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The LIBOR Manipulation, Who’s To Blame: Bankers Or The Process?

ImageThe LIBOR (London Interbank Offer Rate) is currently the centre of attention after the City Regulator ordered its biggest ever fine – £290 million penalty – to Barclays for manipulating the LIBOR rate.

Indeed, the recent revelations of the alleged manipulation of the LIBOR by most of the major banks have made this interest rate the top topic in the news around the world. However for me, the ultimate question is (as it has always been since April 2008 when the LIBOR stopped being in line with the UK base rate) to know whether the issue was actually the operator (i.e. the bankers) or the way the LIBOR is calculated/consolidated (i.e. the process).

Since 2007 at the beginning of the global financial crisis , I have been following the LIBOR rate. In April 2008, I started questioning the way the LIBOR was calculated as it started falling dramatically (at 2.48% from 4.22% in January 2008 and 5.27% in September 2007) and was no longer in line with the UK base rate (which was at 5% in April 2008). Although it must be said that the LIBOR does not necessarily always have to be in line with the base rate, I am however increasingly vindicated in my concerns with regards to the way Thomson Reuters (on behalf of the BBA) gather and consolidate data in order to reveal the daily LIBOR rate. Source of data:  

In practice, Thomson Reuters calculates and distributes LIBOR on behalf of the BBA. The BBA names the panel banks that submit the rates to Thomson Reuters and also sets the methodology Thomson Reuters follows for the calculation. Every morning Thomson Reuters receives the contributions electronically from the panel banks. It performs a series of high-level validity checks following the criteria set and agreed with the BBA. The rates contributed by the panel banks are meant to answer the question: “At what rate could you borrow funds …?”

Not too bad as a method of calculation but could it be more accurate & transparent?

Indeed, instead of relying on a panel of surveyed banks that provide data on their prospects of borrowing along with their forecast of liquidity which later are consolidated by an agency, would it not be more sensible to have a system where the actual rates of borrowing between banks are automatically recorded as transactions take place? Banks / financial institutions lending to each other at different rates …, the consolidation would ultimately and automatically takes place when financial markets close, thereby producing a rate that would be the market’s opening price?

I can already hear some critics arguing that the LIBOR rate is different from other rates or index values as this is solidly linked to the level of liquidity in circulation. But wait a minute, the same principle applies: if the rate falls below its real value, this will mean that there was plenty of liquidity in such a way that it became cheap … the rate will progressively appreciate as liquidity will become rare and the cycle will start again.

I can hear some others arguing that not all banks will be on the automated electronic system, thus some transactions will be missed out and therefore jeopardise the accuracy of the LIBOR. Hang on; does the current method include all banks? Is it not just a panel of banks set by the BBA?

Other critics suggest that the separation of the retail and investment banking is the ultimate solution. I have to admit that, although this would be a giant step towards resolving the current banking crisis, it would not however help to strengthen the current system in terms of the calculation of the LIBOR. Indeed, most of the so called retail banking products such as mortgages rely on the LIBOR rate; thus being able to manipulate the LIBOR will definitely impact both investment banking as well as retail banking.

With the current system, banks have been manipulating the Libor so as to get funds at a cheaper rate and to lift up gains on trading positions they hold. At this defining moment where we are still in the economic & financial tornado started in 2007 and generated by banks / financial institutions and where there have been some financial scandals (the alleged mis-selling of PPI & Interest Rate Swaps), we cannot really expect Imagebank professionals to suddenly change and no longer be greedy, no longer try to manipulate figures etc, can we? That would be very naïve. At the end of the day bankers are made to make money!  On top of all this, the recent IT issue that prevented millions of banks users (not only RBS/NatWest users – some other bank users could not receive payments as they were paid from a RBS/NatWest bank account) from accessing money has not helped to restore trust.

It is therefore pretty clear that bankers are not likely to deviate from their “raison d’être” that is “making money”. The only way to get this fixed is by making the process as robust as possible.

This paper is a first step of an article that I am preparing on the LIBOR System. This is a first thought aiming to raise questions. For example, is this the time to think about another process of calculating the LIBOR or should we stick to the current system expecting that the FSA (the first to blame in my opinion), the BBA and to some extent the Bank of England and the SFO would finally start doing their job properly?


July 8, 2012 Posted by | Articles In English, Economics, International Business, International Finance | , , , , , , , , , , , , , , | 2 Comments