Beginning in 2012, an international investigation into the London Interbank Offered Rate, or Libor, revealed a widespread plot by multiple banks-most notably Deutsche Bank, Barclays, UBS, Rabobank, and the Royal Bank of Scotland-to manipulate these interest rates for profit starting as far back as 2003. In 2015, investigations continued to implicate major institutions, exposing them to civil lawsuits and shaking trust in the global financial system.
Regulators in the United States, the UK, and the European Union have fined banks more than $9 billion for rigging Libor, which underpins over $300 trillion worth of loans worldwide. While several bankers and traders have also been brought up on criminal charges, these cases have been slow to go to trial. The scandal has sparked calls for deeper reform of the entire Libor rate-setting system, as well as harsher penalties for offending individuals and institutions, but so far change remains piecemeal.
What is Libor?
Libor is a benchmark interest rate based on the rates at which banks lend unsecured funds to each other on the London interbank market. Published daily, the rate was previously administered by the British Bankers' Association (BBA). But in the aftermath of the scandal, Britain’s primary financial regulator, the Financial Conduct Authority (FCA), shifted supervision of Libor to a new entity, the ICE Benchmark Administration (IBA), an independent subsidiary of the private exchange operator Intercontinental Exchange, or ICE.
In order to calculate the Libor rate, a representative panel of global banks submit an estimate of their borrowing costs to the Thomson Reuters data collection service each morning at 11:00 a.m. The calculation agent throws out the highest and lowest 25 percent of submissions and then averages the remaining rates to determine Libor. Calculated for five different currencies-the U.S. dollar, the euro, the British pound sterling, the Japanese yen, and the Swiss franc-at seven different maturity lengths from overnight to one year, Libor is the most relied upon global benchmark for short-term interest rates. The rate for each currency is set by panels of between eleven and eighteen banks.
How does Libor affect global borrowing?
Many banks worldwide use Libor as a base rate for setting interest rates on consumer and corporate loans. Indeed, hundreds of trillions of dollars in securities and loans are linked to Libor-government and corporate debt, as well as auto, student, and home loans, including over half of America's flexible-rate mortgages. When Libor rises, rates and payments on loans often increase; likewise, they fall when Libor goes down. Libor is also used to "provide private-sector economists and central bankers with insights into market expectations of economic performance and interest rate developments," explains the IBA.
Why and how did traders manipulate Libor?
Barclays and fifteen other global financial institutions came under investigation by a handful of regulatory authorities—including those of the United States, Canada, Japan, Switzerland, and the UK—for colluding to manipulate the Libor rate beginning in 2003. Barclays reportedly first manipulated Libor during the global economic upswing of 2005–2007 so that its traders could make profits on derivatives pegged to the base rate, explains CFR's Sebastian Mallaby.
During that period, "swaps traders often asked the Barclays employees who submitted the rates to provide figures that would benefit the traders, instead of submitting the rates the bank would actually pay to borrow money," the New York Times reported. Moreover, "certain traders at Barclays coordinated with other banks to alter their rates as well." During this period, Libor was maneuvered both upward and downward based "entirely on a trader's position," explains the London School of Economics' Ronald Anderson.
Hundreds of trillions of dollars in securities and loans are linked to Libor—government and corporate debt, as well as auto, student, and home loans, including over half of America’s flexible-rate mortgages.
Following the onset of the global financial crisis of 2007–2008, Mallaby says, Barclays manipulated Libor downward by telling Libor calculators that it could borrow money at relatively inexpensive rates to make the bank appear less risky and insulate itself. The artificially low rates submitted by Barclays came during an "unprecedented period of disruption," says Anderson. It provided the bank with a "degree of stability in an unstable time," he says.
The investigation into UBS focused on trader Thomas Hayes, whose alleged rigging led him to post profits in the hundreds of millions for the bank over his three-year stint. After Hayes was arrested in December 2012, UBS executives took the blame for creating a system in which traders were rewarded with large bonuses if they agreed to take part in the scheme. At the same time, collusion allegedly occurred between Hayes and traders at RBS, which is majority owned by British taxpayers, in order to affect submissions across multiple institutions.
What effect has the Libor scandal had on global financial markets?
Many experts say that the Libor scandal has eroded public trust in the marketplace. As the Wall Street Journal's Francesco Guerrera writes, Libor manipulation meant "trillions of dollars of financial instruments were priced at the wrong rate—a fact that could do wonders for plaintiffs' lawyers while undermining investors' confidence in financial markets." Indeed, securities broker and investment bank Keefe, Bruyette & Woods estimated that the banks being investigated for Libor manipulation could end up paying $35 billion in private legal settlements—separate from any fines to regulators.
These sums could pose new challenges for financial institutions that are increasingly required to maintain higher reserves to guard against another systemic crisis. "Relative to the size of the sixteen banks at risk of lawsuits in the Libor scandal, $35 billion is chump change. But it will be another blow to the banks' ability to hold enough capital to satisfy higher regulatory requirements in the wake of the financial crisis," writes the Huffington Post's Mark Gongloff.
What have been the penalties for institutions and individuals?
A wave of Libor-related prosecutions, led by a range of U.S. and European regulatory bodies, has led to several major settlements. All told, global banks have paid over $9 billion in fines, as of May 2015. More than one hundred traders or brokers have been fired or suspended, twenty-one have been charged, and several executives, including former Barclay’s CEO Bob Diamond and Rabobank CEO Piet Moerland, have been forced out.
The UK’s Barclays settled its case with authorities for $435 million in July 2012. In December 2012, Swiss banking giant UBS was slapped with the biggest Libor-related fine up to that point, paying global regulators a combined $1.5 billion in penalties. The complaint, led by the U.S. Commodity Futures Trading Commission (CFTC), cited over 2,000 instances of wrongdoing committed by dozens of UBS employees. Later in 2013, Dutch Rabobank settled charges against it for over $1 billion.
In December 2013, EU regulatory authorities settled their investigation into Barclays, Deutsche Bank, RBS, and Société Générale, fining the latter three banks a combined total of 1.7 billion euros, or over $2 billion. They were all found guilty of colluding to manipulate market rates between 2005 and 2008. In exchange for revealing the cartel to regulators, Barclay’s was not fined. U.S.-based JP Morgan Chase and Citigroup also became the first American institutions fined, with much smaller penalties.
In April 2015, Germany’s Deutsche Bank agreed to the largest single settlement in the Libor saga, paying $2.5 billion to U.S. and European regulators and entering a guilty plea for its London-based branch. In addition, the bank was obligated to fire seven employees. It brings the total amount of fines paid by Deutsche Bank to $3.5 billion, more than twice that of any other institution.
Over one hundred traders or brokers have been fired or suspended, twenty-one have been charged, and several executives, including former Barclay’s CEO Bob Diamond and Rabobank CEO Piet Moerland, have been forced out.
Some politicians have called for more penalties for individuals. In February 2013, British chancellor of the exchequer George Osborne announced that he wanted the fine for RBS to come out of bankers' bonuses. Regulators such as the United Kingdom’s Serious Fraud Office have been criticized for the slow pace of prosecutions, as trader Thomas Hayes was only brought to trial in May 2015—and his is so far still the only case to come to trial against an individual in the Libor scandal. Former employees of the UK brokerage firm ICAP Darrell Read, Colin Goodwin, and Danny Wilkinson—the so-called ICAP trio—are set to face a British jury in September 2015.
Many of these same same banks have also come under scrutiny for similar concerns that they colluded to manipulate global currency markets. In May 2015, five banks—Citigroup, JP Morgan Chase, Barclays, Royal Bank of Scotland, and UBS—pleaded guilty to criminal charges of manipulating foreign exchange markets, agreeing to pay over $5 billion to the U.S. Justice Department and other regulators. As part of that settlement, UBS pleaded guilty to additional Libor-related fraud, paying $203 million in penalties. However, the Justice Department did not indict any individuals.
What are some implications of the Libor scandal?
Efforts to hold Libor to a higher standard of accountability have so far been piecemeal, pointing to persistent problems with the interbank lending system. The scandal showed that leading central banks failed to take remedial action, experts say. Correspondence from 2008 between Timothy Geithner and Mervyn King, then the respective heads of the New York Federal Reserve and the Bank of England, indicate that top central bank officials knew that Libor was unreliable. But despite developing a list of recommendations for “enhancing the credibility” of Libor, both Geithner and King later came under fire for failing to push forward reforms.
In the aftermath of the Libor revelations, regulators in Europe and the United States disagreed on reforms. As an analysis by the New York Fed explains, the options for Libor come down to “repair and reform, or replace.” Most commentators in the United States argue that Libor had been totally discredited and should be scrapped in favor of a new rate based on real transaction data. “Proponents of this approach view it as a quick low-cost method to restore the integrity of the reference rate, while critics caution about the potential for heightened volatility,” writes the Fed. Regulators in the UK, meanwhile, have advocated a gradual shift that would keep the Libor mechanism for existing contracts and allow new contracts to use Libor or a transaction-based benchmark rate until a full overhaul of the system is completed.
In that sense, the WSJ’s Guerrera says, the 2012 Barclays settlement could potentially hold the "seeds" of a new regulatory regime. As part of the deal, Barclays "must now base its submissions on market prices rather than some hazy estimate of borrowing costs," he wrote. The primary Libor reform to date has been to discontinue the British Bankers Association control over the process and shift its administration to ICE. ICE is ultimately required to anchor its Libor calculations in more concrete transactions data, which would be more difficult to manipulate, and has proposed a system, still under consideration, to do so.
The Intercontinental Exchange Benchmark Administration explains the basics of its Libor system in this FAQ.
This 2014 paper published by the Federal Reserve Bank of New York traces the origins of Libor as well as the potential for reform.
This 2013 article by the Centre for Economic Policy Research (CEPR) analyzes what could come next for Libor.
The Congressional Research Service answers some frequently asked questions about Libor.
This New York Times infographic illustrates the complicated process used to manipulate the interest rate.
Donald MacKenzie explains the significance of Libor in this London Review of Books essay.