The still-developing Libor scandal is the latest and biggest blow to the credibility of big banks and their regulators, and should catalyse wide-ranging reforms to the financial system.
THE reputation and credibility of banks, regulators and the banking system in Western developed countries, already battered by the twists and turns of the financial crises, have reached new lows with the Libor scandal, which is still evolving and will yet reveal more wrong-doing. Blow ... Barclays >>
Besides Barclays Bank, which has paid US$456bil (RM1.45 trillion) in penalties to the British and US authorities, at least another 11 banks that were part of the rigging of Libor face up to US$22bil (almost RM70bil) in penalties and damages to investors and counterparties, according to an article in The Financial Times.
This is likely to be an underestimate because in addition, they may also face fines of billions of dollars or euros from anti-cartel actions. And more than the 12 banks that are publicly named are involved.
The Libor scandal could not have come at a worse time because the banking sector is already mired in many deep crises.
That the biggest banks in the world have been manipulating the revered Libor rates, which the public for so many years considered something that is set objectively and scientifically, is almost unimaginable.
The manipulations were reportedly of two types: to influence Libor rates so that the bank could make profits in its derivatives trades, and to dishonestly portray that its own borrowing costs were lower than what they were, so as to raise the bank’s image.
The scandal hits at the heart of the global banking business, because Libor (the London Interbank Offered Rate), is the benchmark relied upon for many thousands of contracts in the financial world.
This new hit to the banks’ credibility comes at a time when there are new signs of a serious downturn in the global economy.
In particular, the growth rates of many major developing countries have declined significantly in the last three months, signifying that the banking and debt crises in Europe are beginning to have a serious impact on the developing world.
The Libor scandal may contribute to the deteriorating world economic situation.
At the least, the banks involved in the scandal may have a worsened financial position, with less credit to provide to the real economy.
The estimated fines would cut 0.5% off their book value, and each bank may also have to pay an average of US$400mil (RM1.27bil) because of lawsuits, according to a study by Stanley Morgan, as reported in The Financial Times.
This may only be the tip of the iceberg. Regulators in many countries, other than Britain and the United States, are investigating, including Canada, Japan, and Switzerland, while many corporations and lawyers are considering lawsuits against the banks. The credibility of the European and US regulators have also been affected.
Either they did not know about the manipulations of the banks and were thus not doing their job, or they knew about it and allowed the deception to continue for years.
Manipulation in the Libor system was apparently known, at least in the trade, by 2005.
In April 2008, an article in Wall Street Journal raised questions about the way Libor was set.
Last week (on July 13), documents released by the New York Federal Reserve showed that US officials had evidence from April 2008 that Barclays was knowingly posting false reports about the rate at which it could borrow, according to several news reports, including in the Wall Street Journal.
A Barclays employee told a New York Fed analyst on April 11, 2008: “So we know that we’re not posting, um, an honest Libor.”
He said Barclays started under-reporting Libor because graphs showing the relatively high rates at which the bank had to borrow attracted “unwanted attention” and the “share price went down”.
The Fed analyst’s information and concerns were passed on to Tim Geithner, then head of the New York Fed.
In June 2008, Geithner sent a memo to the Governor of the Bank of England, with six proposals to ensure the integrity of Libor, including a call to “eliminate incentive to misreport” by banks.
The documents show that the US authorities knew about irregularities in the Libor interest-rate market and had discussed the need for reforms with the British authorities as far back as mid-2008.
The question being asked is why the regulators did not act until this year.
The Libor scandal may be, or should be, the final straw that forces the developed countries’ political leaders and financial authorities to undertake a thorough and systemic reform.
The financial system has been plagued by one crisis and scandal after another, and of crisis responses.
There needs to be reform of the regulatory framework and enforcement, the hugely excessive leveraging allowed by financial institutions, the laws that permit a combination of commercial banking and proprietary trading in the same institution, the speculative and manipulative activities and instruments of financial institutions, fraudulent practices and the incentive system, including unjustified high pay and bonuses and high rewards to bankers for speculation-based earnings.
A reform of the Libor system or establishing an alternative to it is of course also required.
In the Libor system, a panel of banks will set the borrowing rates for 10 currencies at 15 different maturity periods.
Two types of manipulation emerged in the Barclays case.
The first involved derivatives traders at Barclays and several banks trying to influence the final Libor rate to increase profits (or reduce losses) on their derivative exposures.
The second manipulation involved submissions by Barclays and other banks of estimates of their borrowing costs which were lower than what was actually the case.
Almost all the banks in the Libor panels were submitting rates that may have been 30-40 basis points too low on average, according to The Economist.
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THE reputation and credibility of banks, regulators and the banking system in Western developed countries, already battered by the twists and turns of the financial crises, have reached new lows with the Libor scandal, which is still evolving and will yet reveal more wrong-doing. Blow ... Barclays >>Besides Barclays Bank, which has paid US$456bil (RM1.45 trillion) in penalties to the British and US authorities, at least another 11 banks that were part of the rigging of Libor face up to US$22bil (almost RM70bil) in penalties and damages to investors and counterparties, according to an article in The Financial Times.
This is likely to be an underestimate because in addition, they may also face fines of billions of dollars or euros from anti-cartel actions. And more than the 12 banks that are publicly named are involved.
The Libor scandal could not have come at a worse time because the banking sector is already mired in many deep crises.
That the biggest banks in the world have been manipulating the revered Libor rates, which the public for so many years considered something that is set objectively and scientifically, is almost unimaginable.
The manipulations were reportedly of two types: to influence Libor rates so that the bank could make profits in its derivatives trades, and to dishonestly portray that its own borrowing costs were lower than what they were, so as to raise the bank’s image.
The scandal hits at the heart of the global banking business, because Libor (the London Interbank Offered Rate), is the benchmark relied upon for many thousands of contracts in the financial world.
This new hit to the banks’ credibility comes at a time when there are new signs of a serious downturn in the global economy.
In particular, the growth rates of many major developing countries have declined significantly in the last three months, signifying that the banking and debt crises in Europe are beginning to have a serious impact on the developing world.
The Libor scandal may contribute to the deteriorating world economic situation.
At the least, the banks involved in the scandal may have a worsened financial position, with less credit to provide to the real economy.
The estimated fines would cut 0.5% off their book value, and each bank may also have to pay an average of US$400mil (RM1.27bil) because of lawsuits, according to a study by Stanley Morgan, as reported in The Financial Times.
This may only be the tip of the iceberg. Regulators in many countries, other than Britain and the United States, are investigating, including Canada, Japan, and Switzerland, while many corporations and lawyers are considering lawsuits against the banks. The credibility of the European and US regulators have also been affected.
Either they did not know about the manipulations of the banks and were thus not doing their job, or they knew about it and allowed the deception to continue for years.
Manipulation in the Libor system was apparently known, at least in the trade, by 2005.
In April 2008, an article in Wall Street Journal raised questions about the way Libor was set.
Last week (on July 13), documents released by the New York Federal Reserve showed that US officials had evidence from April 2008 that Barclays was knowingly posting false reports about the rate at which it could borrow, according to several news reports, including in the Wall Street Journal.
A Barclays employee told a New York Fed analyst on April 11, 2008: “So we know that we’re not posting, um, an honest Libor.”
He said Barclays started under-reporting Libor because graphs showing the relatively high rates at which the bank had to borrow attracted “unwanted attention” and the “share price went down”.
The Fed analyst’s information and concerns were passed on to Tim Geithner, then head of the New York Fed.
In June 2008, Geithner sent a memo to the Governor of the Bank of England, with six proposals to ensure the integrity of Libor, including a call to “eliminate incentive to misreport” by banks.
The documents show that the US authorities knew about irregularities in the Libor interest-rate market and had discussed the need for reforms with the British authorities as far back as mid-2008.
The question being asked is why the regulators did not act until this year.
The Libor scandal may be, or should be, the final straw that forces the developed countries’ political leaders and financial authorities to undertake a thorough and systemic reform.
The financial system has been plagued by one crisis and scandal after another, and of crisis responses.
There needs to be reform of the regulatory framework and enforcement, the hugely excessive leveraging allowed by financial institutions, the laws that permit a combination of commercial banking and proprietary trading in the same institution, the speculative and manipulative activities and instruments of financial institutions, fraudulent practices and the incentive system, including unjustified high pay and bonuses and high rewards to bankers for speculation-based earnings.
A reform of the Libor system or establishing an alternative to it is of course also required.
In the Libor system, a panel of banks will set the borrowing rates for 10 currencies at 15 different maturity periods.
Two types of manipulation emerged in the Barclays case.
The first involved derivatives traders at Barclays and several banks trying to influence the final Libor rate to increase profits (or reduce losses) on their derivative exposures.
The second manipulation involved submissions by Barclays and other banks of estimates of their borrowing costs which were lower than what was actually the case.
Almost all the banks in the Libor panels were submitting rates that may have been 30-40 basis points too low on average, according to The Economist.
GLOBAL TRENDS By MARTIN KHOR newsdesk@thestar.com.my
Related posts:
Four British banks to pay for scandal!
British rivate banks have failed - need a public solution
After Barclays, the golden age of finance is dead
UK Banking Rules Risk Bank's Future Market Value
RBS, biggest British stated-owned bank losses of £3.5bn !
Cost of bank bailout keeps rising for UK
