LIEBOR: Banks Manipulate the Global Benchmark Rate

The big news of the last few days has been LIEBOR - or how banks like Barclays, Citi, HSBC, JP Morgan and so on - manipulated the London Interbank Overnight Rate, or LIBOR. LIBOR is a world standard for interest rates, but it’s not a single rate - there is a three-month LIBOR, a six-month LIBOR, a one-year LIBOR etc. And then, there is LIBOR denominated in dollars, yen, euro, Swiss franc etc.

It’s a very large market, since LIBOR influences interest rate swaps, currency derivatives and a large number of loans pegged to it. (For instance, some of Tata Steel’s and Bharti Airtel’s loans for their foreign acquisitions are linked to LIBOR). Some estimate the market to be as much as $800 trillion. (about 10 times world GDP)

But the system to actually nail down the number on a daily basis is relatively crude. Banks submit estimates of what it would cost to borrow from other banks, in various currencies, over various time periods. This is then collated into daily LIBOR rates which influence lending all over the globe.

Barclays has been fined $453 million, after admitting that its traders influenced this rate by providing submissions they knew to be incorrect. They have admitted to attempting to set rates artificially so that their traders could profit from market positions that involved the same rates. If a trader benefited from LIBOR being low, he would influence his bank to attempt to set the benchmark lower than reality.

Zero Hedge suggest that the banks might have even manipulated LIBOR during the 2008 crisis to get quick bailouts - a very high number indicates a credit crisis, which means instant bailout rather than the slow “fire-executives-cut-up-bank-sell-pieces” approach.

LIEBOR is plainly fraud, and Washington’s blog provides a linkfest (of gargantuan proportions) saying that Banks have become mafia-style criminal enterprises. Given that anyone spelt bank is too big to fail nowadays, governments have been intentionally lax on them, hitting them with fines that could be made up with a single fraud trade on a good day. What should have happened is that each fraud should have involved increasing fines, to dramatic proportions - such as fine them full profits for the last five years. Let them go bankrupt if they have to. But there is simply no stomach for that, it seems.

Sadly, this lesson is lacking in India as well. Not just banks, we’ll protect anything that’s going down. Like an Air India. Or like any bank (through mergers). Or insurance companies. Or SEBI fraudsters (who get away with a few years of a ban, and no jail time). Or Satyam’s Raju. Or anyone for that matter. We just don’t jail people for white-collar crime, no matter how bad the situation was. This is a very bad precedent.

Coming back to the topic: is such a situation prevalent in India as well? Look at forex rates. The USD-INR contract is settled at a price that is the “RBI Benchmark rate”. This rate is calculated by randomly calling up banks and getting a rate from them. Now if your traders wanted a lower print (let’s say they were short the dollar) then they could request the dealers to tell RBI a lower quote, even if they didn’t intend to trade it that low. Remember the RBI call won’t actually buy or sell - it will just ask for a quote.If the big banks were able to do this, they could effectively manipulate the price.

That situation could change now that RBI has asked all banks to submit details of every single deal (even non-exchange-traded, or OTC) within 30 minutes. They could then use actual trade data to generate the benchmark instead of the calling process they now use.

In the west, the skeletons are only coming out of the closet now, with Barclays’ chairman resigning and having top execs return their bonuses. Unless the regulators are forced to put their tail between their legs when the government shines a “too-big-to-fail” beacon, expect more banks to follow.