Question

Please discuss how does manipulation of LIBOR interactively influence the OTC derivative market (You need to use example to support the discussions).

Answer 1

LIBOR manipulation event is also known as LIBOR scandal. The various international banks who had privilege to negotiate for interbank lending and borrowing have colluded to keep the LIBOR rates artificially low. The low LIBOR for a bank is a good indicator of bank’s good health but due to unethical collusion banks have kept rates lower which was not correct. It is believed that banks were involved in manipulation even before 2008.

The LIBOR rates are used by banks for different types of OTC derivatives which are based on LIBOR rates. By manipulating the LIBOR, itself banks were able to quote lower rates and as LIBOR itself is low therefore the stress level in market is perceived to be lower. The spread quoted over LIBOR was also correspondingly lower in line with low LIBOR.

Example: The quotation for OTC transaction of Repo would require a quotation in LIBOR plus spread terms hence, Bank A quotes to Bank B that LIBOR + 50% for an overnight transaction. If we have low LIBOR then the overall rate would also be lower.

Manipulating market has underestimated the real stress in the market and the bubble bust of 2008-09 has exposed all banks which were involved in scandal.

Banks involved in manipulation: Deutsche Bank, Barclays, UBS, Rabobank, HSBC, Bank of America, Citigroup, JPMorgan Chase, the Bank of Tokyo Mitsubishi, Credit Suisse, Lloyds, WestLB, and the Royal Bank of Scotland