British bank Royal Bank of Scotland Plc announced Feb. 6 that is has entered into a deferred prosecution agreement with regulators in the United States and the United Kingdom. It will settle an investigation into manipulating LIBOR interest rates.
“The Royal Bank of Scotland [RBS] Board acknowledges that there were serious shortcomings in our systems and controls and also in the integrity of a small group of our employees. This is a sad day for RBS, but also an important one in continuing to put right the mistakes of the past. We have to fix the culture in the banking industry,” said Philip Hampton, RBS chairman.
An investigation by the Commodity and Futures Trading Commission (CFTC) found that RBS manipulated the London Interbank Offered Rate (LIBOR), a benchmark interest rate for interbank lending that an elite circle of megabanks set through a bidding process in London.
Because it determines these banks’ funding costs to a large degree, other interest rates such as home mortgages are priced according to LIBOR. The CFTC found that RBS attempted to manipulate LIBOR in the Swiss franc and Japanese yen market, acting by itself and by colluding with other banks.
“As recently as 2010 and dating back to at least mid-2006, RBS made hundreds of attempts to manipulate yen and Swiss franc LIBOR, and made false LIBOR submissions to benefit its derivatives and money market trading positions; RBS succeeded at times in manipulating Yen and Swiss Franc LIBOR,” reads a statement by the CFTC.
RBS agreed to a deferred prosecution agreement with U.S. regulators and will pay $325 million to the CFTC, $150 million to the Department of Justice, and 87.5 million pounds ($137 million) to the U.K.’s Financial Services Authority.
RBS LIBOR Bids Supported Derivative Bets
The CFTC asserts that RBS traders used LIBOR to benefit their derivative positions. Normally, the person charged with tendering the LIBOR bid in the price-setting process should be independent. They need to take into account only the bank’s funding needs and costs as well as its potential to loan out excess capital. In RBS’s case this was different as derivative traders sat next to people responsible for tendering RBS’s LIBOR bids.
“RBS traders would ask their colleagues to make false LIBOR submissions that were beneficial to RBS’s trading positions,” says the CFTC’s statement, admonishing that there was no process in place to separate LIBOR submitters from other traders. Despite the complaint that the bank did not do much to inhibit such behavior, regulators did not find that upper management or RBS as a whole encouraged or knew of this behavior.
“None of the regulators in question concluded that RBS, as a firm, had engaged in any deliberate misconduct,” says RBS. RBS head of the investment bank John Hourican resigned in the wake of the scandal.
Damage to General Public
“The integrity of LIBOR depends on truthful information provided by a select group of some of the world’s most important banks. The public is deprived of an honest benchmark interest rate when a group of traders sits around a desk for years falsely spinning their bank’s LIBOR submissions, trying to manufacture winning trades. That’s what happened at RBS,” said David Meister, the CFTC’s director of enforcement.
Given its widespread use, borrowers and lenders alike claim they have suffered damages.
About $10 trillion of loans and swaps (a derivative contract) with a notional value of about $350 trillion are linked to LIBOR, according to the British Bankers’ Association. Futures traded on the Chicago Mercantile Exchange with a notional value last year of more than $560 trillion, are also priced off LIBOR, according to the CFTC.
Berkshire Bank, which has 11 branches in New York and around $881 million in assets sued the 16 banks involved in the scandal in July 2012, including RBS. It claims that artificially low LIBOR rates deprived it of interest income, the Wall Street Journal reports.
On the other side of the lending business are U.S. homeowners who filed a class action lawsuit in October 2012, according to the Financial Times. The homeowners claim that artificially high rates made mortgage costs more expensive than normal.
Since big banks’ derivative bets can go both ways, it makes sense that traders would try influence LIBOR to be higher on some days and lower on others. “The traders’ requests were either for falsely high submissions or falsely low ones, whatever was needed to turn a profit,” according to the CFTC report.
“It’s just amazing how LIBOR fixing can make you that much money,” one trader said in an internal chat.
RBS said that most of the 21 people found to have committed wrongdoing, have either left the organization voluntarily, have been dismissed, or are undergoing disciplinary action.
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