I agree with Ajit Balakrishnan that the Libor scandal has once again eroded people’s faith in the banking industry (“Best New Summer Fiction: Libor”, July 12). What’s more disturbing is that in this case the collusion among traders was widely tolerated by the banks involved, and so the traders happily put in requests to manipulate Libor rates.
Much like America’s tobacco scandal of 1998, the Libor scandal can cause the banking industry to lose billions of dollars in litigation costs. Equally important is the impact this would have on the European crisis.
Libor, or the London inter-bank offered rate, though obscure, has been one of the most crucial financial figures. It is a borrowing rate for 10 currencies and 15 maturities. The dollar rate is fixed each day by taking estimates from a panel, currently comprising 18 banks, which they would have to pay to borrow. For calculating Libor, estimates in the top and bottom quartiles are ignored and the average of the remaining is considered. Millions of payments ranging from complex derivatives to simple mortgages are made against Libor.
Though Barclays has played a prominent role in the scandal, the behaviour of other banks and regulators is also questionable. Here is why the Libor calculation mechanism is vulnerable to manipulation:
- The rate fixing depends on a bank’s analytical capability to give estimates. The actual prices at which banks have lent to or borrowed from one another are not considered.
- The current system incentivises bank executives/traders to manipulate figures, since their banks stand to make a profit or a loss on the basis of the Libor rate for the day.
- The recorded voices about Libor being rigged have been in the media since 2005, but lack of appropriate regulatory mechanisms on the part of the authorities concerned leaves many questions unanswered.
Though there are definite theoretical solutions to this problem, clearly, there is a lack of ethical willpower on the implementation front.
Ashutosh Kumar Mishra Indore
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