Allegations that the major banks colluded in suppressing their funding costs to appear healthier than they actually were during the financial crisis of four years ago, and the manipulation of rates through an opaque setting process, have come to a head with the resignation of Barclays CEO Bob Diamond. Diamond admitted to manipulating the rates at his firm, which incurred a $450 million (290 million pound) fine. COO Jerry Del Missier and Chairman Marcus Agius stepped down as well, which was also followed by 20 banks undergoing investigation, including Citigroup, UBS, RBS, BOA, JP Morgan, HSBC, Deutsche Bank and Credit Suisse.

Greg Smith resigning from Goldman Sachs in disgust at a culture gone awry, JP Morgan admitting to a botched hedging strategy in its Chief Investment Office, MF Global collapsing beneath the weight of bad trading and a failure to protect its clients, Fabrice Tourre, Jérome Kerviel and Kweku Adobole caught out in bad trades and now this. Has scandal become sufficiently commonplace in the banking community that, like a road show, we can pick it up anywhere? Has the culture of serving clients been turned on its head? There would most definitely appear to be something wrong somewhere.

SEE: An Introduction To LIBOR

The London Interbank Offered Rate (LIBOR) and its Brussels and Japanese equivalents (the European Interbank Offered Rate (EURIBOR) and the Tokyo Interbank Offered Rate (TIBOR), respectively) are set through a process whereby each day about 40 banks submit their interest rates at which they are willing to lend, to the respective trade organizations in their regions. Once the high and low bids are discarded, the rates of the two middle quartiles are arithmetically averaged. This process is repeated about 150 times to determine the final rates each day and extends to 10 currencies and across 15 time zones. The interbank offered rates serve as a reference for the pricing of financial products worth $350 trillion that include floating rate mortgages, savings accounts, interest rate swaps, other OTC derivatives, student loans, corporate loans and credit cards.

Barclays and allegedly other banks during the 2007-2009 period and earlier, took into account traders' requests for them to submit, and submitted artificially low LIBOR rates so as to project an appearance of strength to one another in parlous circumstances and roiled markets. One could make a potential case for such posturing being in the public interest. The other motivation to do so was to boost traders' profits. The rate-setting process appears, at best, translucent and arbitrary, and at worst, potentially fraudulent.

SEE: 5 Signs Of A Credit Crisis

Pour Yourselves a Hard One, Guys
The consequences of perceived malpractice will be palpable across several fronts. To the public, these goings-on smack of continued arrogance of the banks whose conduct appears to be at great odds with ethical business practices. Individual and institutional consumers alike who use any of the numerous financial products based off LIBOR may have been paying artificially low rates, depending upon how widespread the practice will turn out to have been. Redress, if any, will have to be determined.

Investors in the banks potentially caught up in this snare in general and in Barclays PLC in particular may find themselves on the losing end of an investment whose leadership is called into question and whose conduct is reproachable. Moody's Weekly Credit Outlook has shifted to a negative outlook in light of these events, expressing concern about a potential shift away from investment banking and difficulty in finding a suitable replacement for Bob Diamond, who would be facile in investment banking and credible in his or her ability to rectify internal lapses.

SEE: A Brief History Of Credit Rating Agencies

The Bottom Line
To the regulators, the scandal is but more fodder for greater oversight. Indeed, the Commodity Futures Trading Commission (CFTC) is working with Barclays to develop a more transparent and robust rate-setting process. Compliance officers would need to exercise better supervision. When traders brazenly thank each other with the promise of a fine tipple over monitored email, they are nonchalant or blithely unaware. Apparently, they missed the meeting and need retraining, if they haven't been taken to the woodshed already. It appears that mission control has given way to missing control.

Such conduct points to an issue that looms larger still and is not willed away or eradicated so easily by public outrage or regulatory pressure: firm culture. Change must come from within and be pervasive. As the past several weeks' events have shown, firms can police themselves or be policed. Given the long reach of LIBOR, should violations be proven on a grand scale, this incident could shape up as the largest financial fraud in history and a field day for litigators - unless, of course, other nefarious goings-on surface that could be worse.

Related Articles
  1. Economics

    How Negative Interest Rates Work

    Policymakers in Europe go for the unconventional: negative interest. What could happen?
  2. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  3. Fundamental Analysis

    3 Times the FOMC Got It Right This Century

    Learn about three times that the Federal Open Market Committee (FOMC) and the Federal Reserve took positive steps to help the economy in the 21st century.
  4. Fundamental Analysis

    Quantitative Easing Report Card in 2016

    Find out why quantitative easing has not worked, despite the best efforts of the Federal Reserve, and how it has fueled the national debt problem.
  5. Products and Investments

    The One Thing Your Portfolio Must Always Have

    Portfolio diversification is essential in any situation, but especially so as the market finally returns to fundamentals.
  6. Stock Analysis

    3 Risks Emerging Markets Debt Faces in 2016

    Learn about the major risks for emerging market debt in 2016. Discover how low interest rate policies by central banks fueled the growth of debt globally.
  7. Investing News

    How Interest Rates Can Go Negative

    Central banks from Europe to Japan have implemented a negative interest rate policy (NIRP) in order to stimulate economic growth.
  8. Credit & Loans

    The 5 Things You Never Knew About Auto Loan Rates

    Buying a new car is an important decision, and if you're a savvy auto buyer, you know that getting a good deal involves more than snagging a great price.
  9. Mutual Funds & ETFs

    The Top 5 Large Cap Core ETFs for 2016 (VUG, SPLV)

    Look out for these five ETFs in 2016, and learn why investors should closely watch how the Federal Reserve moves heading into the new year.
  10. Economics

    The Delicate Dance of Inflation and GDP

    Investors must understand inflation and gross domestic product, or GDP, well enough to make decisions without becoming buried in data.
RELATED FAQS
  1. How are international investment banking practices regulated?

    The first step in creating international investment banking regulations occurred in 1930, when the Bank for International ... Read Full Answer >>
  2. How did the LIBOR scandal affect interest rate swaps?

    The LIBOR scandal impacted interest rate swaps in two important ways. During the period between 2005 and 2009, more than ... Read Full Answer >>
  3. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  4. What is comparative advantage?

    Comparative advantage is an economic law that demonstrates the ways in which protectionism (mercantilism, at the time it ... Read Full Answer >>
  5. How does the Wall Street Journal prime rate forecast work?

    The prime rate forecast is also known as the consensus prime rate, or the average prime rate defined by the Wall Street Journal ... Read Full Answer >>
  6. What's the difference between microeconomics and macroeconomics?

    Microeconomics is generally the study of individuals and business decisions, macroeconomics looks at higher up country and ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center