MANG 6019 International Banking Semester 1

Lecture 1Lecture 1

International Banking:International Banking:An IntroductionAn Introduction

Richard A. WernerChair in International Banking

School of ManagementUniversity of Southamptone-mail: werner@soton.ac.uk

Tel. 023-8059-2549 Fax 023-8059-3844

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Crisis in International Banking

• London is often called the world centre of International Banking.

• Three years ago (September 2007), the first run on a bank in Britain in almost 100 years took place.

• This turned out to be the starting shot in a massive crisis in international banking, with many casualties, significant government money injections, and subsequent severe cuts of welfare spending and rises in taxes.

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…The British Bank Run of September 2007

• Northern Rock had to borrowed £27bn (as of end of 2007) from the Bank of England to replace deposits withdrawn by the public.

• As its financial position remained unsafe, it was nationalised in Feb. 2008.

• By the way, why did we mainly see pensioners in the queues outside Northern Rock branches?

• The Northern Rock business model had relied on funding up to 75% of its lending not from deposits, but money markets.• It had granted 125% (L/V) mortgages, which are now becoming non-performing, and had been securitising them (e.g. via asset backed commercial paper, ABCP).• Money markets and securitisation markets dried up suddenly in August 2007.

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…The British Bank Run of September 2008

• The bank Bradford and Bingley, specialising in mortgages in the the UK (especially to ‘buy-to-let’ investors) was nationalised in September 2008

• As the UK housing market turned down sharply in 2008, the bank’s stock fell sharply (93% in one year) and counterparties refused to lend it money.

• In October 2008, the government announced that it would inject up to £500 bninto the British banking system, partially nationalising all banks, including the top high-street banks Lloyds TSB, Barclays, Royal Bank of Scotland.

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The American and European Financial Crisis 2008Casualty List: Major Financial Institutions

as of 20 October 2008

USABear Stearns CompaniesWashington MutualMerrill LynchLehman BrothersWachoviaFannieMaeFreddieMacIndymacBankAIG

UKNorthern RockBradford & BingleyHBOS plcLloyds TSBRoyal Bank of Scotland(incl. NatWest)

GermanyIKBHypo Real Estate BankHSH NordbankBayern LB

BelgiumDexia (2008 & 2011)Fortis Bank

IcelandGlitnirLandsbankiKaupthing

SwitzerlandUBS

IrelandAllied Irish Bank (5 Oct 2010)

Finance Minister Lenihan said that, “There will be a very substantial spike in Ireland’s General Government Deficit in 2010 as a result of the capital support that we are providing to our banking system, totalling almost 20% of GDP.

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The American and European Financial Crisis 2008Casualty List: Incl. minor financial institutions

6 October 2011

USA

http://graphicsweb.wsj.com/documents/Failedhttp://graphicsweb.wsj.com/documents/Failed--USUS--Banks.htmlBanks.html

386 banks have gone bust between Jan. 2008 and Sept. 2011

The bank bailouts have sharply increased fiscal deficits and government debt.

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The level of national debt: USA

• On 9 October 2008, ‘National Debt Clock’ ran out of digits: the debt exceeded $10,000,000,000,000 for the first time (WSJ).

• On 29 October 2008 (12:05am GMT) US national debt had reached $10,528,921,429,385.68 = $34,527.62 per capita

• Last night, three years later (6 October 2011, 21:50 hrs) it had reached$14,805,252,500,000 (up by 4 trillion dollars)= $47,394 per capita (and counting)

• National debt increased by $4bn per day in the past years

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• The UK general government debt stood at GBP 614.4 bn in March 2008, equivalent to 43.2% of GDP.

• Three and a half years later, this ratio has now reached 82.3% of GDP.

• Public sector borrowing has been rising at the fastest pace since records began in 1946.

• The UK external debt to GDP ratio peaked at 425% a year ago and is now at 385% (Greece: 200%; Ireland: 1101%).

• Look up http://www.usdebtclock.org/• http://www.usdebtclock.org/world-debt-clock.html

The level of national debt: UK

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What is International Banking?

• The business undertaken by banks across national borders and/or activities that involve the use of different currencies (Casu et al., 2006).

• Traditional foreign banking and Eurocurrency banking (Lewis and Davis,1987, p.221).– Traditional foreign banking: transactions with non-residents in domestic

currency that facilitates trade finance and other international transactions.

– Eurocurrency banking: banks undertake wholesale foreign exchange transactions (loans and deposits) with both residents and non-residents.

– Thus international banking includes: financing trade, transacting foreign exchange business and making wholesale (large) short-term Eurocurrency loans and deposits.

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What is International Banking?

• But: the above can be conducted in one country (e.g. UK) withoutforeign presence; thus sometimes a new term is used to describe banks’business in many countries abroad: multinational banking

• Multinational banking requires some form of foreign direct investment(FDI) by banks in overseas markets reflecting physical presence, similar to other multinational businesses. In practice, multinational banking is used synonymously with international banking.

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History of International Banking

• International banking is 5,000 years old: use of letters of credit, bills of trade/exchange across sovereign boundaries (Mesopotamia).

• Multinational banking is more recent: 550 years (since 15th century, Italian bankers, Medici in Florence) established subsidiaries or foreign

branches to finance trade and military ventures.

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History of International Banking

Modern international banking: • First phase: it started with the British Empire and its colonialism.

– Branches in Australian, Caribbean and North American colonies inthe 1830s.

– By end of 19th century: British bank operations in South Africa, Latin America, India, East Asia, Middle East, Europe

– ‘colonial banks’/’British overseas banks’/’Anglo foreign banks’– In latter part of 19th century also expansion of other European banks

abroad (Belgian, French, German banks): more similar to modern international banking expansion

– But London remained No. 1 financial and banking centre in the world until WWI.

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History of International Banking

• Second phase: late 1950s to mid-1960s: rise of US internationally active firms, shift of US banking to London (Eurodollar market).– Bretton Woods system: US dollar linked to gold ($20 per troy

ounce), and most currencies fixed to US dollar (fixed exchange rate system).

– Regulations on US banks in the US (regulation Q limiting depositinterest rates; reserve requirements)

– No such regulations if US banks set up in London. Why London? Americans could speak the language (mostly); London had good financial infrastructure as former global financial centre

– But: US could create dollars and expand abroad aggressively– Until: France objected to le défi Americain; French raid on Fort

Knox; the end of the Bretton Woods system in 1971

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History of International Banking

• Rise of Japanese and German international banking in 1980s• Rise of Chinese international banking since

History suggests that military might, current account surpluses and influence over an international exchange rate system are significant factors in determining the rise of a nation in international banking

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Reading on International Banking

- BIS (2009) Quarterly Review: Statistical on banks’ cross-border activityHighlights of international banking and financial market activity, BIS Quarterly Review, September 2009, available at www.bis.org/quarterly.htm

- Economist (2007) Survey: Focus on investment bankingInternational Banking, The alchemists of finance, The Economist, 17 May 2007

- Aliber (1984) Survey: survey of theoretical and empirical workRobert Z. Aliber, International Banking, A survey, Journal of Money, Credit and Banking, vol. 16, no. 4 (November 1984, Part 2), pp. 661-695 (including discussions about it)

- Brown and Skully (2003) Survey: survey of empirical workKym Brown and Michael Skully, International studies in comparative banking: A survey of recent developments, 2003; downloadable at SSRN network, abstract ID: 365920

- Batten and Szilagyi (2011) Int’l Banking in East Asia

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Economist (2007) Survey (I)

• Financial and banking crises are a common occurrence; - ‘Panic of 1907’ in the US- ‘Asian crisis’ in 1997- 1998 Russia default and LTCM crisis

• Political power of international bankers (Rothschild, Baring): ‘true Lords of Europe’

• London the leading centre of international banking activities: “London is New York, Chicago, Houston and Washington DC rolled into one” (Michael Klein, Citigroup), since it trades the assets of the first three and is regulated on the spot.

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Economist (2007) Survey (II)

• Greater scrutiny on international (investment) banks: - conflicts of interest; betting against clients?- massive payments (salaries and bonuses) and gains (IPOs, fees) to bankers-- how are these justified? -- ‘we are deploying our intellectual capital’

- exposed to significant risks that may affect everyone: increasingly betting theirown equity on the markets (proprietary trading)

- involvement with private equity and hedge funds.

• Maybe everything is fine:- increased use of credit derivatives (credit-default swaps, CDS, and collateralised debt obligations, CDOs)- Regulation: Basel 2 banking accord, due to come into force in the EU in January 2008, and a year later in the US

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Economist (2007) Survey (III)

• But: There has been an unusually benign economic environment: decreasing volatility in output growth and inflation (‘the great moderation’),measures of market volatility (VIX) at historical lows until early 2007.

• Perhaps the credit and economic cycles are dead?

Index Value: 21.35Trade Time:31 Oct. 07, 11:53AM ETChange: 2.82 (15.22%)

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BIS (2009) Survey (I)

• The BIS monitors banks’ international activities and provides statistics on international banking.

• Its ‘locational reporting system’ provides quarterly data on the international financial claims and liabilities of banks resident in 42 countries, in terms of instrument, currency, sector and vis-à-vis country. This can be used to estimate global bank credit flows.

• Its ‘consolidated banking statistics’ cover banks’ worldwide on-balance sheetclaims, on a worldwide consolidated basis, net of inter-office accounts. Breakdowns are available also on key off-balance sheet items, such as derivative contracts. 30 countries contribute the consolidated banking data. These can be used to measure the size of banks’ country and liquidity risk exposures.

• Definitions: A: cross boarder claimsB: Local claims of foreign affiliates in foreign currencyC: Local claims of foreign affiliates in local currencyD: Domestic claims in the reporting country

International claims = A + BForeign claims = A + B + C

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BIS (2009) Survey (II)

• Total international assets of international banks (BIS reporting) reached $37.4 trn in December 2007. By March 2009 this figure had dropped to $33.1 trn

• The domicile with the largest external banking assets was the UK, with $5.5 trn in March 2009 ($ 6.8 trn in 2007), followed by Germany with $ 3.1 trn ($ 3.6 trn) and the US $2.7 trn ($ 3.0 trn).

Overstretch? • In 2007, UK banks accounted for one quarter ($ 3.1 trn) of all external loans of banks to

the non-bank sector, followed by Japan (12.7%, $ 1.5 trn) and Germany (11.2%, $1.3 trn). • In 2009, the UK lead had shrunk to one fifth ($2.2 trn), followed by Japan (14%, $ 1.5

trn) and Germany (11.3%, $ 1.2 trn)

UK dominance continues in the area of foreign currency lending:• In 2007, UK banks accounted for 30.3% of all foreign currency bank assets, followed by

the Cayman Islands (9.6%), Japan (9.2%) and Switzerland (7.2%).• This had changed to the following in March 2009:

UK (28.0%), Japan (10.2%), Cayman Islands (10.1%), and Switzerland (5.2%).

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BIS (2007) Survey (III)

• In Q1 2007 alone, BIS reporting banks’ total gross cross-border claims rose by $2.2 trn, to $28.5 trn.

• This was the largest quarterly increase recorded. Annual growth was larger than 20%, for the first time since 1987.

• Breakdown: 74% of activity was due to greater inter-bank lending;

• Net flows also expanded in an ‘extraordinary’ way, again dominated by interbank flows

• Japanese residents sent funds to almost all regions (net outflow of $87 bn).

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Net Flow of Funds through the International Banking System

Total net flows Interbank net flows

Notice: net inflows from the UK to the US virtually offset by net outflows from the US to Switzerland, Caribbean and euro area, leaving only a small net inflow of $13 bn to the US.

Source: BIS (2007)

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Why so many cross-border bank flows?

• One important reason is autonomous decisions by investors; e.g. by US residents to invest in hedge funds in the Caribbean, or by Japanese residents investing abroad

• Another reason may be of an accommodating nature: to finance current account imbalances: US, Japan, Germany

• The other route to fund a current account deficit is via financial market flows: UK

• A third reason is banking flows to emerging markets and developing countries.

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External position and the international banking market

In billions of US dollars

Source: BIS (2007)

Net bank inflows to the US

US current account deficit

US case

Source: BIS (2007)

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External position and the international banking market

• International banks have increased their lending to Chinese banks: China has become a net banking borrower for the first time since 1999.

• Is this also driven by a current account deficit?

Chinese case

0

Source: Profit Research Center Ltd. (2007)

China: Trade Balance (Annual Moving Sum) and Exchange Rate with US$

-5000000

500000100000015000002000000250000030000003500000

80 82 84 86 88 90 92 94 96 98 00 02 04 06 080.01.02.03.04.05.06.07.08.09.010.0

Latest: Aug 2009

Yuan per US$US$ millions

Trade Balance (L)

Exchange Rate (R)

RESEARCH CENTER

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Aliber (1984) Survey (I)

• ‘International banking’ not clear as concept:

• There are few uniquely international institutions: international banks are a subset of domestic banks with many foreign offices.

• There are few uniquely international banking activities: even FX trading often involves domestic banks with few foreign branches.

• Three views of the definition of international banking:1. Based on borders: whatever is done abroad by a bank.2. Based on currencies: whenever foreign currencies or denominations involved3. Based on nationality of bank and customer: domestic banking if bank deals with local customer; international banking if with foreign customer

• Aliber follows second definition. Case in point: dollar-denominated transactions in London; they have more in common with US dollar transactions than local £

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Aliber (1984) Survey (II)

• Two aspects of the study of international banking:

I. Industrial Organisation: the study of the pattern of expansion of internationally active banks, and their advantage over local ones.

II. International Finance: the study of the role of banks in cross-border and cross-currency financial flows, from HQ and foreign offices.

• Aspect I.: Apply international trade theory to international banking; use theory of foreign direct investment (FDI) to formulate a ‘theory of international banking’.

Question: Is the pattern of international banking random or systematic w.r.t.size or number of banks headquartered in different countries?

If non-random, then new question: what are the factors that explain ownership patterns in international banking?

• A likely answer may involve the availability and cost of attracting capital.• Next question: is the reason for this due to the specific bank, or to the country?

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Aliber (1984) Survey (III)

Theory of International BankingGravitational pull effect• (Metais, 1979): banks follow their customers abroad, to offer services that local

banks might not be able to offer.- but why, if local banks offer competitive services?- new rationale: because they do not want to lose the business of their customers;

• Caves (1977): banks’ close link with a group of firms is one differentiated product

Competitive advantage:• Aliber (1976): banks used to a competitive environment (narrow deposit/loan rate

spreads) have developed low-cost technologies for intermediation and thus find it profitable to expand abroad. See also Giddy (1981), Grubel (1977)

• Gray and Gray (1981): Dunning’s theory of production, combining ownership-specific and location-specific advantages.

But: these theories find it hard to explain the rapid growth of European and Japanese international banking since the 1970s.

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Aliber (1984) Survey (IV)

Empirical Evidence on the Expansion of International BankingSurvey of studies until 1983. ‘No significant conclusion can be made from these studies…’

Regulation and the Structure of International Banking

Profitability, the Cost of Capital and the Structure of International BankingExample of Japanese bank expansion in the US since the early 1980s. Lower cost of capital? Higher profitability?But: empirical studies have found that Japanese, British and German banks were only

marginally profitable by international comparisonAliber: Q ratios (market value of the firm/book value) might explain this. Ultimately

this means: higher bank stocks in their home country, which itself is determined by the situation of the domestic asset markets.

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Aliber (1984) Survey (V)

Aspect II: International Finance and the Role of International Banking

1. International Banks and the International Payments Process

Costs: Frenkel and Levich (1977), Aliber (1983)RisksDetails of settlement rules and accounting/booking practices little researched!

2. International Banks and International Capital FlowsExternal debt of developing countries increasingDebt servicing problems due to balance of payments problemsOver-commitment by banks (Guttentag and Herring, 1983) Faulty country risk/creditworthiness evaluations? (Friedman, 1977, 1979)Redistribution of income? (Agmon and Dietrich, 1984)Large losses by international banks inevitable… so why do they do it (again & again)?

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Aliber (1984) Survey (VI)

Aspect II: International Finance and the Role of International Banking

3. Lender of Last Resort in International ContextHerstatt Bank failure in the 1970s raised issue of who is the lender of last

resort for international banks?Kindleberger (1978): worldwide financial collapse of early 1930s due to lack

of suchIMF? US Fed? BIS?

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Bank Internationalisation in East Asia

Bank internationalisation during the Global Financial Crisis: An Asia Pacific perspective Jonathan A. Batten, Hong Kong University of Science & Technology & Peter G. Szilagyi, University of Cambridge

Abstract Bank internationalisation traditionally takes the form of lending to non-residents, but increasingly non-resident securities are purchased. These assets are funded mostly by international loans and deposits, rather than the issuance of securities. Within the Asia Pacific region, the largest net beneficiaries of international bank funding to developing economies are China, India and South Korea. Importantly, apart from the financial centres of Hong Kong and Singapore, which show significant outward as well as inward banking flows, Chinese Taipei is an important international lender. Australia and New Zealand remain significant net international borrowers. The Global Financial Crisis reversed earlier developments with China and Japan now becoming net international borrowers, while both Hong Kong and Singapore have reduced their net asset positions.

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Casu et al. (2006), Introduction to BankingChapter 4

Why banks go abroad: Theories1. FDI literature reasons: factor prices and trade barrier theories explaining vertical

and horizontal FDI, respectively. (The latter more relevant to banking)2. Arbitrage and the cost of capital reasons: banks of countries with strong currency

buy banks/expand in countries with weak currency (but: why do banks expand in markets with same currency? Why opposite direction of bank expansion between two countries?

3. Ownership advantages: technological expertise, marketing know-how, production efficiency, managerial expertise, innovative product capability;

4. Diversification of earnings5. Excess managerial capacity 6. Location and the product life cycle: 1. innovation; 2. maturing product; 3.

standardised product; After innovation at home, banking taking abroad in phase 27. Location advantages; group together in financial centres to benefit from

proximity to large FX markets

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Casu et al. (2006), Introduction to BankingChapter 4

Why banks go abroad: Other strategic reasons

1. Customer-seeking strategies

2. Obtaining a foothold strategy

3. Follow the leader strategy

4. Customer-following strategies

5. Performance and efficiency advantages

6. Managerial motives

7. Government motives (regulation, deregulation)

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Brown and Skully (2003):Survey of Empirical Work on International Banking

- Survey of 170 international comparative banking studies

- Goal is to identify research gaps and trends

- Central themes covered: competition, contestability, efficiency, performance, regulation, financial crises, structure, restructuring, mergers and acquisitions, and risk

- Opportunities for future research:

- replication studies outside the European region, esp. developing countries- Studies about impact of regulatory changes (before/after)- Revisiting previous studies with improved methodologies and better data

sources

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LIBOR

London Interbank Offered Rate

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London Interbank Offered Rate

Average rate at which banks loan to

one another

LiborFED

HistoryWhy Libor Matters

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Libor Calculation16 Banks

10 Currencies

LiborFED

HistoryWhy Libor Matters

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Higher spreads

Source: Historical data

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Commercial Banks

Federal Reserve

(Central Banks)

Market Conditions

Market Conditions

PR

EM

IUM

LiborFED

HistoryWhy Libor Matters

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The Credit Crunch

Washington Mutual Barclays Capital

Citigroup Lehman Brothers

Merrill Lynch UBS

Market Conditions

Market Conditions

LiborFED

HistoryWhy Libor Matters

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Crisis Cycle ?

LiborFED

HistoryWhy Libor Matters

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Not US - Exclusive

LiborFED

HistoryWhy Libor Matters

LEGEND:CURRENT Sept 2007

Dec 2007

LEGEND:CURRENT Sept 2007

Dec 2007

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Why the Libor Matters• Borrowing

– Short-term interest rates– Forward rate agreements– Syndicated loans– Variable rate mortgages

• Financial Instruments– Derivatives - futures, forwards, options, and swaps.– Floating rate notes

• Currencies

Source: WSJ, Apr 2008

LiborFED

HistoryWhy Libor Matters

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IMPACT OF SPREAD

Borrowing CostsMortgage RatesBank ProfitsCounter Fed

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Borrowing Costs

• Borrowers v. Lenders• Businesses v. Consumers

Borrowing CostsMortgage Rates

Bank ProfitsCounter Fed

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Mortgage Rates

FED: 47 % Decrease

Mortgage Rates: 10% Increase

Borrowing CostsMortgage Rates

Bank ProfitsCounter Fed

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MARKET MANIPULATION?

Borrowing CostsMortgage RatesBank ProfitsCounter FedImpact of Spread

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MARKET MANIPULATION?Twelve banks worldwide sued for manipulating LiborTue, Apr 19 2011* 12 banks said to conspire to keep Libor artificially low* Class-action status, unspecified damages sought* US regulators eye possible manipulationNEW YORK, April 19 (Reuters) - A European asset manager has sued one dozen U.S., European and Japanese banks, accusing them of conspiring to manipulate Libor, a benchmark used to set interest rates on hundreds of trillions of dollars of securities.Vienna-based FTC Capital GmbH and two funds it operates in Luxembourg and Gibraltar accused the banks of conspiring to artificially depress Libor, and limit trade in Libor-based derivatives from 2006 to 2009.The defendant banks include Bank of America Corp (BAC.N), Barclays Plc (BARC.L), Citigroup Inc (C.N), Credit Suisse Group AG (CSGN.VX), Deutsche Bank AG (DBKGn.DE), HSBC Holdings Plc (HSBA.L), JPMorgan Chase & Co (JPM.N), Lloyds Banking Group Plc (LLOY.L), Norinchukin Bank, Royal Bank of Scotland Group Plc (RBS.L), UBS AG (UBSN.VX) and WestLB AG.

Libor, whose full name is the London Interbank Offered Rate, is a measure for rates that banks charge each other, and is used worldwide as a short-term rate benchmark. About $350 trillion of derivatives and other financial products are based on Libor. Small changes in the rate can have large impacts on the amounts of interest that can be charged.

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MARKET MANIPULATION?

FTC said the 12 banks colluded to suppress Libor to make them appear healthier than they were, and take advantage of trading opportunities not available to outside investors.

"During the most significant financial crisis since the Great Depression, U.S. dollar Libor rates submitted by contributor banks did not vary markedly, nor did they increase or decrease sharply," FTC said in its complaint filed Monday in the federal court in Manhattan. "In a market not artificially suppressed, Libor rates should have increased significantly during this period," FTC added. "In addition, because different banks were experiencing different levels of severe stress, the banks should have been receiving markedly different borrowing rates.“Citigroup spokeswoman Danielle Romero-Apsilos said: "The lawsuit is without merit." Bank of America spokesman Lawrence Grayson, Credit Suisse spokesman Steven Vames, JPMorgan spokeswoman Jennifer Zuccarelli and Lloyds spokeswoman Sarah Swailes declined to comment.

Representatives of the remaining banks declined to make an immediate comment or could not immediately be reached for a comment. U.S., British and Japanese regulators are examining whether major banks understated Libor to reduce their borrowing costs and the potential for investor panic, a person familiar with the matter said last month. The case is FTC Capital GmbH et al v. Credit Suisse Group AG et al, U.S. District Court, Southern District of New York, No. 11-02613. (Reporting by Jonathan Stempel in New York, editing by Maureen Bavdek) © Thomson Reuters 2011. All rights reserved.

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MARKET MANIPULATION?Charles Schwab Bank, N.A. v. Bank of America CorporationOn August 23, 2010, The Charles Schwab Corporation and certain affiliates filed a lawsuit against Bank of America Corporation, Credit Suisse Group AG, J.P. Morgan Chase & Co., Citibank, Inc., and additional banks for allegedly manipulating the London Interbank Offered Rate ("LIBOR").

Libor manipulation lawsuits hit banksDuncan Wood, Asia Risk | 02 Aug 2011 At least 12 lawsuits alleging manipulation of Libor have been filed since April, and six different authorities – including the US Department of Justice – are investigating. But how would manipulation work in practice, and is there any evidence of it so far?

The banker is angry. He raises his voice, waves his hands in the air and – at one point – slaps the desk in front of him. “I know for a fact it wasn’t real – Libor wasn’t real in 2007 and 2008. I know for a fact that some banks were putting in artificially low rates. I still find it hard to believe someone would deliberately do that, but if they did, that person shouldn’t work in banking,” he says.

For something that sounds so mundane, Libor – a daily average of the borrowing rates for a panel of banks, which is referenced in an estimated $350 trillion of financial products, including deposits, loans, bonds and swaps – angers people.

The banker’s frustration comes from his time working in the treasury department of a large, AA-rated European bank during the early stages of the crisis. When his employer at the time sought to borrow from similarly rated Libor panel banks, it was quoted rates that were 20–30 basis points away from the levels the banks had provided earlier that day to the British Bankers’ Association (BBA), which manages the Libor process, he says.

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MARKET MANIPULATION?One of the treasury official’s former colleagues still works on that bank’s money markets desk and remembers it the same way. “We had internal lending obligations and had to hike the rates at which we would lend. We would say, ‘Look – we cannot physically borrow money here – if we quote you three-month Libor, we’d be losing half a percentage point immediately’. Libor was fictitious, irrelevant – no-one could borrow cash at those levels. And it was the same for everyone. It was absolutely the same for everyone,” he says.

These kinds of comments aren’t new. At the peak of the crisis, a number of analysts claimed Libor was too low, and a series of academics and economists looked into the issue – with varying results. The suspicion was that banks were claiming they could borrow at a lower level than they actually could – either because they wanted to appear more creditworthy or because they were hoping to drag down the average rate, increasing the value of listed and over-the-counter derivatives positions. Following a public consultation, the BBA made some changes to the Libor process in November 2008 – for example, adding three non-bank representatives to the 13 banks that sit on the foreign exchange and money markets (FX&MM) committee, which polices the Libor process –but questions about the benchmark’s truthfulness haven’t gone away. Now, definitive answers are coming.

On March 15, UBS revealed it had received subpoenas from the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and the US Department of Justice as part of an investigation into whether the bank – acting alone or with others – had tried to manipulate the Libor rate.UBS also disclosed it had received an order to provide similar information to Japan’s Financial Services Agency. Barclays, Lloyds Banking Group and Royal Bank of Scotland (RBS) have since confirmed they are targets of the probe. Their statements also reveal that the army of investigating authorities has grown to include the European Commission (EC) and the UK’s Financial Services Authority (FSA). Other banks, including Bank of America Merrill Lynch, Citi and Deutsche Bank, have also reportedly received subpoenas. All three declined to comment for this article.

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MARKET MANIPULATION?The UBS announcement was followed a month later by a lawsuit filed in the US District Court for the Southern District of New York by US law firm Kirby McInerney, on behalf of an Austrian fund manager and two of its funds. The suit named 12 banks – BoA Merrill Lynch, Barclays, Citibank, Credit Suisse, Deutsche Bank, HSBC, JP Morgan, Lloyds, Norinchukin Bank, RBS, UBS and WestLB – all of which are members of the panel for US dollar Libor. By June 24, at least 11 more cases – all alleging traders or pension funds had lost money because of Libor manipulation – had been filed in New York and Chicago courts. The process of consolidating these cases into a class-action suit will begin on July 28 with a hearing in San Francisco.

All this scrutiny is good news, says Thomas Youle, who co-wrote a paper on Libor published in April 2010, while he was a doctoral student at the University of Minnesota. “There is a fact of the matter here, which you could find out if you could just get access to the banks’ books, emails and so on. Libor is so important, so central, that people really should be thinking about this more, and I imagine these cases will go some way to resolving the question of whether manipulation was happening or not,” he says.

David Kovel, a New York-based partner at Kirby McInerney, is convinced it was happening. “The more you dig into the numbers, the more implausible they look. I’m not worried about proving that Libor was mis-priced – it was,” he says.

Read more: http://www.risk.net/asia-risk/feature/2098696/libor-manipulation-lawsuits-hit-banks#ixzz1a1MltDc3