10 Apr 2017
What do we know so far?
A recording discovered by the BBC’s flagship investigative programme Panorama has added to a growing body of allegations that the UK’s central bank pressured commercial banks to lower their Libor submissions during the 2008 financial crisis.
The recording is of a phone call between senior Barclays manager Mark Dearlove and the bank’s Libor submitter Peter Johnson. Dearlove tells Johnson to lower the bank’s Libor submission, which Johnson questions, saying that this would be pushing the figure below a ‘realistic level’. Dearlove responds:
“The fact of the matter is we’ve got the Bank of England, all sorts of people involved in the whole thing… I am as reluctant as you are… these guys have just turned around and said just do it.”
Didn’t we know this already?
Manipulation of Libor rates by commercial banks during and after the 2008 financial crisis is well documented. Allegations of the Bank of England’s involvement have surfaced before, but until now little has been offered by way of evidence.
How does Libor differ from the Bank of England interest rate?
The Bank of England’s Monetary Policy Committee meets eight times a year to review the Bank Rate, the rate of interest the Bank of England pays on the reserve balances it holds for commercial banks and building societies. This acts more as a signal than a direct lever, nudging financial institutions to adjust the rates they offer to customers.
Libor, the London Interbank Offered Rate, is the benchmark rate that some of the world’s leading banks charge one another for short term loans. It is the first step in calculating interest rates on loans to customers, including mortgages and student loans, and as such is considered one of the most important interest rates in finance.
Libor is calculated by averaging daily submissions from a group of major banks of the rate at which they think they can borrow money from other banks. There are 150 Libor figures in total, reflecting loans of 15 different time periods in 10 different currencies.
By ‘lowballing’ Libor – making unrealistically low submissions – the average rate is brought down. Banks use the benchmark to set their rates, so if the reported average goes down, the true cost of interbank lending may drop in turn.
Why would the Bank of England want lower Libor rates?
The primary responsibility of a central bank is to manage interest rates. Lower rates make saving less attractive and reduce the cost of debt. This encourages spending, which is critical in a recession.
As explained above, the Bank of England sets the Bank Rate—but this only works as a signal to commercial financial institutions. Artificially lowering Libor, on the other hand, could reduce interest rates more directly.
In addition, a lower Libor rate reduces stress on banks. The cheaper banks think money is to borrow, the less of their own cash they need to hold in reserve. On top of that, if money is cheaper to borrow, banks are in less trouble when they have a bad day and need liquidity at short notice.
In the run up to the 2008 financial crisis, when the bankruptcy of Lehman Brothers and near collapse of other major banks caused an acute shortage of liquidity, Libor rates rose sharply.
Lower Libor rates would imply that banks were more confident and that the UK economy as a whole was stronger than it really was.
What makes the allegations against the Bank of England so significant?
The Bank of England performs multiple roles as regulator, policy authority and, ultimately, a guarantor of the strength and legitimacy of the UK economy. Artificially manipulating commercial lending rates is antithetical to the way such an institution should behave.
Millions of global contracts are priced with reference to Libor. Almost everyone in the UK, for example, has a pension, mortgage or student loan, all of which are affected by Libor. Tinkering with the rate has implications for an unknown number of people, potentially pushing up the repayments on money they’ve borrowed or cutting returns on their savings.
Manipulating the Libor rate could paint an inaccurate picture of the strength of the UK economy. The involvement of the Bank in such a process would be corrosive to public and investor trust in the probity of UK institutions.
If the allegations against the Bank of England are substantiated, the individuals responsible will have been guilty of an extremely serious breach both of regulatory duty and the law.
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