenders, they would be benefited from higher IBOR rates; on the other hand, if borrowers they would welcome lower interbank rates. Another reason could have been to present to the public lower operating costs (since the quote submitted was the interbank borrowing cost and mirrored the position of the bank in the interbank market) or simply to show that their funding costs were lower or similar than the other banks (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 137). The scheme consisted in artificially inflate or deflate the quotes to profit and to instill a deceitful impression of solvency (Choy, Ping Shung, and Chng, 2012. p. 3).
Two facts contributed to facilitate the crisis. First, since the financial crisis began in 2007 the interbank market had decreased remarkably, and therefore, several banks were anxious for funds; however, they tried to hide this reality and hence submitted lower quotes than the real ones (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012 p. 138). Second that there was total dependence on specialist’s decision on the part of submitter when setting their LIBOR proposals (Garcia, 2012, p. 1). The BOE trusted totally in the quotes submitted for the respective specialists of the panel member contributor banks.
One surreptitious element, mostly overlooked, by the media is the ethical code of conduct of the authorities of the financial institutions involved in this scheme. Is the lack of social and moral concern a weakness of the Management and Finance schools and universities? Has the education system underestimated the importance of instilling a pervasive code of conduct morale on the higher education programs? A survey showed that 26% of interviewed consider that misconduct or being unscrupulous is a crucial for achievement (Farooq, 2012, p. 26). This finding is worrisome since even if new regulations are implemented and additional legal tools are approved to avoid this type of wrongdoings; what will be done with the ultimate decisive factor, which is the human professional behavior and conduct? Focusing on the former while underestimating the later would just pave the road for a future inconceivable outcome.
Probable Reasons for the LIBOR manipulation
Fully knowing the real reason of why the bank panel members manipulated their quotes will be really hard to obtain. However, this was thought that the group of banks which provided the BBA with rate quotes utilized to originate the LIBOR rate underrated their real inter-bank borrowing cost in order to disguise ostensible cash difficulties (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 136). The interbank quotes each contributor submitted mirror the health and creditworthiness they had about each other. Therefore, it was plausible that Banks tried to sell the impression they were stronger than they really were during the credit crisis by underrating the funding costs (Scheiner & Broda, 2012, p. 1).
Even international banks could have an additional incentive to influence the LIBOR i.e. an bank with operations in America would welcome a lower LIBOR vis a vis the cost of US Federal capital effective rates so that they could hedge international money transaction (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 137).
The Bank Barkley was the first to admit the rate manipulation. The traders of derivatives of Barclay made requests to its LIBOR counterparts so that the LIBOR setting would favor their trading positions (Garcia, 2012, p. 2). However, it is possible that others institutions eventually admit wrongdoings in the way they submitted their quotes as the investigation and litigation advance. Employees of Barkley attested that the underreporting of quotes was done to prevent the stigma related to be an outlier (higher quotes) among the rest of the panel members (Kregel 2012. p. 7).
Some banks; such as: Barclays Plc, RBS, HSBC, Citigroup, USB AG, Deucht bank, JP Morgan, Rabobank, Societe Generale, Sumimoto Misui Banking Corporation, Credit Suisse, Mizuho Financial Group, Tokyo-Mitsubishi UFJ have been approached by regulators investigating and some have terminated employees related to LIBOR quotes submissions (Scheiner & Broda, 2012, p. 3). The financial burden of legal processes coupled with possible compensation packages would damage even more the institutions involved in the scandal. The legal spending could be staggering as a result of the widespread impact of the LIBOR scandal (Scheiner & Broda, 2012, p. 4).
It seem that some of the authorities of the banks were not so interested in forging a stronger financial position compared to their competitor, but to plainly increased profits, i. e. if the panel members were net borrowers they would earn extra earnings. Banks were underrating their LIBOR quotes in order to profit rather than to improve their financial position (Choy, Ping Shung, and Chng, 2012. p. 1). However, one goal lead to the other, if the banks obtained financial profits, they could have utilized those funds to strengthen their positions in the market.
Main players involved in the LIBOR scheme
Tangina’s and Tshomo’s parts
Recommendations on what to do to avoid this problem
• Select the banks of the panel submitting the LIBOR quotes, so that there is balance between net lenders and net borrowers. By doing so, the possibility that the formers inflate the quotes or the latters deflated them artificially would be decreased.
• Not to rely entirely upon the knowledge of the bank specialists, but also analyze the market ratios and financial figures that reflect the currents interbank funding cost. This in order to detect any possible collusion of several banks or manipulation for even a single quote submitter. Though a group of banks could have manipulated the LIBOR rate; even one single bank could also do so (Choy, Ping Shung, and Chng, 2012. p. 3).
• The size of the inter-Bank activity is so colossal that, in order to strengthen the regulatory authorities, new mechanisms and punitive legislations should be implemented to assist in preventing bank officer to commit wrongdoings. According to Kregel Managers and controllers were not able to monitor the ongoing activity because of the hugeness of the operation; it was too enormous to be controlled (Kregel 2012. p. 1). Any attempt to blame regulators just paves the way to overlook the accountabilities of the managers of the banks to stop the underrating practice (Kregel 2012. p. 5).
• Any new mechanism must be aimed at preventing, not only, obtaining profits unscrupulously, but also, misrepresenting the real effective market quotes. Before the crisis the traders colluded to obtain earnings, but during the crisis there was an extensive misquoting proposed to influence market opinion of financial conditions rather than rigging rates that is the main emphasis of the three aforementioned reports (Kregel 2012. p. 4).
• There also should be implemented a system of incentives to those bank officers that report wrongdoings or corrupt practices. The fact that the panel members were being benefitted from the underrating of LIBOR rates, means there was no incentive to report such unethical practices (Kregel 2012. p. 5).
• The instilment of strong moral values and code of conduct must be not just a decorative mantra in a company it has to be practice in a daily basis. Even firms with attractive code of ethics committed deleterious acts against society; i. e. Lehman Brothers had a code of ethics that indicated to “help maintain a culture of honesty and accountability” (Farooq, 2012, p. 26). Furthermore, Enron code of ethics read “Employees of Enron, Corp., its subsidiaries and affiliated companies…are charged with conducting their business affairs in accordance with the highest ethical standards” (Farooq, 2012, p. 26).
• Increase the number of members of the submitting panel so that the probabilities to collude or manipulate the LIBOR setting be reduced significantly.
Abrantes-Merz, Kraten, D. Metz, and Seow. (2012). LIBOR Manipulation? Journal Banking & Finance, 36, 136-150. Retrieved from http://www.sciencedirect.com/science/article/pii/S0378426611002032
Choy, Ping Shung, and Chng. (2012). Interest Rate manipulation Detection using Time Series Clustering Approach. Cornell University Library. Retrieved from http://arxiv.org/abs/1208.2878
Farooq. (2012). Libor or Lie-bor: the challenge of ethics and education. Islamic business & Finance. 74. P. 22-28. Retrieved from http://ssrn.com/abstract=2135241
Garcia. (2012). Fixing the Benchmark- Wheatley considers LIBOR overhaul. Financial regulation International. P. 1-8. Retrieved from: http://ssrn.com/abstract=2143137
Kregel. (2012). The LIBOR Scandal: The Fix is in – The Bank of England Did It! Levy Economics Institute of Board College. 9. 1-8. Retrieve from http://www.levyinstitute.org/pubs/pn_12_09.pdf
Scheiner and Quinn. (2012). Move over subprime? Financial institutions and brokers face increasing concerns over allegation of improper LIBOR manipulation. Plus Professional liability underwriting society Journal. 25 (5). 1-5. Retrieved from http://scholar.google.com/scholar?q=move+over+subprime%3F+financial+institutions+and+brokers+face+increasing+concerns+over+allegation+of+improper+libor+manipulation&btnG=&hl=es&as_sdt=0