note: This article, by Professor Philip Booth, editorial and program
director at the Institute of Economic Affairs, the UK free-market think
tank, examines some of the underlying issues that arise following the
recent scandals concerning the LIBOR interbank interest rate system.
While we understand that investigations are ongoing and more banks may
be punished following the fines on Barclays, it is important at this
stage to explore some of the issues beneath the headlines. The financial
products sold to wealth management clients are, in part, linked to the
LIBOR system. This publication should stress that while it does not
necessarily endorse all the opinions expressed here, it is delighted to
share these insights. Please do respond with your views.
Last week a major scandal came to light in the UK with regard to
setting of LIBOR, which is the interest rate at which banks lend to each
other. It would appear that this rate, which is a useful index of
short-term interest rates by which interest rates on other contracts
(including mortgages) are set, was manipulated by traders in a
particular financial institution. Presumably this was done for their own
gain – at the expense of others who were counterparties to the
There have been the predictable calls for regulation. The French
said that this is a problem of rampant Anglo-Saxon capitalism which
needs regulating – ignoring the fact that EURIBOR uses a more or less
identical system. Mark Hoban – the relevant government minister – has
said both that this is a moral problem and that LIBOR should be
regulated. Others have said that the problem is that we have
nationalized central banks setting interest rates. Still elsewhere, it
has been suggested that the problem is that we have a banking cartel and
we need more competition.
The latter two positions have been taken by respected
commentators, but I don’t think they are correct. Certainly, central
banks distort LIBOR. They do this both because they determine
very-short-term interest rates which feed into LIBOR indirectly and also
because they try to smooth liquidity in the market. However, even if
central banks did not do this, there would probably be a need for
something like LIBOR as a base interest rate that is used to set
interest rates on other financial transactions. In fact, LIBOR is a very
useful market instrument because it means that banks can lend to and
take deposits from customers at a rate which is always related to an
objective and transparent market interest rate. Customers can be sure
that they will not get taken for a ride. At the same time, the bank will
know that it can always get funding for or make deposits at roughly
that rate. Without LIBOR long-term, floating-rate mortgages would be
that much more risky.
The bank cartel argument is also something of a red herring. Yes,
is true that the smaller the number of banks, the easier it is to
manipulate the rate, but there are 16 banks on the sterling LIBOR panel,
so the cartel argument is stretching things somewhat.
However, the main threat comes from those who only have the
regulatory hammer and think that regulation is the only solution to any
Older readers may remember the Maxwell scandal. This was a case
theft from a pension fund. Not surprisingly, theft of hundreds of
millions of pounds is illegal. But, the UK government thought that,
rather than making some simple changes to primary legislation to make
theft less likely (for example, by having more independent trustees
within pension funds), they would regulate defined-benefit pension
schemes. Older readers might also remember private-sector,
defined-benefit pension schemes. Younger readers cannot join them
anymore because the regulation hammer (and some other factors) led to
the vast majority closing down.
We must be careful with regard to the LIBOR scandal. The
Bankers Association (BBA) is, in a sense, a private regulator for LIBOR
and the government seems to be using this as an excuse for castigating
the private sector and bringing in government regulation. However,
private regulation has an excellent history, and government regulation
certainly has not proven itself superior in the financial sector.
We should resist arguments for more government regulation of
neither government nor private regulation can bring about perfection.
But we also need to point out any disingenuous statements from the
proponents of government regulators given that the BBA states: "As all
contributor banks are regulated, they are responsible to their
[government] regulators, rather than BBA LIBOR Ltd or the FX&MM
Committee, for maintaining appropriate procedures for contributing,
including the maintenance of internal chinese walls."
But, surely, the main problem is not regulation in any case.
Britain’s strict libel laws, I need to tread carefully. However, if what
has happened is not fraud (and it is not being prosecuted as such at
the moment) it ought to be. We do not need a specific government
financial regulator to prosecute fraud and theft.
Secondly, as the minister has said, there is a moral and
issue here. Regulation is the wrong tool to deal with moral and cultural
We have a confused regulatory system here. Instead of blaming
regulation we should perhaps go the whole hog and remove government
regulation from the picture. LIBOR is a private arrangement and the
banks that set it have the strongest incentives to keep it honest. The
government should stick to prosecuting fraud. The private sector
institutions that have an interest in LIBOR should club together and
make sure that they impose the strongest possible penalties on those
that disobey the letter or the spirit of the LIBOR regulations set by
Something like ‘my word is my bond’ would be a good start and,
someone’s word proves not to be their bond then the sanctions –
administered by the club itself – should be severe. Indeed, the market
sanctions have been severe already. Barclays’ share price is down 15 per
cent. We cannot expect perfection and to avoid all incidents within
financial markets, but this seems like a good feedback mechanism to me.