Regulators Didn't Know What Libor Was In 2008, Even As They Were Being Warned Of Fraud

Regulators Didn't Even Know What Libor Was
A view of London's City financial district, Friday, June 29, 2012. Britain's financial regulator says the country's four biggest banks have agreed to a settlement for mis-selling interest-rate protection products to small and medium-sized businesses.The Financial Services Authority said Friday that Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland have all agreed to provide redress to victims of mis-selling.The FSA says that some 28,000 interest rate protection products have been sold to businesses since 2001. It gave no estimate of how many customers would be entitled to redress, or how much it would cost the banks.(AP Photo/Lefteris Pitarakis)
A view of London's City financial district, Friday, June 29, 2012. Britain's financial regulator says the country's four biggest banks have agreed to a settlement for mis-selling interest-rate protection products to small and medium-sized businesses.The Financial Services Authority said Friday that Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland have all agreed to provide redress to victims of mis-selling.The FSA says that some 28,000 interest rate protection products have been sold to businesses since 2001. It gave no estimate of how many customers would be entitled to redress, or how much it would cost the banks.(AP Photo/Lefteris Pitarakis)

Banking regulators in the United Kingdom did not fully understand how the global interest rate-setting system worked back in 2008, even as they were being told the system was a fraud, a report by the British Financial Services Authority out Tuesday shows.

Their lack of deep knowledge on the subject appears to have contributed to the regulators' approach during their 2008 investigation of the process used to set the London Interbank Offered Rate, or Libor. Regulators trod lightly when considering what to do about improprieties they found, going so far as to dismiss the Libor-setting process as "not a regulatory activity" they needed to concern themselves with.

The FSA did eventually conduct a deep probe of the issue in 2012, resulting in multimillion-dollar fines for a host of European banks, including Barclays, UBS and the Royal Bank of Scotland.

The new report by the main British markets regulator was issued after pressure from lawmakers to explain why it took until last year for banks that rigged Libor to be penalized, even though press reports dating back to 2008 suggested manipulation was rampant.

“The FSA did not respond rapidly to clues that low-balling might be occurring,” Adair Turner, the FSA's chairman, said in a press release, which noted "the FSA's bank supervisors were primarily focused on ensuring they understood the prudential implications of severe market dislocation."

The report itself did not criticize FSA staff for their lack of knowledge about Libor. Yet at least one email communication noted in the report shows people inside the agency had mixed-up understandings of the rate: "1 year LIBOR should be the London Inter-Bank Offered rate where LIBOR would be willing to lend 1 year cash to another similar bank if approached," reads a memo, reprinted in the report, from an unidentified staff member to a director within the FSA.

That is not a correct definition of Libor. The rate is determined by asking banks at what rate they would be willing to borrow, not lend cash. The distinction is important because banks tend to understate their likely borrowing costs during times of market panic -- exactly the dynamic that led to Libor manipulation in 2008.

This is not the first time communications released by a regulator have shown that the people who were supposed to be watching banks closely in 2008 did not have a complete grasp of the issues at hand.

Last July, just weeks after the Libor scandal erupted, the Federal Reserve released a trove of documents that included communications with Barclays in which Libor manipulation was discussed.

Various 2008 phone calls between Federal Reserve Bank of New York economist Fabiola Ravazzolo and unidentified employees at a Barclays trading desk in London show Ravazzolo had little knowledge of what Libor was, even as a Barclays trader told her the bank was “not posting an honest LIBOR.”

Ravazzolo committed the same error as the FSA staffer -- thinking Libor was a lending, not borrowing rate -- and at one point she admitted to the trader she had confused the benchmark with another rate known as EONIA. Ravazzolo still works at the New York Fed.

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