What is it?
A number of banks in the West are being probed and fined by regulatory authorities for allegedly rigging London Inter-Bank Offered Rate (Libor) for a considerable period of time. The investigation and resultant fine on banks is being termed by many as the “tobacco moment” for banks. Tobacco moment refers to a 1998 settlement reached between different tobacco companies and states in the US for medical lawsuits. In the settlement, the companies agreed to pay at least $200 billion over a specified period of time.
Libor gives an indication of the rate at which banks can borrow from the London inter-bank market for a given period of time. The rates are released for 15 different time periods and in 10 currencies every day. For the calculation of the rate, the participating banks are asked for rates at which they can borrow in the money market. The Libor rates are released on the basis of these daily quotes. Libor serves, or used to serve until recently, as a benchmark for fixed income and derivatives contracts worth trillions of dollars all over the world.
However, earlier this year, news surfaced that some banks deliberately attempted to rig the rate by giving wrong quotes. At the centre of the storm was UK-based bank, Barclays Plc, whose then chief executive Bob Diamond had to resign under public and political pressure.
The reason for rigging could have been the difficult market condition during the crisis of 2008 when financial institutions were extremely careful about lending money even to the banks; no one knew who was holding what. Therefore, it suited the banks to give a lower quote; a higher quote would have attracted market attention to the banks’ balance sheet and would have actually pushed borrowing cost. The other thing could be that the rates were given according to the needs of traders on the fixed income desk of the bank.
The present tobacco moment
The rigging of Libor is being viewed as a serious breach of trust and authorities and regulators in different jurisdictions are probing and hearing different angles of the scandal and fines are being imposed. The unfolding investigation suggests that a series of fines and litigations could be imposed over a long period of time and therefore it is being compared with the earlier tobacco moment in the US.