Beginning in 2012, an international investigation into the London Interbank Offered Rate, or Libor, revealed a widespread plot by multiple banks—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. Investigations continue to implicate major institutions, exposing them to 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. Since 2015, authorities in both the UK and the United States have brought criminal charges against individual traders and brokers for their role in manipulating rates, though the success of these prosecutions has been mixed. 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 UK subsidiary of the private U.S.-based exchange operator Intercontinental Exchange, or ICE.
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, including government and corporate debt, as well as auto, student, and home loans, including over half of the United States’ 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, the new Libor administrator.
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. In 2012, as part of a settlement with U.S. and UK authorities, Barclays admitted to “misconduct” in the manipulation of rates.
The investigation into the Swiss bank UBS focused on the UK trader Thomas Hayes, who was the first person convicted for rigging Libor. Prosecutors argued that this allowed him to post profits in the hundreds of millions for the bank over his three-year stint, after which he moved to the U.S.-based Citigroup. After Hayes was arrested in December 2012, UK politicians criticized UBS executives for “negligence” after the bank’s leadership denied knowledge of the traders’ schemes due to the complexity of the bank’s operations. At the same time, most of the fraudulent collusion occurred between Hayes and traders at Royal Bank of Scotland (RBS), which is majority owned by UK taxpayers, 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. 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. “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 financial institutions?
A wave of Libor-related prosecutions, led by U.S. and European regulatory bodies, has led to multiple major settlements. All told, global banks have paid over $9 billion in fines.
The UK’s Barclays settled a case with U.S. and UK authorities for $435 million in July 2012, and in 2016 agreed to pay an additional $100 million to forty-four U.S. states for its role in manipulating the dollar-denominated Libor rate. 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 two thousand instances of wrongdoing committed by dozens of UBS employees.
In early 2013, U.S. and UK authorities fined RBS $612 million for rate rigging. Then, 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 by the EU. JP Morgan Chase and Citigroup also became the first U.S. institutions fined, albeit with much smaller penalties. (In 2016, a separate investigation by U.S. authorities fined Citigroup $425 million after finding that senior managers at the bank knew about Libor trader Tom Hayes’ illicit manipulation of the rate.) Also in 2013, Dutch Rabobank settled charges against it for over $1 billion.
In April 2015, Germany’s Deutsche Bank agreed to the largest single settlement in the Libor case, paying $2.5 billion to U.S. and European regulators and entering a guilty plea for its London-based branch. It brings the total amount of fines paid by Deutsche Bank to $3.5 billion, more than twice that of any other institution.
Many of these 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 at that time.
How have individuals involved been punished?
Investigations have placed most of the individual responsibility on the traders who sought to influence the Libor rate, as well as the managers who encouraged them, the brokers who helped carry out the schemes, and the rate-submitters themselves. As the extent of the Libor fraud became clear, more than one hundred traders or brokers were fired or suspended. Bank executives pled ignorance of the misconduct, but a number of them, including former Barclay’s CEO Bob Diamond and Rabobank CEO Piet Moerland, have been forced out. As part of its 2015 settlement, Deutsche Bank was obligated to fire seven employees.
However, regulators came under criticism for being slow to respond to the allegations, and some politicians called for stiffer penalties for the individuals responsible. In 2013, for instance, the UK’s then-Chancellor of the Exchequer George Osborne announced that he wanted the fine for RBS to come out of bankers’ bonuses rather than taxpayer funds.
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.
Since 2015, over twenty people have also been criminally charged in connection to Libor-related fraud by both UK and U.S. authorities. The UK’s Serious Fraud Office (SFO) has charged twelve people over Libor, beginning with the 2015 trial of Hayes. He was convicted of leading a conspiracy by recruiting traders and brokers at other banks to manipulate Libor, and was sentenced to fourteen years in prison. However, the SFO prosecutors faced a setback in January 2016 when six of Hayes’ alleged co-conspirators, brokers at three UK firms, were acquitted of all charges. Hayes is also appealing his conviction. In July 2016, a separate SFO prosecution resulted in the conviction of three Barclays traders, who received prison sentences of between two and six years. Other cases are ongoing.
The first U.S. convictions came in November 2015, with a New York judge sentencing two former Rabobank employees to one to two years in prison. In June 2016, the DOJ indicted two former Deutsche Bank traders and revealed that several others had pleaded guilty. In total, the DOJ has charged sixteen people in connection to its Libor probe.
What are some implications of the Libor scandal?
Despite the scandal, Libor continues its role as the primary benchmark for global lending rates. However, the efforts of authorities to increase the oversight and accountability of the Libor system have spurred debate over whether reforms go far enough.
One of the first impacts of the Libor investigation was to raise questions over the role of central banks, in particular the Bank of England, in failing to address, or even abetting, problems with the system. As New York Fed economists David Hou and David Skeie explain, the New York Fed communicated its concerns over Libor manipulation to the Bank of England in 2008, and suggested reforms to the system that weren’t followed up. And in 2012, Bank of England officials strenuously denied allegations that the central bank had encouraged some UK banks to underreport their borrowing costs at the height of the 2008 crisis.
As a result, the UK government began considering reforms to Libor, whose regulation, as a London-based benchmark, falls under the UK’s purview. The UK Parliament passed legislation in 2012 to strengthen financial regulation in general, and reform the Libor system in particular. The 2012 law created the Financial Conduct Authority (FCA), a new government agency with centralized and expanded powers to investigate and regulate financial markets, including Libor.
Subsequent changes to Libor were based on the recommendations of a UK government report led by UK financier Martin Wheatley, who became the first head of the FCA. While many 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, the Wheatley report advocated more gradual changes. In addition to the creation of the FCA, these included the transfer of Libor to a new entity, the ICE Benchmark Administration, increasing penalties for manipulation, and a more transparent process for setting the rate. The Libor mechanism was kept for existing contracts and new contracts were allowed to use either Libor or a transaction-based benchmark rate until the ongoing reforms of the system are completed.
In that sense, according to the Wall Street Journal’s Francesco Guerrera, 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. Administration of Libor has been shifted to ICE, which is ultimately required to anchor its Libor calculations in more concrete transactions data which would be more difficult to manipulate. That process is underway, with ICE having proposed a system, still under development, to do so.
Christopher Alessi and Mohammed Aly Sergie also contributed to this report.
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.
The ICE Benchmark Administration lays out its vision for reforming the Libor process to be more transparent in this 2016 report.
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.