LIBOR, or the London Interbank Offered Rate, helps determine interest rates on between $350 and $800 trillion worth of loans around the globe, according to CNBC. However, as you’ve probably heard, at least some of the banks that report the interest rate they would expect to pay on a loan from another bank – the reports that cumulatively make up LIBOR – have been accused of fudging the numbers. Some would report a lower number, giving the impression that their banks were less risky than the market thought. Some reported higher numbers in order to goose the interest rates on the loans they were making.
While the allegations have only made the news in the past few months, at least one bank, Barclays, manipulated its reporting as far back as 2005, according to a June report by the U.K.’s Financial Service Authority. Last month, Barclays announced it had reached settlements with U.S. and British regulators, and would pay penalties totaling about $450 million. A number of other banks reportedly are under investigation, as well.
The shenanigans that went on behind the scenes with LIBOR reporting may seem esoteric, but they likely had a bottom-line impact on many companies around the world. “If the rate was higher than it should have been, any business with a debt instrument tied to LIBOR paid more than it should,” says Evan Segal, former president and owner of Dormont Manufacturing Company and former CFO at the United States Department of Agriculture (USDA). Segal also is the author of From Local To Global: Smart Management Lessons To Grow Your Business.
Say a business had a $10 million loan with the interest rate tied to LIBOR. If the rate was artificially inflated by 1% due to faulty reporting by the banks whose numbers contribute to LIBOR, that means an extra $100,000 in interest, Segal points out. “That’s not insignificant.”
Conversely, banks that reported lower interest rates while attempting to appear healthier than they actually were obscured their true level of risk. Investors in the bank wouldn’t get a true picture of its financial condition, Segal points out.
Now that the calculations behind LIBOR have become suspect, what can corporate treasurers and CFOs do? Segal offers a few ideas. A starting point is trying to shift any debt agreements that are tied to LIBOR to another rate that’s more transparent, such as one based on the U.S. Fed Funds rate.
In addition, companies that borrow primarily from the huge, money center banks – which are the ones making the reports that go into LIBOR – should consider moving at least part of their funds to community banks. Not only does this diversify the company’s financing supply base, but it helps the local community and sends a message, Segal says.
While Segal says he’s not a fan of class action lawsuits to address issues like LIBOR rate rigging, it is an option that at least a few entities are trying. Earlier this month, the Baltimore Sun announced that the city of Baltimore was suing its banks over alleged LIBOR-rigging.
Finally, all adults, but finance professionals especially, should consider learning more about LIBOR and the financial system, and asking elected officials and candidates for public office what actions they will take to put confidence back in the financial system, Segal system. The current headlines about the ways in which LIBOR has been manipulated have been “almost like the Wizard of Oz pulling the curtain back,” he says.
Until recently, few people outside the financial industry really understood how LIBOR was calculated. Now that they do, many realize the opportunity for manipulation inherent in the process. “Get educated,” Segal says. As with any business operation, the more you know, they less likely you’re at the mercy of other people, he adds.
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