China’s Predatory Lending
February 12, 2025
Financial reporting is used by a wide variety of users for a wide variety of purposes. For this reason it has been difficult to set a common framework of accounting. The many stakeholders often have contrasting needs from accounting information. Let’s look at the stakeholders and their need for accounting data: Capital Markets: Accounting information […]
The South Sea Bubble is one of the largest asset bubbles that the world has ever seen. In fact, this bubble bankrupted the newly prosperous British economy during the 17th Century. At one point in time, all the money is Britain was not enough to pay down the debts that accrued as a result of […]
The geographical boundaries drawn by nation states are blurring in the 21st century. In many parts of the world, free movement of goods, services, and even personnel have become a norm. However, strangely, the concept of credit and loans is still dependent upon national boundaries. The H1B visa system of America is a testimony to […]
In the previous articles, we have already seen how the use of securitization has grown in sports. We also know that the increasing use of securitization is because of certain benefits that are provided by this method of raising capital. However, it is important to note that securitization is a part of structured finance. Structured […]
The money market is interlinked with other markets such as the stock market and the bond market. As such, if there is turbulence in the money market, it often quickly spirals to other areas of the economy as well. This has already been in the 2008 global crisis. The liquidity crisis which greatly exacerbated the […]
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 *