Question

The manipulation of the LIBOR can be broken down into three phases. What were these and how did they differ in terms of motivation and moral justification?

Answer 1

LIBOR stands for London Interbank Borrowing Rate. It is used as a benchmark to set payments on about $800 trillion worth of financial instruments around the globe. Three month Dollar LIBOR ,is supposed to indicate what a bank would pay to bowwow dollars for three months from other banks at 11am on the day it is set. The dollar rate is fixed each day by taking estimates from a panel comprising of 18 banks, of what they think would have to pat to borrow if they needed money. The top four and bottom four estimates are then discarded and LIBOR is the average of those left. The submissions of all the participants are published along with each day’s LIBOR fix.

The manipulation of LIBOR rate can be broadly classified into three phases –

1. Traders of the Bank involved in making bets on the 3 months forward interest rate swaps would first check their open positions.
2. In the second phase, Traders would ask the submitters to submit rates according to their vested interest considering the open positions of bets involving 3 months forward interest rate swaps. They would deliberately ask the submitters to quote higher or lower rates so that the Bank is not considered in the average and they are discarded.
3. Finally, the rates would be frozon according to their projection and the traders square off the position making good money by rigging the LIBOR.

So where is the Flaw?

• LIBOR is based on bank’s estimates rather than the actual prices at which banks have lent to or borrowed from one another
• Transparency issues
• Incentive to lie

Bets involving Eurodollar futures – which allow traders to take bets on how interest rates will move over certain time period - caused the submitters to alter the lending rates they reported. Typical contract size is of $1million and even one basis point change in the rate would favour Bank’s traders on their open position in three month forward interest rate swaps would help them milk good profits. And hence Traders would request the submitters to rig the rate.

The primary reason for such manipulation was " greed " since higher profits for the banks would lead to more bonuses and incentive for the bank management. The pressure to show higher profit on Quarter on Quarter basis and rising competition, weak market conditions and rising cost base forces banks to look out for opportunities to make profits. And since this LIBOR submission was based on estimate rather than actuals, the bank management may have justified it and it seems everyone has taken the phrase "Morale to his own " quite seriously.