by

Rajesh Goyal

What is full form of LIBOR ? What is full form of MIBOR ?

The full form of LIBOR is London Inter Bank Offered Rate.    The full form of MIBOR is Mumbai Inter Bank Offered Rate.

LIBOR is used for which currencies ?  For Which currency is MIBOR used ? What are the maturities / periods for which LIBOR and MIBOR are quoted on regular basis ?

Originally, in 1986 LIBOR was published for three currencies ie USD, GBP and JPY.  Later on other currencies were added and after merger of some currencies in 2000 into Euro, now Libor rates are calculated for 10 currencies and 15 borrowing periods ranging from overnight to one year.   These are published daily at 11:30 am (London time).     LIBOR  is calculated  and published by Thomas Reuters on behalf of British Bankers' Association (BBA) for currencies like  (1)  US Dollar,   (2) GB Pound (GBP),  (3) Euro (EUR),  (4) Swiss Franc (CHF),  (5) Canadian dollar (CAD),  (6)Japanese Yen (JPY),  (7) Danish Krone (DKK),  (8) Swedish Korna (SEK), (9) Australian Dollar (AUD), (10) New Zealand Dollar (NZD).    MIBOR is the benchmark for overnight interet rates for  Indian Rupee (INR).    [In view of LIBOR scandel (see last question at the end of this article), now an independent authority is being mooted, which is likely to start working in 2013 itself.]

The rates are published for period ranging from 1 day to 12 months  (i.e. 1 day, 1 week, 2 weeks, 1 month, 2 month ...... upto 12 months at monthly intervals)

Define LIBOR and MIBOR ?How are LIBOR and MIBOR arrived at ?

The interbank borrowing is undertaken by financial institutions either to make profits or to cover short-term liquidity shortfalls      Thus, we can define LIBOR as the average interest rate estimated by leading banks in London that they would be paying if they borrow from other banks.   LIBOR is arrived at each day by BBA through a survey from 18 major global banks for the USD by asking 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 11.00 AM (London local time).   Then BBA excludes the highest 4 and lowest 4 responses, and averages the remaining 10 responses.  This average rate is published at 11.30 AM.   As we have made it clear it is declared for 15 different maturities i.e. 1 day (overnight) to 1 year.   Thus, we can say that LIBOR is a set of indexes.

MIBOR is the interest rate at which banks can borrow funds, in marketable size, from other banks in the Indian interbank market.   MIBOR is calculated everyday by the National Stock Exchange of India (NSEIL) as a weighted average of lending rates of a group of banks, on funds lent to first-class borrowers.  The MIBOR was launched on June 15, 1998 by the Committee for the Development of the Debt Market, as an overnight rate. The NSEIL launched the 14-day MIBOR on November 10, 1998, and the one month and three month MIBORs on December 1, 1998.  Further, the exchange introduced a 3 Day FIMMDA-NSE MIBID-MIBOR on all Fridays with effect from June 6, 2008 in addition to existing overnight rate.    Thus, we can say that MIBOR is is arrived  now a days by FIMMDA and NSE,  based on inputs from PS Banks, Private Sector Banks, Primary Dealers and Foreign Banks   An example of the MIBOR rates is

Fixed Income Money Market and Derivative Association of India (FIMMDA) has been in the forefront for creation of benchmarks that can be used by the market participants to bring uniformity in the market place. To take the process of development further, FIMMDA and NSEIL have taken the initiative to co-brand the dissemination of reference rates for the Overnight Call and Term Money Market using the current methodology behind NSE – MIBID/MIBOR. The product was rechristened as 'FIMMDA-NSE MIBID/MIBOR'. The 'FIMMDA-NSE MIBID/MIBOR' is now jointly disseminated by FIMMDA as well as NSEIL 

What is the importance of LIBOR and MIBOR ?

The Libor is widely used as a reference rate / bench mark for many financial instruments in both financial markets and commercial fields.   In 2012, it was estimated that at least US$ 350 trillion in derivatives and other financial products were tied to the LIBOR.  Thus, for banks and other financial institutions, huge number of transactions are valued based on the current trend of LIBOR.

The MIBOR (alongwith MIBID)  rate is used as a bench mark rate for majority of deals struck for Interest Rate Swaps, Forward Rate Agreements, Floating Rate Debentures and Term Deposits in Indian markets.

What are other indexes for money market / term deposits in the interbank dealings popular in the world financial markets:-

Besides, LIBOR and MIBOR, some other interbank offered rates popular are : SIBOR (Singapore);  HIBOR (Hong Kong)

Can you name few products that are poular linked to LIBOR ?

Some products which are linked / bench marked / reference rated to LIBOR include,  Forward Rate Agreements, Interest Rate Futures, Interest Rate Swaps, Swaptions, Overnight Index Swaps, Interest Rate Options, Floting Rate Notes, Range Accrual Notes.

 What is LIBOR Scandal all about ?

We have seen above that LIBOR is the average rate (declared on daily basis) and is calculated based on the rates submitted by major international banks in London.  We have also seen that huge amount of transactions / deals, specially derivative deals, are benchmarked or have reference to LIBOR.    Thus, the daily mark to market valuation of such deals depends on the LIBOR and even settlement among banks / government is done by banks based on LIBOR.   In case LIBOR is manipulated, it will impact the valuation / settlement amount of huge volume of transactions across the world as LIBOR is widely used.

On 16th April, 2008, The Wall Stree Journal published an article which suggested that some banks seems to have understated their borrowing costs they reported for the LIBOR during 2008 credit crunch and this might have misled others about the financial position of these banks.  However, at that time, it was contradicted by banks and thus a lid was placed on this issue.   Later on a study by Srider and Youle in April 2010, once again came to light which corroborated the results of the earlier Wall Street Journal Study.   However, there was one difference that this study gave different reasons for this manipulation by banks.   These two economists suggested that the reason for understatement by member banks was not that the banks were trying to appear strong, especially during the financial crisis of 2007 and 2008, but rather they did it to make substantial profits on their large LIBOR inter linked portfolios.    Even a change of quarter percent would change valuation / profit of one bank to be tune of US$ 1000  million as banks had built huge derivative books.

Based on these, criminal investigations were started since 2011 and details started tumbling in 2012.  In February 2012, it was reported that US Department of Justice was conducting a criminal investigation into LIBOR abuse.   It came to light that traders were in direct communication with bankers before the rates were set, thus allowing them an unprecedented amount of insider knowledge into global instruments.  One of the traders from Royal Bank of Scotland agreed that it was common practice among senior employees at his bank to make requestes to the bank' s rate setters as to the appropriate LIBOR rate.    The magnitude of small tinkering can be seen from the message sent by a trader from Barclays Bank that for each basis point (0.01%), the involved could net "about a couple of million dollars"!.   Similarly, some investigations started in Canada and UK  too in 2011 and 2012.

On 27th June 2012, Barclays admitted to misconduct and thus UK's FSA imposed a 59.5 million pound penalty.  US Department of Justice and Commidity Futures Trading Commisison too imposed fines worth 102 and 128 million pound penalties .   Thus Barclays paid total of about 290 million pound as penalty.

On 31st July, 2012, Deutsche Bank confirmed that a "limited number" of staff were involved in the LIBOR rate rigging scandel, but it cleared the senior management of the charges. 

On 19 December 2012, UBS agreed to pay regulators $1.5bn ($1.2bn to the US Department of Justice and the Commodity Futures Trading Commission, £160m to the UK Financial Services Authority and 60m CHF to the Swiss Financial Market Supervisory Authority) for its role in the scandal.

Early estimates are that the rate manipulation scandal cost U.S. states, counties, and local governments at least $6 billion in fraudulent interest payments, above $4 billion that state and local governments have already had to spend to unwind their positions exposed to rate manipulation.

The British Bankers’ Association said on 25 September that it would transfer oversight of Libor to UK regulators, as proposed by Financial Services Authority Managing Director Martin Wheatley and CEO-designate of the new Financial Conduct Authority.    On 28 September, Wheatley's independent review was published, recommending that an independent organization with government and regulator representation, called the Tender Committee, manage the process of setting Libor under a new external oversight process for transparency and accountability

The FSA announced final proposals for new regulations on how financial market benchmarks are calculated, tightening requirements that information be more transparent.

Investigations and follow up is still going on, and more may come out in the coming months.

(Last updated on 26/3/2013)