LIBOR scam: Time to opt transacted rate? Experts discuss
Jul 14 2012, 16:56 | By CNBC-TV18
LIBOR, or the daily London interbank offered rate, is a key benchmark rate that reflects how much it costs banks to borrow from each other. It is the reference rate for about USD 350 trillion of financial products, ranging from interest rate swaps and corporate loans to credit cards, mortgages and savings accounts.
The LIBOR, like many reference rates is not a transacted or traded rate. It is arrived at by the British Bankers' Association (BBA) by polling 20 big banks from three continents. The traders are asked before 11am each morning, "How much will it cost their bank if it had to borrow from another bank for an overnight loan, a 3 month, a 6 month and a one year loan".
The LIBOR scam occurred between 2007 and 2009 when traders who submitted their rate to the BBA allegedly lowered the rate to suit their banks trading positions. Barclays Bank has acknowledged taking into account requests from traders at the bank and elsewhere when deciding what rate to submit in the daily process.
The settlement papers include detailed email requests for particular rates as well as effusive thank you emails after rates were set. Nearly 20 banks, on three continents, have received subpoenas and information requests from regulators. At least a dozen banks and interdealer brokers have fired or suspended employees in connection with the probes.
Below is the edited transcript the interview with CNBC-TV18.
Q: How will the problem emerge first will it be with regulatory penalties or will it be with lawsuits galore, how will the problem start emerging?
Goodhart: It is starting with investigations by the regulatory authorities and they will find some banks probably guilty. Some banks may accept, some banks may try and fight this through lower courts, some banks may be found not guilty.
When banks have been found or accepted guilt of having talked to influence, these wholesale market rates then there are likely to be legal actions particularly in US asking for recompense and penalties in response to whatever losses those outsiders who dealt in these wholesale markets claimed to have suffered.
Q: What is your sense, will this become a messy problem as lawsuits' galore come in?
Gopinath: Yes, I do think it is going to be a messy problem. One is the investigations and how many banks get caught in these investigations even I don't know whether brokers would get involved. The second is about the lawsuit that is going to be messy.
It is not going to be so straightforward, you bring a class action suit and you get huge damages awarded to you. That would involve a lot more investigation into how each bank quoted the rate and what would have been the rate if this lowering of the rate had not happened and how the other banks did.
So that is going to be difficult. There have been some estimates of what would be the penalties that could be imposed on individual banks because of this scandal and some assessment has been made as to how much impact it would have on their tier-I capital, but that is going to be awfully messy. But the far more important issue here is what is the alternative?
Q: Who will rock the boat, the entire set of corporates across the world are dependent on the LIBOR, so are the entire banking system, will this come in the form of a public interest litigation, who will bell the cat?
Gopinath: Yes, this is not very clear now. The LIBOR is set every three months, I think the three months was dense there and so at different points of time one gets affected differently. T
hat is why I feel that it is going to be more in terms of how each company has lost or gained rather than coming up with a massive class action. But I don't know about the US mortgages because the adjustable rate mortgages were also linked to LIBOR and increasingly they were getting linked to LIBOR. There that could be an issue.
Q: Will this get big enough to destabilize the markets itself?
Goodhart: I don't know, we never know. If there are law cases of this kind, which have been introduced by private agents particularly in America, these law cases tend to take years. So, we won't actually know what the final outcome will be in many years.
In some law cases will be settled out of court, and other cases, they would drag on for years and years. Nobody will actually be entirely sure of what the conditional hypothetical cost to the banks might be.
Q: What is the alternative? It is very clear that you should move towards a transacted rate, do you see that happening anytime soon instead of polling to find out one first hour of traded rates?
Gopinath: In condition such as today's when we still don't have a very normal functioning interbank markets particularly worldwide, it is difficult to do even transacted rates. Imagine that on maybe a few billion volume of transactions you set that as a reference rate for trillions of derivatives and loans, it may not be an appropriate fix.
But in a floating rate regime, you need a reference rate. Until we get the transacted rates normal markets functioning, this is going to be an issue, but atleast if banks are transparent and if banks give the right details, the correct information - what has irked everybody here in this scandal is the fact that the rates were manipulated.
I am sure people understand that sometimes markets are dysfunctional and we may not be able to get the correct rate and maybe it is imputed or imputed through by having your own yield curve or an interest rate curve. But, the fact that this has been manipulated is the one that is not only messy, that is what hurts everyone.
Q: Do you think the next step will be a respective regulators getting to get there and asking banks to put in a due process whereby they arrive at the rate, would that be perhaps an intermediate step?
Gopinath: That could be. For instance even in our own case when we did the PLR and we did find that banks were just reckoning computing the PLR in different ways, we did tell them to be very transparent about how they calculate the PLR and how they base their floating rates, which are the benchmarks.
We said it should be a market benchmark at that time. Something like that will have to be done and probably all the regulators would be reviewing all the reference rates in their own jurisdiction to see how transparent they are and how they are computed.
Q: In the meanwhile, has the market evolved any method to help reach somewhere near a LIBOR?
Gopinath: There have been attempts by certain market participants to try to use certain traded rates for instance the repo rates. True, even the British Banker's Association did put out the repo rates, which were again polled not traded, but currently some of the big banks are looking at repo transactions that are put out by the depository trust and clearing corporation, that would be more realistic.
They are trying to build an index. So maybe that would be closer to the traded prices than the LIBOR. I am sure over a period we would find some alternative to the LIBOR and get into traded prices rather than just the polled rates.