The artificial determination of LIBOR as an indication of interbank unsecured rates perpetuated by the financial industry is becoming increasingly more ridiculous.
Bloomberg: “We used to say during the financial crisis a few years ago that interbank rates are rates at which banks won’t lend to each other, and sadly that’s still the case today - Richard McGuire, a senior fixed-income strategist at RabobankIndeed this index is not an indication of any real transactions in spite of having permeated many aspects of the financial services industry. The chart below shows the increasing dispersion between the lowest (HSBC) and the highest (UBS) contributions from a number of banks used to determine this composite index, which is continuing to rise.
|LIBOR quotes (highest and lowest) provided to BBA (Bloomberg)|
WSJ: Swiss bank UBS AG disclosed the probe Tuesday in its annual report. The bank said it has received subpoenas from the three regulators and that it believed "the investigations focus on whether there were improper attempts by UBS, either acting on its own or together with others, to manipulate Libor rates at certain times."There are two reasons for banks to manipulate the index (although real proof of such behavior is hard to come by):
1. In times of crisis, a bank can intentionally quote a low rate to the British Bankers Association (BBA) who computes the index, in order to project "healthy" financial conditions at the firm.
2. On the other hand a good reason to quote a higher level of LIBOR has to do with a bank's current exposure to the index. For example if a bank has a large portfolio of loans paying LIBOR plus spread (which most corporate loans and some mortgages do), the firm may be quite interested in elevating the LIBOR level to boost its revenue. The bank may be funding itself in the overnight markets or via bond issuance, making interest expenses insensitive to LIBOR. Thus by keeping the index artificially high, the net interest income would be elevated. Using rate swaps (fixed for "floating") a bank can dial up or down its LIBOR exposure, giving it a perfect opportunity to influence the BBA's index at different times to increase profitability.
It is surprising that droves of corporate borrowers have not been complaining about having to pay extra on this artificial and possibly manipulated index. The industry needs to find an alternative to LIBOR, such as term repo rates, commercial paper rates, or some other index where real transaction history is available.