Libor Lowballing Never Ended as Global Probes Accelerated

Banks lowballed Libor submissions long after probes began into allegations they were doing so, research suggests, raising questions of whether lenders can be relied on to provide sound data for interest-rate benchmarks.

In the worst days of the euro-zone crisis in 2012, the 12-month dollar London interbank offered rate -- a measure of how much banks would pay to borrow U.S. cash for a year -- was about half what it should have been, showing they were significantly understating how much loans would cost, according to a study by Fideres Partners, a research firm that gave evidence to the U.K. government on benchmark-rigging in July.

“Libor suppression was not confined to the great financial crisis but carried on until at least 2012,” said Alberto Thomas, a Fideres founding partner and former head of credit structuring and solutions at Royal Bank of Scotland Group Plc, referring to the economic turmoil that began in 2007.

The report comes amid a debate over whether changes to fix the benchmark go far enough, or whether it should be replaced altogether. Libor is used in more than an estimated $300 trillion of securities, from interest-rate swaps to mortgages and student loans. During the crisis, as it became harder to access credit, banks began to under-report their borrowing costs to make themselves seem healthier.

Since 2012, a dozen firms have been fined $6.5 billion in Libor-related investigations, which also uncovered that traders were colluding to push interest rates up and down to benefit their derivatives positions.

Perceived Creditworthiness

Libor is calculated daily by asking banks how much it costs them to borrow cash from each other for various periods in different currencies. When financial institutions stopped lending to each other during the credit crisis, firms were forced to estimate the figures with few underlying transactions on which to base their submissions.

For its study, Fideres, which also acts as a technical expert in litigation including against banks accused of rigging Libor, looked at credit-default swap prices for an indication of how financial markets perceive individual institutions’ creditworthiness. The researchers assumed the submitting bank with the lowest CDS spread was giving an accurate answer, then calculated an implied Libor submission for each of the others by looking at how much that diverged from theirs.

June 2012

On June 1, 2012, as concerns over the creditworthiness of European countries were reaching a crescendo, 12-month dollar Libor was 1.07 percent. If banks had accurately reflected their borrowing costs, it should have been 2.01 percent, Fideres said, based on its estimates of their implied borrowing costs. The biggest discrepancies were from RBS, Societe Generale SA, Credit Agricole SA and Bank of America Corp., whose submissions were a third of what Fideres estimated they should have been.

Spokeswomen for the banks declined to comment on the study. Edinburgh-based RBS has been fined about $1.1 billion by regulators for rigging Libor and Euribor. Paris-based Societe Generale was fined 446 million euros ($550 million) by the European Union last year for rigging Euribor. It’s appealing the decision.

The gap between banks’ actual Libor submissions and what Fideres calculates they ought to be has narrowed as stability has returned to financial markets and the incentive for firms to massage the figures has diminished.

Patchy Lending

The issue now is that interbank lending remains patchy, particularly for periods of longer than a few weeks, because firms prefer to lend to each other using collateral as guarantees. New capital and liquidity rules also discourage unsecured loans between banks.

That fundamental challenge has led some regulators to question whether Libor can be fixed. Its administration has already been stripped from the British Bankers’ Association and handed over to New York Stock Exchange owner Intercontinental Exchange Inc., which has said it supports improvements including standardizing how banks calculate their submissions rather than creating a new benchmark.

Finbarr Hutcheson, president of ICE Benchmark Administration and the former chief executive officer of the NYSE Liffe exchange, declined to comment.

Others argue even broad-ranging reforms don’t go far enough and the lowballing could return with another credit crunch.

‘Central Vulnerability’

“These efforts cannot address the central vulnerability of Libor, Euribor and similar interest-rate benchmarks: the lack of transactions in the underlying market,” Gary Gensler, then chairman of the U.S. Commodity Futures Trading Commission, said in a speech in London last year. “It is critical that international regulators work with market participants to promptly identify alternative interest-rate benchmarks anchored in observable transactions with appropriate governance.”

Gensler left the CFTC, which took the lead in the global Libor-rigging probes, at the end of 2013. When contacted by Bloomberg News, he reiterated his remarks in London and declined to comment on Fideres’s findings.

The Financial Stability Board, which issued a report in July on the issue, said benchmark rates “should be anchored in observable transactions wherever feasible” to minimize opportunities to manipulate them. In some cases, that might not be enough, and it may be better for some trades, including many derivatives, to be tied to the risk-free rate of borrowing rather than to unsecured bank borrowing rates, the FSB said. Those alternatives could include the overnight indexed swap rate, government bond rates or compounded overnight interest rates.

Risk-Free Rate

“Shifting a material proportion of derivative transactions to a risk-free rate would reduce the incentive to manipulate rates that include bank credit risk and would reduce the risks to bank safety and soundness and to overall financial stability,” said the FSB, whose members include regulators and central banks from around the world.

That poses its own problems. Any significant changes to the way Libor is calculated could risk invalidating the trillions of dollars of existing contracts tied to the rate, say lawyers, leaving banks open to another wave of legal actions.

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