China’s Predatory Lending
February 12, 2025
Pension funds across the world generally invest in traditional asset classes such as debt and equity. However, over the past few years, many experts have suggested that pension funds should branch out and invest in alternative asset classes. Theoretically, investing in alternate asset classes has many benefits. However, when the pension fund actually starts making […]
It is a myth that financial ratios are to be used only by investors and analysts in deriving a fair valuation for the firm. In reality, financial ratios are used by a wide variety of people for a wide variety of reasons. A common usage is by the sales department. Usually sales departments in large […]
Sports franchises are also business entities just like other private companies. Hence, it is possible for the owners of these companies to want to sell their stake just like other companies do. If the owner does want to sell off their stake, they need to know its valuation. Also, the valuation of different clubs can […]
Governments all over the world generally levy graduated taxes on their population. This means that as the income being taxed increases, the tax rate also increases. Under a graduated tax structure, some amount of income is exempted from the tax. Then, there is a different tax slab, which becomes applicable as soon as the income […]
Banking services in general and corporate banking, in particular, have witnessed a lot of innovation in the past few years. Innovations have touched almost every area of banking except the way the products and services are priced. The commercial banking pricing still seems to be anchored to old business models. However, since commercial banks are […]
The British banking regulator FSA has prosecuted Barclays for rigging the interest rates in the market. The regulator termed it as being equivalent to stealing money from people who invest in derivatives and other stock market instruments that are sensitive to LIBOR.
Barclays, one of the largest banks in the United Kingdom had to pay over 290 million GBP to settle the issue out of court. Barclays is not the only one being sued for this massacre. All major European banks and even some big American banks have been accused of defrauding the investors in this gigantic scandal. In this article, we will study the details of how these banks rigged LIBOR and used it to their advantage.
London Interbank Offered Rate (LIBOR) is a benchmark interest rate that is used across the world. For instance, if your mortgage is variable it is usually expressed as LIBOR + 2% and so on. London is considered to be the nerve center of the modern financial system. Hence, the confidence that banks have while borrowing and lending money in London is considered to be a proxy for general confidence in the financial world.
Hence, if banks in London are willing to lend money to each other at low rates of interest, then we have a healthy economy. A rise in LIBOR causes a rise in all the other interest rates linked to it. This has a recessionary effect on the economy.
LIBOR was earlier calculated based on the estimates given by the major banks in London. They estimated the rate at which they were willing to lend money to other banks for overnight transactions. A central body would compile this information and the average derived was the LIBOR i.e. the benchmark interest rate that could literally move the world!
The huge flaw with this approach was that estimates were being used to arrive at the LIBOR. Hence nobody had to actually borrow and lend at the rate mentioned in LIBOR, the banks merely had to tell the regulator that they would do so. In practice they would be borrowing and lending at completely different rates. Banks therefore realized that they could form a cartel and rig the LIBOR in their favor. For a couple of years, the LIBOR number would be whatever the banks wanted it to be.
The ability of the banks to rig interest rates has been mentioned above. However, why would they want to do such a thing? Well, the answer lies across the Atlantic. United States is one of the largest derivative markets in the world. The notional value of the derivative contracts traded on American exchange is over $350 million and almost all of them are based on the LIBOR. Even the change of a few basis points in LIBOR causes billions of dollars to be made in profit. It was therefore no surprise that banks that could rig the LIBOR also had huge positions in the derivatives markets and also an enviable record of stellar success.
The FSA termed the interest rate rigging as being similar to robbing common people. The reason for this statement is as follows:
When the lid was blown off the LIBOR scandal, the FSA was forced to make several changes to protect common people that were being ripped off by the banks. The changes are as follows:
The LIBOR scandal is just one of the reasons why the common man has absolute mistrust for bankers and the banking system.
Your email address will not be published. Required fields are marked *