The latest news of the LIBOR rate being manipulated by a company is sure unsettling. We have always had standards, the norms which define the banking philosophies and interestingly most of these norms are defined by the rich west and the reason being quite imaginable as the rich ones being in the finance division for a longer time than the other countries.
Looking at the recent news items, the manipulation of the LIBOR rate seems quite evident. The LIBOR- London InterBank Offered Rate is
– The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11:00 London time.
Another parameter in the same lines is EURIBOR
– Euro interbank offered rate. It is the average interest rates at which the EUROZONE banks offer funds or lend to the other banks. It is the reference rate for the countries which rely on the Euro whereas the LIBOR is the one for the countries that operate on the dollar.
They define Average interest rates charged by the London banks (or European ones) while offering loans to the other banks. It is the benchmark for all the interest rates all across the world. In other words, a mistake in this parameter would extend to the other countries which depend on this. This is exactly where the concern lies if something goes wrong with this.
LIBOR is widely used as a reference rate for many financial instruments, such as:
- forward rate agreements
- short-term-interest-rate futures contracts
- interest rate swaps
- inflation swaps
- floating rate notes
- syndicated loans
- variable rate mortgages
- currencies, especially the US dollar (see also Eurodollar).
They, thus, provide the basis for some of the world’s most liquid and active interest-rate markets.
The situation now is that Barclays was found guilty of rigging the LIBOR rates. Problems that can be created are the under reporting or the over reporting by the benchmarks. Using it and modifying it so that the bank rates could be changed to serve the individual needs of some companies over the others.
Relevance of LIBOR and EURIBOR in the global money market. How does it affect us?
Now, considering the relevance of the LIBOR and the EURIBOR rates in the current situation. It certainly affects the flow of money between the banks which means it certainly affects the lending rates and the base rates at the banks. In other words, the amounts in which companies or corporate borrow or lend also is largely affected by this. In total, it affects the money flow throughout and a discrepancy in the rates also implies a discrepancy in the money lending. This probably explains why someone would want to rig the rates? Of course to make a benefit of the situation and to score a loan at a lesser rate and get the money rolling in the market. Probably lowering the rates may help the liquidity crunch. That may help one problem but I am pretty sure it would be a host to many other new ones.
How would one alter the global borrowing rates? What is the technical possibility of such things happening?
There are two main components of the rates- trader and submitter. Job of a submitter is to send the accurate information about the day’s trading to the banking authorities. An under reporting or an over reporting can always be a threat to the scenarios and considering the scenario the whole global front is in, tiny errors in this section even if small can make a huge difference. Job of a trader is to make bets on the level of interests. Again this is subject to a subjectivity which could be influenced by a strong player. So there sure seem to be some ends which do not tie up very objectively on the parameters for making the rating standards.
So the question would be whether we would need a new monitoring system for the inter bank rates? Is there a need for something more reliable and something which can be a little more objective and easily delineable? Well for now it seems that we just gotta wait and see. Hopefully something intelligent is gonna turn up. After all necessity is the mother of invention 😉