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FINANCE IN INTERNATIONAL MARKETS
PROF. LUC KEULENEER
WHAT WENT WRONG WITH LIBOR RATES?
“Honesty is a very expensive gift. Do not expect it from cheap people” Warren Buffet
Table of Contents
Origen of the crisis
Probable Reasons for the LIBOR manipulation
Main players involved in the LIBOR scheme
Recommendations on what to do to avoid this problem
What when wrong with LIBOR rates?
Commerce and trading are essential for the world economy and both are intrinsically dependent on money transfers and currency swap; not only, from one country to another, but also from one financial institution to another. The glue that allows this efficient funneling of funds is the rate that both the borrower and lenders agree to pay. However, the rate per se is not useful if it does not trustworthy. That is why it is so important to count on with an interest rate whose fixing and utilization be clean of any spot of misrepresentation and manipulation from its authors. There are a handful of such as rates in the current international financing market: Tibor, Libor, Sibor and Euribor. Nevertheless, by far the main interest rate utilized is LIBOR (London Inter-Banking Offered Rate). The total financial impact varies from nearly $554 trillion in OTC Interest rate Derivatives and €316 trillion in Short term Interest (Garcia, 2012, p. 1) to $360 trillion in financial products in different currencies (Scheiner & Broda, 2012, p. 1).
Unfortunately, since 2007 to 2009 there were reports and investigations containing evidence that the LIBOR rate had been artificially manipulated. The scheme was to benefit a selected group of banks which were in charge of providing the Thomson Reuter (the LIBOR fixing rate agency) with quotes used as a raw material to estimate the final published LIBOR rate.
In 1984 the BBA (British Bank Association) began the standardization of Interest Swap…it became the reference rate of numerous securities such as: syndicated loans, futures, contracts, and forward agreement rates. In the process the BBA choose 16 banks that provide daily rate appraisals to estimate the LIBOR. Those banks are designated based on their reputation, size of market activity, and perceive expertize in a specific currency. Thomson Reuter is the agency that estimates the LIBOR after excluding 25% of both highest and lowest quote submitted (Scheiner & Broda, 2012, p. 1). The BBA would eliminate the higher and the lowest quote and any outliers and would only average the center quartile (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 137).
Origen of the crisis
On May 29, 2008 one article published in the Wall Street Journal opened the Pandora Box when purported that there has been an artificial reduction of the LIBOR (London Inter-Bank Offered Rates) rates submitted by the banks members of the panel of contributing banks (Abrantes-Merz, Kraten, D. Metz, and Seow, 2012. p. 136). Then three probing reports form The Financial Services Authority, the Commodity Future trading Commission, and the Department of Justice (USA) containing evidence that several banks colluded to influence and pervert their quotes to estimate the LIBOR BBA. (Kregel 2012. p. 1).
One of the elements that could have caused the underrating of the submitted quotes is that after the crisis shock in 2007 the inter-bank market was almost frozen. Therefore, there were not real interbank rates to be submitted by the individual institutions. The Barkley had been submitting higher quotes that the rest of the banks and the BBA asked it to decrease them, in case it...
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