Member Article

The background to the LIBOR scandal

I know you can’t escape press coverage on this issue at the moment but I think it is important to look in more detail at the circumstances that allowed this to happen in the first place.

To start with it is worth explaining what LIBOR is and is not. (The London Interbank Offered Rate). It is basically a subjective view of the interest rate at which the banks expect to lend to one another. It is compiled by Thomson Reuters daily from data given to them by up to 20 banks. It is worth stressing therefore that LIBOR is not a statistic figure like base rate, it is a benchmark.

Since 1984 when LIBOR first appeared it has become more and more important to the point now where it is used throughout the banking system to determine cost of funds for loans and swaps, and therefore also to calculate savings rates. It is now more relevant and more frequently used than base rate.

So why did these traders manipulate the system? Simple really, greed. They are incredibly intelligent and highly competitive people. They work in an environment that rewards success handsomely. I suspect that they worked out very quickly that they could circumvent the normal controls to suit their own ends. They are a small and very close knit group of people and I guess that once one had worked what to do it was passed on to other team members in much the same way as the phone hacking bad practice spread through parts of Fleet Street.

Another big question is why didn’t customers or counterparties notice what was happening? Again it is a very straightforward answer, information asymmetry. Basically most customers did not, and probably still do not, understand LIBOR, whereas the traders know it inside out. In these circumstances there is an imbalance of power, which in this case was exploited by these people.

http://en.wikipedia.org/wiki/Information_asymmetry

Who is responsible? Well in my view this goes to the very top of the organisation. If the controls were insufficient to prevent this happening the senior management have failed. If they knew or suspected that this was happening then again they are responsible.

Who knew what was going on? This will, I think, have been restricted to this very small group of traders and LIBOR analysts all of whom knew they were acting improperly. It would appear that the FSA have detailed information including e- mail traffic which has enabled them to pinpoint the individuals – many of whom may well be facing criminal charges.

The fall out from the issue will be felt for sometime to come. In the short term there will be even more introspection and internal investigations which will distract from customer management. It certainly will not lead to an improvement in the availability of credit for SME’s.

In the medium term the UK banks reputations will have been damaged worldwide. Interbank lending will become even tougher which in turn will lead to more liquidity problems. We may even see a further downgrade of the banks by the ratings agencies. This will make it more expensive for the banks to raise finance, which in turn will be mean more expensive debt for customers.

The long term future for the banks is at best uncertain given this huge loss of credibility.

In conclusion this issue is far bigger than the swap or PPI mis-selling as it goes right the very core of how our banking system works and unless we have decisive action very soon the damage could be permanent.

If you have a view on this subject I would like to hear from you.

Phil Dibbs

Managing Director

Hawkmoor Associates Limited

www.hawkmoorassociates.com

phil@hawkmoorassociates.com

www.twitter.com @hawkmoortweets

07866362333

This was posted in Bdaily's Members' News section by Phil Dibbs .