Question

Case 2: LIBOR Manipulations Cause Widespread Impacts

On any given day, a bank may have either a surplus or a deficiency of cash. When this occurs, banks tend to lend to and borrow from other banks at a negotiated rate of interest. these interbank loans could be as short as one day and as long as several months.

The interest rate charged on these interbank loans is estimated by various banks and averaged every day by the British Banking Association (BBA) to create a benchmark interest rate called LIBOR. Eighteen of the world’s largest banks submit information about their borrowing costs. The BBA then determines the LIBOR rates based on those submissions. LIBOR, in turn, is used as a benchmark rate to price more than $800 trillion of securities and loans around the world, including swaps, derivatives, mortgages, and corporate and consumer loans. In September 2012, the United Kingdom’s Financial Securities Authority (FSA) announced that the BBA would no longer be administering LIBOR because of a scandal. This LIBOR scandal has had a significant impact on several banks.

Barclays Bank

In June 2012, Barclays Bank PLC admitted to wrongdoing and was fined £290 million ($453 million) for artificially manipulating the LIBOR rate from 2005 to 2009. The bank paid £59.5 million to the FSA, £102 million to the U.S. Department of Justice, and £128 million to the Commodity Futures Trading Commission. The next month, Marcus Agius, chairman o f the bank; Robert Diamond, CEO; and Jerry del Missier, COO, all resigned. Diamond agreed to forgo his £20 million bonus for 2012, but he was still entitled to his £2 million pension.

Barclays admitted that it reported artificially high (or low) borrowing costs when it wanted the LIBOR rate to be high (or low). For example, in 2007, it made submissions indicating high borrowing costs, while in 2008, during the credit crisis, the bank began to underreport its costs of borrowing. Part of the reason for these incorrect submissions was to create the false impression that the bank was financially healthier than it really was. In October 2008, the Royal Bank of Scotland and Llyods Banking Group were partially nationalized through bailout money provided by the U.K. government. There was a widespread concern at Barclays that it would be next. The bank wanted to indicate that it was financially viable to forestall a government takeover. During this period, there was media speculation concerning the true position of the bank, although a Barclays’ compliance officer assured the BBA that its submissions were “within a reasonable range.” There was also widespread concern that LIBOR was being manipulated.

Later, when the FSA report on the scandal was released, it stated that Barclays; derivative traders (who could make profitable trades based on a manipulated LIBOR) made 257 requests of other banks to misstate LIBOR submissions between January 2005 to June 2009. In addition, in November 2008, the BBA issued a draft report on the guidelines for LIBOR submissions that included a recommendation that submissions be audited as part of compliance. Barclays ignored the guidelines until June 2010, when the bank implemented new policies, one of which required the reporting of any attempt to influence LIBOR by either internal or external parties.

UBS

In December, the Swiss bank UBS paid £940 million ($1.5 billion) in penalties for its role in the LIBOR scandal. This was more than twice the fine paid by Barclays Bank. UBS also admitted to manipulating LIBOR, EURIBOR (the Eurozone rate), and TIBOR (the Tokyo rate) from 2005 to 2010. The bank said that all employees involved in the manipulations were no longer with UBS, including the 35 who left in 2012. In February 2013, the bank announced that it was reducing investment bankers’ bonuses by a third in order to recoup some of the fine.

At UBS, brokers were allowed to make the LIBOR submissions, creating a direct conflict of interests. Derivative traders could make a lot of money if they knew what LIBOR would be in advance of it being published. Traders boasted in the chat forums and through e-mail about how successful they were at manipulating the rate. “Think of me when yur on yur yacht in Monaco,” one broker wrote. Another said that he was “getting bloody good” at rate rigging. Another allegedly said that LIBOR “is too high (be)cause I have kept it artificially high.”

There were at least 2,000 manipulations designed to simply enrich the brokers themselves.This was collusion on a grand scale. According to the FSA, the manipulations involved at least 45 people, including UBS employees as well as external brokers. In one case, the bank paid £15,000 every three months to outside brokers to assist the manipulations.

UBS also admitted that management had asked staff to submit artificially low LIBOR borrowing costs during the final days of the subprime mortgage crisis in order to give a false impression that the bank was financially more secure than it actually was. Barclays had similarly used LIBOR submissions to artificially maintain market confidence.

Other Banks

In January 2013, the Deutsche Bank of Germany announced that it was recording a €1 billion provision to cover the cost of potential lawsuits concerning LIBOR manipulations. In February 2013, the Royal Bank of Scotland agreed to pay £390 million for its role in the LIBOR scandal.

Subsequent Event and Additional Information

As a result of this scandal, perpetrated by various banks designed to manipulate the LIBOR rate and the valuation of many security prices, the NYSE Euronext beginning in early 2014.

QUESTIONS

1. Which groups were most at fault for the LIBOR manipulations: brokers, traders, bank executives bank boards of directors, or regulators? Why?

2. What should the regulatory bodies do with the fines paid by these banks? Reduce tax rates for the general public? Use the funds to reeducate investment bankers?

3. Robert Diamond continues to receive his £2 million pension annually. Should he suffer financially by having to forfeit this pension because the LIBOR scandal occurred while he was CEO of Barclays?

4. Both Barclays and UBS reduce the bonuses of current employees to help pay part of the fines that occurred because of the actions of the former employees. Is this fair?

5. The rate manipulations seemed to be systemic to the industry because so many banks were involved. What can be done to curtail such wide-spread unethical practices within an industry?

6. Why weren’t the directors of the banks that had caused the scandal fines or jailed? Should they have been?

7. Why should members of the public trust the banks that were in volved in manipulating LIBOR rate.

Answer 1

1.) The bank executives bank board of directors were most at fault for the LIBOR manipulations because they engaged in falsely or artificially reporting low or high interest rates so as to profit from trades and show an impression that they are more worthier. LIBOR was used for such manipulation because it acted as an indicator of bank's health, they manipulated it to highlight they are much stronger so as to yield more profits.

2.) The fines could be used to reduce tax for public and provide incentives to the investors or shareholders in the public so as to compensate for the losses i.e. sudden downfall of the bank's value once the LIBOR scandal was exposed.

3.) It is absolutely not fair, for the wrong committed by a former employee why should the current employees suffer, in addition paying the pension of Robert Diamond worth £2 million is not fair too, he needs to pay-off the fines as he was the Chief executive officer during the LIBOR manipulations and has safely resigned amid the LIBOR scandal exposition. Thereby, the bureaucrats must take concerned action against the people of UBS and Barclays who were involved in the scam and charge fines from their financial sources.

4.)  As we are in the era of digital economy, the booming output of FinTech(Financial Technology) can be used to deal with such crimes and manage the banking ecosystem at ease. The RegTech(Regulation Technology) which forms to be a part of FinTech model can assist the authority in managing the activities of the banks, interest rates, market fluctuations by linking all the banks details in real-time on a centralized platform that will be highly secured( say by uing Blockchain Technology) and any determination of interest rate or market indicators will be mathematically computed using various mathematical and financial models, indicators and metrics.

5.) LIBOR is the most important factor that forms the base for determining the rate of interest for a wide range of loans across segments and LIBOR involves multiple currencies and different loan durations into determining it.

6.) All the employees and traders involved in the scandal either resigned or were fired and since the manipulation was directed and supported by the bank, fines were slapped on the banks but the employees should have also been fined as they breached work ethics and involved in committing a crime.

7.)  These banks showcased their financial credibility as strong and since it happed post the financial crisis, people trusted these banks because they seemed less riskier and people trusted and invested in it with a hope of huge returns.