Should corporates worry if banks lowball the benchmark?
Should corporates worry about allegations of market manipulation when it runs in their favor? That’s a question of growing importance as US and Japanese regulators expand their probe into whether banks made “improper attempts” to manipulate Libor during the financial crisis in an attempt to appear more creditworthy.
The latest bank to receive a subpoena in the year-old investigation is UBS, which disclosed it in its annual report on March 16. According to the Financial Times, all 20 banks that supply data for dollar Libor to the British Bankers’ Association (BBA) are now being investigated.
It may be easy for corporates to shrug this off. If the allegations are true, the manipulation didn’t victimize borrowers. And the rate would be difficult to game, since the BBA discards both the highest four and the lowest four quotes it receives. That means at least five banks would have had to act in concert.
This would require an unusual confluence of interests since the Libor rate a bank submits to the BBA is an indication of what it would charge another bank, not what it would be charged. Even so, banks don’t really lend to one another at Libor. Bilateral rates vary, and there is evidence that Libor hovers around the low end of the spectrum.
Libor’s purported value as an indicator of bank sector credit is tested infrequently. But there are times when Libor reflects a surge in interbank credit risk. The spread widened by about 20bp in June 2007 when the extent of Bear Stearns’ hedge fund problems became apparent, and by over two percentage points in September of the following year, when Lehman Brothers and AIG imploded.
After the US and European governments’ subsequent interventions in their banking sectors, dollar Libor became strangely quiescent, and has hugged, with a couple exceptions, the fed funds rate tightly ever since. Even if that was due to bank collusion, corporates might be expected to applaud.
Except for the fact that a low benchmark rate is of little use if no one is lending. And many of those banks that did begin to extend term loans as the crisis receded required borrowers to agree to Libor floors, to protect the interests of total return investors. These made the actual Libor level irrelevant below a certain threshold.
For corporates looking to evaluate their counterparty risk, Libor was always too blunt an instrument. CDS prices, despite their noise, are somewhat harder to game and reflect market sentiment more rapidly.
Even so, it is important for investigators to get to the bottom of this issue, if only to restore some degree of market confidence in the benchmark. Corporates may not care about it now. But if banks are colluding, and they push Libor up next time, treasury will be sorry such manipulation wasn’t stamped out earlier.