The Libor Scandal Analytical Essay

Abstract

London Interbank Offered rate (‘Libor’) scandal occurred when banks were fraudulently increasing or lowering the interest rates so that they gain from trade or give an impression that their entities are performing better and are credit worthy (Miller-Jones, 2012).

‘Libor’ is calculated on a daily basis by the British Bankers’ Association. ‘Libor’ was introduced in 1986 to act as a measure of uniformity because there were several banks that were trading actively on a number of market instruments.

Since the occurrence of the fraud, there has been a change in the perception of the public about the rate. This paper will discuss the worldwide use of ‘Libor’ and its application and future outlook of ‘Libor’.

Worldwide Use of ‘Libor’ and Its Application

Never intended to be used like it is today when created in 1986

At that time when the Libor was formulated, it was not of much significance and wide coverage as it is now. In the current international financial system, ‘Libor’ has an imperative role because it gives an indication on the well-being of the banking segment and the overall financial structure.

The banks will report a low rate when they have self-assurance in the state of affairs in the financial structure. On the other hand, they will report a high rate when they have low confidence.

Also, ‘Libor’ is used by several institutions as a benchmark rate for the various financial instruments that they trade in. Examples of the instruments that rely on the ‘Libor’ are mortgages, derivatives, savings and student loans among other products.

The usage of ‘Libor’ has grown tremendously over the years. This makes it more significant in the current financial system than it was when it was created in 1986.

Besides, several countries across the globe such as Switzerland, Canada, the United States and the United Kingdom rely on ‘Libor’ as a benchmark and a reference rate (Morini, 2011).

The total amount that trades on ‘Libor’

As mentioned in the section above, ‘Libor’ is used to fix the borrowing charges for various products. Thus, when ‘Libor’ rate changes, the costs of borrowing for the various products also change. Trillion of dollars that have been loaned out depend on ‘Libor’.

Precisely, ‘Libor’ places rates on overwhelming $360 trillion of financial products worldwide. Thus, apart from the number of products that rely on the ‘Libor’ rate, the value of these products is also high.

This shows the importance of the ‘Libor’ rate in the financial system. It also indicates that any slight manipulation of the rates will have a significant impact on the financial system.

Several other ‘Libor’ types instruments

There are several other ‘Libor’ types of instruments. Examples of these types of instruments are ‘Libor’, ‘Euribor’,’ Hibor’, ‘Sibor’, and ‘Tibor’. ‘Sibor’ (Singapore Interbank Offered Rate) is the rate used between bank lending for unsecured funds in Singapore. The rate is widely used in Asia.

Besides, the Association of Banks in Singapore fixes the rate. The ‘Euribor’ (Euro Interbank Offered Rate) is also used for interbank lending for unsecured loans. The daily rate is used by the banks that operate in the Eurozone.

The rate is used as a benchmark and a reference rate for other products such as Swaps and forwards. Another type of instrument is the Hibor (Hong Kong Interbank Offered rate). Banks use it as a bid rate for a period that is less than one year.

Another type of instrument is the ‘Tibor’ (Tokyo Interbank Offered Rate). The rate is set by the Japanese Bankers Association. The rate is widely used in the Japan region. ‘Tibor’ takes two forms, these are Euroyen ‘Tibor’ and Japanese Yen ‘Tibor’.

Japanese Yen ‘Tibor’ is widely used in the interbank lending while the Euroyen ‘Tibor’ is widely used for offshore trading. Thus, it can be noted that various financial markets are coming up with the Interbank Offered Rate (Hall, 2013). ‘Libor’ and Euribor are the most widely used rates.

Future outlook of ‘Libor’

Is ‘Libor’ a rate of the future?

As discussed in the previous section, ‘Libor’ is vital in the international financial market. Besides, it has a wide coverage in terms of usage.

During the financial crisis that was experienced in 2008, banks lowered the rates that they submit to the British Bankers’ Association so that they could create the impression that the financial sector is performing well and is not affected by the crisis.

This scandal created doubt on whether ‘Libor’ can be relied upon for future use. However, various studies carried out showed that these flaws were inherent in the submission of the rates by banks even before the global financial crisis.

Thus, the value of ‘Libor’ can be fixed by the big players in the industry. Research conducted by groups such as the central banks and the Wall Street Journal confirm that ‘Libor’ is exposed to the risk of price fixing and manipulation.

Such manipulations resulted in multi-billion losses for the players in the international financial market. These findings cast doubt on the reliability of the Rate for future use (Halle & Beveridge, 2013).

Will ‘Libor’ still be important in the future and can it restore its credibility in the new management?

‘Libor’ will still be important in the future because it is widely used as a reference rate for a number of products in several countries. The Rate is also used internationally in various financial markets as indicated above. These reasons will make ‘Libor’ to be important in the future.

Replacing it might take a longer period. The ‘Libor’ scandal was a result of the loopholes that existed in the process of submission by the banks and other internal processes.

The credibility of the ‘Libor’ can be restored under the new management when it effectively seals all the loopholes that exist in the system.

Besides, the new management should also implement the numerous recommendations that were proposed by the independent groups that reviewed the system.

What does the new management do to save ‘Libor’ and what is their expectation for ‘Libor’ in the future?

First, the management needs to improve on the accountability of rates submitted by banks. This can be achieved by appointing a person who will be held accountable for manipulations.

Secondly, the management must ensure that the banks have adequate supporting records for the rates submitted.

Besides, the information on such reports should be published for public scrutiny. Further, management should come up with a disciplinary framework for banks that are involved in the manipulation of the rates.

Finally, the management should ensure that at all times the rates the banks submit are based on the market transactions for inter-banks deposits.

The management expects that ‘Libor’ will be more appealing to the players once changes are made in the system (Gatarek, Bachert & Maksymiuk, 2007).

How does the market treat ‘Libor’ now and how will it treat it in the future?

Currently, the market has lost credibility on ‘Libor’ especially due to flaws pointed out during the global recession. However, if changes are made in the process, then there is a possibility that the public will change their perception of the Rate.

References

Gatarek, D., Bachert, P., & Maksymiuk, R. (2007). The ‘Libor’ market model in practice. United States of America: John Wiley & Sons.

Hall, J. (2013). The importance of being civil: The struggle for political decency. United States: Princeton University Press.

Halle, D., & Beveridge, A. (2013). New York and Los Angeles: The uncertain future. United Kingdom: Oxford University Press.

Miller-Jones, E. (2012). The ‘Libor’ scandal: Who are the parties concerned? Germany: Fastbook Publishing.

Morini, M. (2011). Understanding and managing model risk: A practical guide for quants, traders and validators. United States of America: John Wiley & Sons.

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