What Is the Scandal Over LIBOR?

In the well-known LIBOR scandal, bankers at multiple large financial institutions banded together to manipulate the London Interbank Offered Rate (LIBOR). The incident caused a tsunami of fines, legal measures, and regulatory actions, as well as sowing mistrust in the financial sector. Even though the controversy just surfaced in 2012, there is evidence that suggests the alleged cooperation was going on as early as 2003.

A number of prominent financial organizations were linked to the scandal, such as the Royal Bank of Scotland (RBS), JPMorgan Chase (JPM), Citigroup (C), Deutsche Bank (DB), and Barclays (BCS).

LIBOR is currently being phased out due to concerns raised by the rate-fixing scandal over its credibility as a benchmark rate. On June 30, 2023, LIBOR will be phased out and replaced with the Secured Overnight Financing Rate (SOFR), according to the Federal Reserve and U.K. regulators. The one-week and two-month USD LIBOR rates will be discontinued as part of this phase-out on December 31, 2021.

An explanation of the LIBOR scandal

In order to determine the cost of loans and other derivative products, the LIBOR is the global benchmark interest rate. The reference interest rates that the member banks submit are used to form it. Many of these banks’ traders purposefully reported deceptively low or high interest rates during the LIBOR scandal in an attempt to boost the derivatives and trading activities of their own institutions, forcing the LIBOR to rise or fall.

The significance of the LIBOR scandal stems from its pivotal role in the global financial system. The LIBOR is used to calculate interest rates on loans for large organizations as well as for individual consumers, such as those for home mortgages or school loans. Pricing for derivatives also makes use of it. The traders in question were thereby indirectly contributing to a cascade of mispriced financial assets throughout the whole global financial system by manipulating the LIBOR. This, understandably, caused a significant outcry from the public as people questioned whether they had suffered financial hardship.

The scandal’s seeming brashness among several of the actors involved further fueled public resentment. Email and phone data obtained during investigations made this clear. There was evidence of traders directly requesting that rates be fixed at a certain level in order to make a specific position lucrative. Banks implicated in the fraud faced fines of approximately $9 billion from regulators in the US and the UK, in addition to several criminal prosecutions. Corporations and governments have also brought legal action, claiming that rate-fixing has a detrimental effect on them because many of the financial instruments they employ are priced based on LIBOR.

An illustration of the LIBOR Scam

There are numerous ways that the LIBOR scandal could have had an influence, even though it is difficult to determine whether any one individual was impacted. For instance, it’s possible that individual homeowners started fixed-rate mortgages during a period when the LIBOR was artificially manipulated upward to raise mortgage rates. Every dollar of additional costs brought on by the inflated rates could be viewed by the homeowner as a form of “theft” perpetrated by the LIBOR rate fixers. In a similar vein, the LIBOR scandal would have caused needlessly large losses for a number of traders who were parties to derivative contracts.

In the end, the LIBOR incident brought about a lot of changes. The British Financial Conduct Authority (FCA) transferred oversight of LIBOR from the British Bankers Association (BBA) to the Intercontinental Exchange’s Benchmark Administration (IBA) after the LIBOR collusion was made public. An independent subsidiary of the private exchange operator with its headquarters in the United States, Intercontinental Exchange (ICE), is the IBA. ICE LIBOR is the new standard name for LIBOR.

As of late, the FCA has declared that it will only continue to support LIBOR until 2021, at which time it intends to switch to a different framework. The New York Federal Reserve introduced the Secured Overnight Financing Rate (SOFR), which is based on short-term loans seen in the repo market, in April 2018 as a potential LIBOR substitute. The vast trading volume of Treasury repos—roughly 1,500 times that of interbank loans as of 2018—makes it, potentially, a more accurate measure of borrowing costs than the LIBOR. Furthermore, unlike projected borrowing rates, which are occasionally the case with LIBOR, the SOFR is based on information from observable transactions.

Conclusion

• During the LIBOR scandal, several banks changed one of the world’s most important standard interest rates. This was a big case of financial collusion.
• All over the world, the plan skewed the prices of financial contracts in things like mortgages, business donations, and derivative trades.
• People lost faith in the financial markets because of the scandal, which led to new rules, cases, and fines.