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LIBOR Scandal

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  International Trade and Finance Assignment LIBOR scandal Pushpendra Vishal Kaushal E 07 Smita Mishra E 08 Sandeep Kumar E 09 Sudeep Sengupta E 10 Ravi Kumar Singh E 11 Jyoti Gaikwad E 12 What is LIBOR? LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate that some of the world‟s leading banks charge each other for short -term loans. It stands for Inter Continental Exchange London Interbank Offered Rate and serves as the first step to calculating interest rates on various loans throughout the world. LIBOR is administered by the ICE Benchmark Administration (IBA), and is based on five currencies: U.S. dollar (USD), Euro (EUR), pound sterling (GBP), Japanese yen (JPY) and Swiss franc (CHF), and serves seven different maturities: overnight, one week, and 1, 2, 3, 6 and 12 months. There are a total of 35 different LIBOR rates (number of currencies x number of different maturities) each business day. The most commonly quoted rate is the three-month U.S. dollar rate (usually referred to as the “current  LIBOR rate”).  ICE LIBOR was previously known as BBA LIBOR until February 1, 2014, the date on which the ICE Benchmark Administration (IBA) took over the Administration of LIBOR from The British Bankers‟ Association (“BBA”), a UK trade association responsible for banking and financial services. LIBOR is the world‟s most widely -used benchmark for short-term interest rates. It serves as the primary indicator for the average rate at which banks that contribute to the determination of LIBOR may obtain short-term loans in the London interbank market.   International Trade and Finance Assignment LIBOR scandal Pushpendra Vishal Kaushal E 07 Smita Mishra E 08 Sandeep Kumar E 09 Sudeep Sengupta E 10 Ravi Kumar Singh E 11 Jyoti Gaikwad E 12 LIBOR's primary function is to serve as the benchmark reference rate for debt instruments, including government and corporate bonds, mortgages, student loans, credit cards; as well as derivatives such as currency and interest swaps, among many other financial products.  LIBOR “represents the lowest real -world cost of unsecured funding in the London market.”   LIBOR is also used as a barometer to measure the health of the banking system and as a gauge of market expectation for future central bank interest rates. It is the basis for settlement of interest rate contracts on many of the world's major futures and options exchanges. Why LIBOR came into existence? LIBOR is equivalent to the federal funds rate, or the interest rate one bank charges another for a loan. The advent of LIBOR can be traced to 1984, when the British Bankers Association (BBA) sought to add proper trading terms to actively traded markets, such as foreign currency, forward rate agreements and interest rate swaps. LIBOR rates were first used in financial markets in 1986 after test runs were conducted in the previous two years. Today, LIBOR has reached such stature that the rate is published daily by the ICE at about 11:45am GMT. It is used as the key point of reference for financial instruments, such as futures contracts, the U.S. dollar, interest rate swaps and variable rate mortgages. LIBOR takes on added significance in times of tight credit as foreign banks yearn for U.S. dollars. This scenario usually sends LIBOR for dollars soaring, which is generally a sign of imminent economic peril. How is LIBOR calculated? ICE Benchmark Administration maintains a reference panel of between 11 and 18 contributor banks for each currency calculated. IBA currently fixes in the following five currencies: (1)   CHF (Swiss Franc) (2)   EUR (Euro) (3)   GBP (Pound Sterling) (4)   JPY (Japanese Yen) (5)   USD (US Dollar) The panel selects contributor banks based on (1)   Market activity (2)   Credit rating (3)   Expertise  International Trade and Finance Assignment LIBOR scandal Pushpendra Vishal Kaushal E 07 Smita Mishra E 08 Sandeep Kumar E 09 Sudeep Sengupta E 10 Ravi Kumar Singh E 11 Jyoti Gaikwad E 12 Every contributor bank is asked to base their ICE LIBOR submissions on the following question: “At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size  just prior to 11 am London time?”   Therefore, the submissions are based upon the lowest perceived rate at which a bank could go into the London interbank money market and obtain funding in reasonable market size, for a given maturity and currency.  “Reasonable market size” is intentionally unquantified: it would have to be constantly monitored and in the current conditions would have to be changed very frequently. It would also vary between currencies and maturities, leading to a considerable amount of confusion. All ICE LIBOR rates are quoted as an annualised interest rate. This is a market convention. For example, if an overnight Pound Sterling rate from a contributor bank is given as 2.00000%, this does not indicate that a contributing bank would expect to pay 2% interest on the value of an overnight loan. Instead, it means that it would expect to pay 2% divided by 365. Every ICE LIBOR rate is calculated using a trimmed arithmetic mean. Once each submission is received, they are ranked in descending order and then the highest and lowest 25% of submissions are excluded. This trimming of the top and bottom quartiles allows for the exclusion of outliers from the final calculation. Calculation method NUMBER OF CONTRIBUTORS METHODOLOGY (Values excluded) NUMBER OF CONTRIBUTOR RATES AVERAGED 18 Contributors Top 4 highest rates, tail 4 lowest rates 10 17 Contributors Top 4 highest rates, tail 4 lowest rates 9 16 Contributors Top 4 highest rates, tail 4 lowest rates 8 15 Contributors Top 4 highest rates, tail 4 lowest rates 7 14 Contributors Top 3 highest rates, tail 3 lowest rates 8  International Trade and Finance Assignment LIBOR scandal Pushpendra Vishal Kaushal E 07 Smita Mishra E 08 Sandeep Kumar E 09 Sudeep Sengupta E 10 Ravi Kumar Singh E 11 Jyoti Gaikwad E 12 13 Contributors Top 3 highest rates, tail 3 lowest rates 7 12 Contributors Top 3 highest rates, tail 3 lowest rates 6 11 Contributors Top 3 highest rates, tail 3 lowest rates 5 Thomson Reuters, a financial data and news provider, acts as the LIBOR collection agent. Each business day, it collects the submissions from the banks Once collected, the collection agent discards the highest and lowest 25% of submissions and averages the remaining submissions, in order to prevent individual banks from manipulating LIBOR. Importantly, banks should not base submissions on “the pricing of any derivative financial instrument,” but rather on the banks‟ cash.  Banks often tie derivatives contracts to LIBOR, which creates an incentive for banks to submit false rates to move LIBOR in their favor. Panel Composition BANK/CCY   USD   GBP   EUR   CHF   JPY   BANK OF TOKYO-MITSUBISHI UFJ LTD LLOYDS TSB BANK PLC BARCLAYS BANK PLC BNP PARIBAS SA, LONDON BRANCH CITIBANK N.A. (LONDON BRANCH) CRÉDIT AGRICOLE CORPORATE & INVESTMENT BANK CREDIT SUISSE AG (LONDON BRANCH) DEUTSCHE BANK AG (LONDON BRANCH) HSBC BANK PLC JPMORGAN CHASE BANK, N.A. LONDON BRANCH BANK OF AMERICA N.A. (LONDON BRANCH)

Group 7 - Steering

Jul 23, 2017
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