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. Investing News

    Timing of the Fed Interest Rates Hike

    Until the beginning of August, Fed watchers expected the central bank to raise rates in September. However, recent news pertaining to China’s slowing economy and its devaluation of the yuan have ...
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  3. Economics

    A Look at Greece’s Messy Fiscal Policy

    Investigate the muddy fiscal policy, tax problems, and inability to institute austerity that created the Greek crises in 2010 and 2015.
  4. Forex Education

    China's Devaluation of the Yuan

    Just over one week ago the People’s Bank of China (PBOC) surprised markets with three consecutive devaluations of the yuan, knocking over 3% off its value.
  5. Markets

    The Vodka Industry Keeps Growing, But Why?

    Understand what the vodka industry is and where it performs best. Learn about the growth of the industry and three reason why it continues to grow.
  6. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  7. Term

    What is the Macro Environment?

    The macro environment is the conditions existing in an economy as a whole, rather than in a single sector or region.
  8. Economics

    Puerto Rico Will Soon Become America's Greece

    Explore the similarities that exist between Puerto Rico in relation to the United States and Greece in relation to the European Union.
  9. Taxes

    What's Wrong with the American Tax System

    American's are highly taxed and we still run a deficit. We explain why.
  10. Mutual Funds & ETFs

    The 8 Best ETFs for Rising Rates, Flagging Stocks

    With the markets starting to sag, should you go on the defensive? If so, which ETFs should you consider?
RELATED TERMS
  1. Principal-Agent Problem

    The principal-agent problem develops when a principal creates ...
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Cost, Insurance and Freight - CIF

    A trade term requiring the seller to arrange for the carriage ...
  4. International Monetary Fund - IMF

    An international organization created for the purpose of standardizing ...
  5. Black Money

    Money earned through any illegal activity controlled by country ...
  6. Inflation

    The rate at which the general level of prices for goods and services ...
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 are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  4. How can the federal reserve increase aggregate demand?

    The Federal Reserve can increase aggregate demand in indirect ways by lowering interest rates. Aggregate demand is a measure ... Read Full Answer >>
  5. How does the stock market react to changes in the Federal Funds Rate?

    The stock market reacts to changes in the federal funds rate in various ways depending on where it is in the business cycle. ... Read Full Answer >>
  6. When has the United States run its largest trade deficits?

    In macroeconomics, balance of trade is one of the leading economic metrics that determines the trading relationship of a ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!