Four thoughts about the Libor scandal

by Ed Bowsher on 04 July 2012  |  6 comments
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The Libor scandal is a watershed moment in the ongoing financial crisis. Here are four thoughts for policymakers to chew on as they decide how to respond.

1. An understandable mistake

The Libor scandal has two parts. The first part was from the mid noughties through to 2008.  During this time Barclays was manipulating market interest rates for no other reason than to make money for the bank.

The second part was in October 2008. At this point we’re told that the Bank of England and the Government were telling Barclays to lie about its borrowing rates. Those lies then helped to reduce Libor. 

Now assuming that this is actually what happened, the Government and the Bank of England made a mistake. You have to have trust at the heart of a financial system, and governments should never encourage banks to lie over such a serious matter.

So yes, it was a serious mistake, but I can understand how it happened. Let’s not forget that October 2008 was a massive crisis and it really felt that disaster was around the corner.

As a financial journalist I remember obsessively watching Libor as a gauge of how bad the crisis was at that particular moment. Many market participants were doing the same thing. If Libor went up, that suggested that some big banks were more likely to go bust. If the perceived risk of bank insolvency rose, that had the potential to become a self-fulfilling prophecy.

So I can understand the rationale of trying to manipulate Libor in that climate. If we do discover that politicians and regulators encouraged Barclays to lie, we should be critical but not go completely berserk. Heck, if I had been working a financial regulator in October 2008, I might have made the same mistake myself.

2.  Bank regulation must change

I said last week that there was one silver lining to this scandal. It might encourage policymakers to break up the big banks that operate retail banking and investment banking divisions.

Sadly, I see no sign that the Government is going to change its mind on this issue, so all we can say is that at least the issue is firmly back on the agenda.

Moving on from that, if we can’t split retail and investment banks, there’s another possible change that could be almost as useful. Let's ban all banks from engaging in ‘prop trading.’ In other words, they shouldn’t be allowed to buy and sell financial instruments using the bank’s own money. They should only be able to trade on behalf of clients.

If that ban had been in place back in 2006, Barclays wouldn’t have had the financial incentive to distort Libor.

3.  Tough job

Even though I’m calling for more regulation, there is a danger that regulation could go too far. I don’t want to kill the City. It provides jobs and much needed tax revenue. 

Regulatory change is important, but changing the rules can only achieve so much. It’s also really important that the next generation of City regulators use the rules at their disposal more effectively than their predecessors.

Regulators need to reduce the chances of future crises, while not killing the City goose that generates so much cash for the UK. That’s a difficult balancing act and I don’t envy the folk who have to walk that line.

4.  Better retail banks

For too long, the UK retail banking market has been dominated by four big players: Lloyds TSB, Barclays, RBS/Natwest, and HSBC.

Many individual customers have been dissatisfied with the quality of service that they’ve received, and I don’t think the big banks have done a great job with business either.

I heard the journalist, Will Hutton, give a talk this morning and he made the point that only about 5% of UK bank lending goes to UK businesses, and only about 5% of that 5% goes to small and medium-sized businesses. That’s not enough.

I strongly believe that the retail banks can be improved by new players entering the market and generating more competition. I also hope that we can see more variety in the structure of our financial institutions – more building societies, more peer-to-peer lending, more credit unions.

But we’re not going to get a more diverse banking market if bank customers just carry on sticking with the same bank for 30 years. If you’re not satisfied with your current bank, then switch! Everyone has a role to play in ensuring that we can build a better financial system for the UK.

More: 

What is Libor?

Barclays Libor scandal: what should happen now