Bba Libor

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  • Topic: Bank, Finance, Money market
  • Pages : 6 (1981 words )
  • Download(s) : 29
  • Published : May 4, 2013
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Breakdown: Libor Scandal
LIBOR (London Inter-Bank Offered Rate) is a benchmark for short term interest rates estimated by averaging the lending rates charged by large banks in London to other banks in London. Financial markets use LIBOR as a benchmark rate for mortgages, student loans, derivatives contracts, and interest rates for credit cards. This benchmark also measures trust in the financial system and the faith that banks have in each other’s financial health. In June 2012 traders at Barclays were caught intentionally fixing the LIBOR rate to make huge profits on derivative trades or to make the banks look more secure than they were. This has since spiraled into a massive scandal in which 15 other banks are under some form of investigation for fraud connected with Libor fixing. Issue Background

Financial institutions use Libor as a benchmark for products more than any other index rate (bbalibor.com, 2012) and approximately $800 trillion of transactions are tied to Libor (“Libor”, 2012). The British Bankers Association (BBA) owns Libor and it includes bank lending rates for 10 currencies and at 15 different maturities (bbalibor.com, 2012). Every day these member banks answer the question “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?” (p. 4). As depicted in figure 1, the 18 member banks submit their rates to Thomas Reuters who calculates the average rate and reports it (bbalibor.com, 2012). Figure 1 Libor calculation. Courtesy of Google Images

Figure 1 Libor calculation. Courtesy of Google Images
The rates submitted by each bank are supposed to represent the lowest rates each bank could borrow funds at for each given currency and maturity. The rate is a trimmed average of the reported rates by throwing out the four highest and four lowest rates to provide a more accurate rate for the market. According to the BBA Libor website (2012): bbaLibor is not necessarily based on actual transactions, as not all banks will require funds in marketable size each day in each of the currencies/ maturities they quote and so it would not be feasible to create a suite of LIBOR rates if this was a requirement (p.6). Banks are not required to report what rate they are actually charged for borrowing funds from the market, but what they estimate they would be charged. The BBA defends this requirement by stating that a bank can use its’ credit and liquidity risk information to predict accurate rates for submission (bbalibor.com, 2012). This subtle difference in requirements opens the door for temptation to cheat the system which is exactly what happened with Barclays and other banks. Libor banks have an incentive to misstate the rate it reports or collude with other banks to rig rates where they want them instead of where they should be. Key Events

Barclays
In June 2012 traders at Barclays were caught intentionally fixing the Libor rate to make huge profits on trades or to make the banks look more secure than they were. This fraud was discovered in 2012 but evidence demonstrates that Barclays was intentionally cheating the system since at least 2005; Barclay’s traders requested their Libor submitters to fix Libor rates 257 times according to a timeline published on BBCnews.com (2012). Banks such as Barclays make money off derivatives and futures trading that depended on the level of interest rates. Essentially traders would enter into a contract and would request a low or high Libor submission depending on their position on the trade. These actions are detailed in the numerous emails exchanged between Barclays derivatives traders and the Libor submitters. One conversation between a trader and submitter reads, Trader: "We need a really low 3m fix, it could potentially cost a fortune. Would really appreciate any help.” Submitter: “Done… for you big boy”

Figure [ 2 ] Barclays logo, courtesy of Google Images
Figure [...
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