LIBOR Scandal

A wash trade is a form of stock manipulation in which an investor simultaneously sells and buys the same financial instrument. Wash Trading occurs when an investor sells a security via one broker and then buys the same security through another broker within 30 days of sale. It is done to artificially increase trading volume to give an impression that the instrument is more in demand than it actually is. In some cases like that of LIBOR Scandal, it was used to generate commission for brokers in order to compensate them for something that cannot be openly paid, in other words, bribe them.

LIBOR stands for London Inter Bank Offering Rate and is a global benchmark interest rate used to set a variety of financial deals worth $450 trillion (the amount was $800 trillion before the scam). It is the rate at which the banks are willing to lend other banks for a period ranging from overnight to one year and hence, also serves as a measure of trust in financial system and reflects the confidence banks have in each other’s financial health. It was earlier set by British Banker's Association (BBA). 18 banks are connected to LIBOR and every day, these 18 banks are polled by the BBA and asked the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?“. The banks are required to submit their interest rate estimate to Thomson Reuters which acts like an intermediary between banks and BBA. Thomson Reuters then strikes off the lowest two and highest two interest rate estimates. BBA takes out the average of the remaining 14 estimates and the figure so generated is the LIBOR rate. This rate gets communicated to all the banks at 11:30 a.m.

In November 2007, bankers and other market participants began expressing concerns to BBA about whether LIBOR-setting banks were reporting rates that reflect their true borrowing cost. This was the time of great financial crisis and investor sentiment and confidence in the banking and financial sector was at an all time low. This implied that LIBOR should have been very high at the time but it was low in reality. Investigations revealed that many leading banks like JP Morgan, UBS, Royal Bank of Scotland, Barkley's etc were involved in rigging the interest rate. Barclay was identified as the main accuse. One belief as to why the LIBOR was set low is that banks wanted to project a better financial health than what the case actually was. The other and the main reason was that people responsible for submitting bank’s LIBOR rate estimate wanted to provide benefit to their relatives and friends.

Traders used to ask the person responsible for submitting bank's (like Barclay's) LIBOR number to lower the rate they submitted for a particular day as they had some money in forward interest rate swap. Thus, the larger the difference between the fixed rate and LIBOR (a floating rate that changes daily), the more money they make.  In other words, traders made higher profit the lower the LIBOR was set. 

This scandal has been termed as the largest scandal of the banking and finance sector in the world. As a conclusion of the scandal, Barclay's paid $450 million to three regulators in US and UK. LIBOR is now no longer under BBA but under ICE (Inter Continental Exchange) and USA banks have stopped using it.

- PAVITRA GARG