Allegations that the major banks colluded in suppressing their funding costs to appear healthier than they actually were during the financial crisis of four years ago, and the manipulation of rates through an opaque setting process, have come to a head with the resignation of Barclays CEO Bob Diamond. Diamond admitted to manipulating the rates at his firm, which incurred a $450 million (290 million pound) fine. COO Jerry Del Missier and Chairman Marcus Agius stepped down as well, which was also followed by 20 banks undergoing investigation, including Citigroup, UBS, RBS, BOA, JP Morgan, HSBC, Deutsche Bank and Credit Suisse.
Greg Smith resigning from Goldman Sachs in disgust at a culture gone awry, JP Morgan admitting to a botched hedging strategy in its Chief Investment Office, MF Global collapsing beneath the weight of bad trading and a failure to protect its clients, Fabrice Tourre, Jérome Kerviel and Kweku Adobole caught out in bad trades and now this. Has scandal become sufficiently commonplace in the banking community that, like a road show, we can pick it up anywhere? Has the culture of serving clients been turned on its head? There would most definitely appear to be something wrong somewhere.
The London Interbank Offered Rate (LIBOR) and its Brussels and Japanese equivalents (the European Interbank Offered Rate (EURIBOR) and the Tokyo Interbank Offered Rate (TIBOR), respectively) are set through a process whereby each day about 40 banks submit their interest rates at which they are willing to lend, to the respective trade organizations in their regions. Once the high and low bids are discarded, the rates of the two middle quartiles are arithmetically averaged. This process is repeated about 150 times to determine the final rates each day and extends to 10 currencies and across 15 time zones. The interbank offered rates serve as a reference for the pricing of financial products worth $350 trillion that include floating rate mortgages, savings accounts, interest rate swaps, other OTC derivatives, student loans, corporate loans and credit cards. (For related reading, check out Government Regulations: Do They Help Businesses?)
Barclays and allegedly other banks during the 2007-2009 period and earlier, took into account traders’ requests for them to submit, and submitted artificially low LIBOR rates so as to project an appearance of strength to one another in parlous circumstances and roiled markets. One could make a potential case for such posturing being in the public interest. The other motivation to do so was to boost traders’ profits. The rate-setting process appears, at best, translucent and arbitrary, and at worst, potentially fraudulent.
Pour Yourselves a Hard One, Guys
The consequences of perceived malpractice will be palpable across several fronts. To the public, these goings-on smack of continued arrogance of the banks whose conduct appears to be at great odds with ethical business practices. Individual and institutional consumers alike who use any of the numerous financial products based off LIBOR may have been paying artificially low rates, depending upon how widespread the practice will turn out to have been. Redress, if any, will have to be determined.
Investors in the banks potentially caught up in this snare in general and in Barclays PLC in particular may find themselves on the losing end of an investment whose leadership is called into question and whose conduct is reproachable. Moody’s Weekly Credit Outlook has shifted to a negative outlook in light of these events, expressing concern about a potential shift away from investment banking and difficulty in finding a suitable replacement for Bob Diamond, who would be facile in investment banking and credible in his or her ability to rectify internal lapses.
The Bottom Line
To the regulators, the scandal is but more fodder for greater oversight. Indeed, the Commodity Futures Trading Commission (CFTC) is working with Barclays to develop a more transparent and robust rate-setting process. Compliance officers would need to exercise better supervision. When traders brazenly thank each other with the promise of a fine tipple over monitored email, they are nonchalant or blithely unaware. Apparently, they missed the meeting and need retraining, if they haven’t been taken to the woodshed already. It appears that mission control has given way to missing control.
Such conduct points to an issue that looms larger still and is not willed away or eradicated so easily by public outrage or regulatory pressure: firm culture. Change must come from within and be pervasive. As the past several weeks’ events have shown, firms can police themselves or be policed. Given the long reach of LIBOR, should violations be proven on a grand scale, this incident could shape up as the largest financial fraud in history and a field day for litigators – unless, of course, other nefarious goings-on surface that could be worse.