LIBOR Scam has been termed as the “Wall Street scandal of all scandals.”
LIBOR (London Interbank Offered Rate) is the rate at which banks in London lend each other. It is calculated by British Bankers’ Association (BBA) daily. Individual banks submit the rates (for ten currencies and 15 lengths of loans, ranging from overnight to 12 months) at which they expect to borrow short-term loans from other banks. The highest and lowest 25 percent of submissions are excluded, and an average of the remaining rates is taken. In 2008, 16 banks had submitted their borrowing cost: the top and bottom four figures were excluded and the average rate of the median eight banks was taken.
During the financial crisis, when the economy was in severe recession, and banks had accumulated billions of dollars worth of toxic assets, they lost faith in each other. They either stopped lending to each other, or charged high interest rates on their loans. In order to give the investors the impression that their bank was in good shape, some banks reported artificially low borrowing rates to the BBA. If a bank pays low interest rate on its loans from other banks, it implies that the bank is considered to be credit-worthy. LIBOR rate is thus an indicator of the health of the entire financial sector.
At least 15 banks (including Barclays), individually and through co-ordination with the staff from other banks, rigged the LIBOR. They had the tacit support of both its regulators and the Bank of England. Barclays was fined $160 million in June 2012, which is a paltry sum compared to its revenue of $50 billion in 2011.
This may appear to be a scam involving old British banks, but it has huge global significance as well. LIBOR is used as a benchmark to set almost all interest rates in the world- home loans, education loans, mortgages, derivatives, etc. Almost $800 trillion worth of payments on loans is determined by LIBOR. Sure, low interest rates benefit investors also, but it largely benefits banks, which have to make lower interest payments on loans based on LIBOR. Also, if banks have knowledge of information that will affect a security, say a derivative, they can trade in it to either make profits or avoid losses at the cost of ignorant investors.
It has been rightly said,” Give a man a gun and he can rob a bank, give a man a bank and he can rob the world.”
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