KATHMANDU: London Interbank Offer Rate (Libor) is the average interest rate determined by leading banks in London which is used while borrowing among banks.
Libor, along with Euro interbank offered rate (Euribor), is taken as benchmark for short term interest rate around the globe. Many
global financial institutions set their own short-term interest rate in relation to Libor, which impacts the interest rate for almost USD 350 trillion worth of financial product around the globe.
The ongoing flash of the Libor scandal with the recent resign-ation of British banking giant Barclay’s CEO Bob Diamond has taken this scandal to new heights. During the financial crisis of 2008, major banks coordinated with each other to suppress the interest rate through Libor to maintain healthier financial status than they were actually in. Altogether 16 banks from the US, Canada, UK, Switzerland and Japan part-icipated during the process of Libor, where banks used to quote the interest rate to benefit their trader (which was why
Barclays was fined by UK regulatory authorities).
Moreover, during the financial crisis of 2007-08, banks collabo-ratively and intentionally understated the interest rate, which
resulted in lesser interest rate and substantial profit on their Libor interest linked portfolios. During the first quarter of 2009, Citi bank, Bank of America and JPMorgan and Chase had interest rate swap of notional value of USD 14.2 trillion, USD 49.7 trillion and USD 49.3 trillion respectively. So, any changes in the interest rate — even by a single point — would have a greater degree of effect in these banks’ profitability. Now, Barclays is fined for its wrong-doing and many other banking giants are stepping forward to coordinate with the US and
European regulatory authorities.
The implication of this scandal could be huge in the global financial marketplace. News regarding such scandal can distort the
trust of the market participant.
Moreover, this scandal also means that trillions of dollars of financial instrument were priced at a wrong rate, which could have long-term effects in terms of investors’ confidence and legal hassles that these banks might have to go through. On top of this, banks involved in this scandal might have to pay billions of dollars in legal settlement, which could ultimately impact the banks’ financial status.
On the other hand, the process of setting Libor is not based on real transactions, which can be changed as per the actual
borrowings and lendings done by the banks. This might help determine the rate as per the market place scenarios.
(The author is the manager of research and development at Mercantile Exchange Nepal. He can be reached through firstname.lastname@example.org)