LIBOR Scandal

Published on :

21 Aug, 2024

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The LIBOR Scandal was a grave yet historic event in which bankers from big financial organizations conspired to influence the London Interbank Offered Rate (LIBOR). This unethical behavior rocked public trust in the financial industry, prompting numerous sanctions, legal action or lawsuits, and regulatory measures.

The 2012 Libor scandal drove regulators to initiate measures that made interest rates more reliable and the financial system more transparent. Eventually, the decision to eliminate LIBOR and create new systems for interest rate calculation was made. Every measure was aimed at restoring trust in the financial system and preventing further interest rate manipulation.

What Is The LIBOR Scandal?

The LIBOR Scandal refers to major banks manipulating the London Interbank Offered Rate (LIBOR), which impacted worldwide financial markets, borrowers, investors, and institutions, resulting in regulatory fines and judicial actions.
This deceptive method allowed banks to profit from deals using fraudulently inflated or deflated LIBOR rates.
The scandal was exposed in 2012 when large banks were incriminated for manipulating LIBOR. It shook global financial markets, and many lost trust in the banking sector.
It resulted in heightened scrutiny of benchmark rates, regulatory reforms, and significant fines for affected institutions. The scandal exposed systemic vulnerabilities, prompting measures to protect market integrity.

LIBOR Scandal Explained

The LIBOR Scandal was a massive financial infraction with far-reaching consequences for the institutions involved and the wider financial industry. However, first, let us define LIBOR.

LIBOR is an interest rate that serves as a benchmark rate and guides the setting of borrowing expenses for various financial products and services, such as mortgages, credit cards, and student loans, among others. It is calculated by averaging the borrowing/interest rates indicated and published by a group of global banks. This rate is based on the amount these global banks pay for interbank borrowing.

In 2012, several big banks, including Barclays, UBS, and the Royal Bank of Scotland, were found to be involved in manipulating the LIBOR. The intention was to secure unfair monetary benefits by manipulating the LIBOR and prompting changes across markets based on the falsified LIBOR numbers.

An inquiry was initiated by financial authorities from the United States and the United Kingdom, who discovered that these banks gave inaccurate information regarding their borrowing rates. Evidence surfaced that the banks worked together to influence the LIBOR rate, damaging their reputations and calling into question the integrity of the benchmark-setting process.

When it became widely known that misleading information was shared on purpose, it affected morale greatly, leading to a general environment of uncertainty across financial systems. It also triggered extreme market instability. The crisis not only harmed the banks' reputation but also raised questions about the financial industry's overall ethical standards.

As trust in financial systems took a beating, the widespread impact resulted in questions being raised about the reliability of banking and financial services. Concerns over the reliability of financial benchmarks and institutional honesty were noted, which highlighted an overall decline in public confidence in the banking industry.

Examples

This scandal impacted nearly every player operating across global financial systems. Let us study some examples in this section and discuss the impact in detail.

Example #1

Suppose FirstAdvantage Bank, operating in the US, relied on LIBOR to set the interest rates for its products. One of the bank’s products, commercial loans, was in great demand across various states in the US in 2012. The bank extended this loan to its customers based on the interest rate derived from LIBOR.

When the scandal was exposed, many customers withdrew their deposits immediately from FirstAdvantage Bank. At the same time, borrowers bombarded the bank with incessant inquiries about whether their commercial loans were tied to the rigged LIBOR. To support withdrawals while dealing with delinquent accounts, FirstAdvantage Bank borrowed funds from other banks at high rates. As a result, the bank was left fighting to maintain reserves and liquidity.

This shows how banks that were not directly involved in the manipulation of LIBOR were forced to face severe consequences of this scandal.

Example #2

A 2012 NPR article throws light on the scandal from various angles. Major banks, notably Barclays, have tried to manipulate the LIBOR rate in the past, which later led to the LIBOR controversy. For their benefit, traders attempted to move LIBOR rates both up and down during the flourishing financial years of 2005–2007.

Afterward, banks such as Barclays were under pressure to manipulate LIBOR rates downward in order to project stability and conceal financial distress when the global financial crisis engulfed the markets from 2007 to 2009. The effects were twofold: institutional investors, including cities and pension funds, lost money, while loans with variable interest rates likely negatively impacted individuals.

Various organizations became the victims of the fraudulent activities carried out by large-scale banks during the LIBOR crisis. Customers were believed to have seen changes in their borrowing expenses for loan rates that were based on LIBOR. Before the financial crisis, some people were forced to pay higher rates, but others might have profited from artificially cut rates during the crisis.

Manipulations in the LIBOR rate resulted in financial losses for institutional investors, such as cities and pension funds. For example, the City of Baltimore filed lawsuits against the accused banks after disclosing significant losses. Eventually, the true cost of the scandal was the loss of confidence in the banking system, which led many people to doubt the accuracy of financial benchmarks and the morality of financial organizations, regardless of whether rates were manipulated upward or downward.

Penalties

Regulatory agencies in the US and Europe moved decisively after the LIBOR scandal shook the banking sector. They were the driving force behind multiple prosecutions of large institutions implicated in the manipulation. These institutions were consequently hit with hefty fines totaling an astounding $9 billion. Among the most notable instances is Barclays, which consented to a $435 million settlement in July 2012 and a subsequent $100 million settlement in 2016.

At the time, UBS had to pay the biggest penalties, totaling $1.5 billion, in December 2012. European Union (EU) regulators penalized RBS $612 million in early 2013, and in December 2013, Deutsche Bank, RBS, and Société Générale jointly paid fines of over $2 billion.

Rabobank, Citigroup, and JP Morgan Chase were also hit with penalties. Notably, in April 2015, Deutsche Bank achieved the largest-ever single settlement of $2.5 billion. Due to their participation in comparable collusion in international currency markets, these institutions came under increased scrutiny, which resulted in further LIBOR scandal fines totaling more than $5 billion.

Impact On Financial Markets

Following the LIBOR event, legislators and regulators improved the benchmark-setting process's integrity and restored investor confidence.

The implementation of the Financial Conduct Authority's (FCA) new benchmark-setting code of conduct in 2013 was a significant development. This code established guidelines for benchmark-setting procedures, requiring benchmark administrators to be impartial and open. In addition, more initiatives were taken to strengthen the benchmark-setting procedure's integrity. For example, the EU enacted the Benchmarks Regulation to improve transparency and integrity in benchmarks, while the International Organisation of Securities Commissions (IOSCO) created criteria for financial benchmarks.

Many experts claim that the LIBOR scandal has seriously damaged the public's confidence in the financial industry. In fact, in addition to regulatory fines, investment bank Keefe, Bruyette & Woods, a securities broker, predicted that the banks under investigation for manipulating LIBOR might wind up paying up to $35 billion in private lawsuit settlements.

Financial institutions may face new difficulties as a result of these possible financial obligations since they are being required to hold bigger reserves in order to reduce the possibility of another systemic collapse. According to Mark Gongloff of the Huffington Post, this may make it harder for banks to comply with the stricter regulations put in place following the financial crisis.

Frequently Asked Questions (FAQs)

Has LIBOR been discontinued after the LIBOR scandal?

The London Interbank Offered Rate (LIBOR) was no longer available for new business as of the end of 2021. The one-week and two-month US dollar LIBORs were no longer published, and after June 30, 2023, the remaining tenors were also to be stopped. The Secured Overnight Financing Rate, or SOFR, is the main LIBOR substitute in the United States. The rates that US financial institutions pay for overnight loans made possible by Treasury bond repurchase agreements, or repos agreements, serve as the basis for the SOFR. These transactions use Treasury securities as collateral, allowing banks to meet reserve and liquidity requirements. The weighted average of the rates seen in these repo transactions is used to compute SOFR.

Who was affected by the LIBOR scandal?

This scandal had far-reaching consequences for borrowers, investors, and governments worldwide. Manipulated LIBOR rates had unfavorable financial effects on individuals with adjustable-rate loans and institutional borrowers, hurting financial planning. Investors also suffered as the share prices of companies with LIBOR-linked debt were misvalued.

Which banks were involved in the LIBOR scandal?

The banks involved in the LIBOR scandal were Deutsche Bank (D.B.), Barclays (BCS), Citigroup (C), JPMorgan Chase (JPM), Royal Bank of Scotland (RBS), HSBC, UBS, Bank of America, Credit Suisse, Lloyds Banking Group, and Rabobank, among others.