LONDON (Reuters) – Minos Zombanakis, born 86 years ago on a Greek island, remembers the birth of the interest rate benchmark now at the heart of a global rigging scandal well.”I was, more or less, if you excuse the lack of modesty, the one who started the whole thing,” he laughs, speaking by telephone from his village among citrus orchards in Crete.
Zombanakis was running the newly-opened London branch of Manufacturer’s Hanover, now part of JPMorgan, when the bank organised one of the first syndicated loans pegged to what he dubbed a London interbank offered rate (Libor) in 1969.
The $80 million loan, for the Shah of Iran, embodied the way cross-border financial markets that had been effectively closed since 1929 were being prized open – sowing the seeds for London to flourish as a global financial centre.
The ambitious bankers of that era had little idea that the rate they were using to price these loans would become a central cog in the global financial system and a benchmark for $550 trillion in contracts ranging from interest rate derivatives to home loans and credit cards.
Four decades on, that rate has been discredited by the brazen attempts of traders to game it, by the banks that have lied about their true costs of borrowing and by the regulators accused of either condoning or failing to stop manipulation.
Libor, designed to reflect a bank’s borrowing costs accurately, burst into the headlines in June when Barclayswas fined a record $450 million for allowing traders to rig it and its euro cousin Euribor and for low-balling rates during the 2007/08 credit crunch. Other global banks are still under investigation.
Even regulators admit privately they were taken aback by the public and political backlash, which forced out four top Barclays directors, sparked a fraud squad probe and a string of reviews into what has been dubbed “the crime of the century”.
Bankers working in London in the decades before the credit crisis, when interbank funding dried up and speculation grew that banks were being dishonest about their borrowing costs, insist there was no hint of rigging in the early days.
Stanislas Yassukovich, a veteran banker who arrived in London in the early 1960s with New York bank White, Weld & Co, blames the modern bonus culture and emergence of “all singing, all dancing” mega banks for destroying corporate loyalty.
Libor evolved to meet rising demand around the 1960s for “Euro” currencies – offshore, stateless and often in dollars – that swept London and allowed companies and countries to borrow, deposit and repay while dodging domestic regulation and taxes.
The wave of oversees dollars was triggered in part by the costs of the Vietnam War and U.S. trade deficit and fears the Berlin blockade would prompt the United States to freeze Soviet deposits on American soil. Those factors compounded longer term concerns over the weight of U.S. regulation.
“Geopolitical forces, especially the Vietnam war, coincided with the emergence of global trade imbalances and restrictive legislation in the U.S. and resulted in the unexpected and sudden creation of the Eurodollar market in London in the 1960s,” says David Clark, another banking veteran and current Chairman of the Wholesale Markets Brokers Association.
“It was from this start that syndicated lending and capital markets recycled offshore dollars using floating interest rates based on Libor.”
Other countries played their part in creating Euro currencies. But London, where many overseas banks had branches, became the home of the loosely regulated Eurodollar.
Bankers such as Zombanakis, George Bolton, the chairman of the Bank of London & South America (BOLSA), Bankers Trust International chairman Evan Galbraith, who later became U.S. ambassador to France, and Walter Shipley of Chemical Bank, were among those who spotted the market’s potential.
Former World Bank president James Wolfensohn has paid tribute to the role played by the likes of Zombanakis, who jostled with rivals to organise banks into consortia, sharing the risks for massive syndicated loans funded through a series of short-term deposits based on floating interest rates.
Loan requests poured in and financial markets took off.
“In the early days it was very much like a club,” said Yassukovich, a former chairman of the UK Securities Association, a forerunner of Britain’s Financial Services Authority regulator, speaking from his retirement home in France.
Often the only force keeping eager bankers in check was when the Governor of the Bank of England expressed his displeasure by “raising an eyebrow”: summoning a bank’s manager if he saw anything inappropriate.
Overseas bankers often struggled with the traditions of the City of London, where chairmen of discount houses – traditional money brokers – strode around town in top hats. Soft, rather than starched, collars were only tolerated on Mondays on the assumption the weekend had been spent in the country.
But the old world ways were under threat as bankers circumvented rules that capped the risk individual banks were allowed to shoulder. Their syndicates offered loans with interest rates that were renegotiated every three or six months to reflect changing market conditions.
Zombanakis says he devised the formula whereby a group of big “reference banks” within each syndicate would report their funding costs shortly before a loan rollover date. The weighted average, rounded to the nearest 1/8th per cent plus a ‘spread’ for profit, became the price of the loan for the next period.
He named this the London interbank offer rate, or Libor. The formula, which now involves stripping out the highest and lowest outliers, remains broadly similar today.
In the early days, there was no incentive to low-ball rates, as this would have left a bank out of pocket. After all, banks were lending money at those rates rather than borrowing it.
Zombanakis said any bank that submitted an unreasonably inflated interest rate would be ejected from the syndicate – and see a potentially valuable relationship with the borrower destroyed.
But within a few years, Libor had evolved from a measure used to price individual loans to a much broader benchmark for deals worth hundreds of billions of dollars a year.
LET THE GAMES BEGIN
As client demand for loans surged, so did the market’s complexity. Trading began in instruments such as interest rate swaps, foreign currency options and forward rate agreements.
Meanwhile, banks were borrowing ever more of their own funding from credit markets, meaning they might have had an incentive to push Libor rates lower.
To formalise the process of collecting interbank rates and boost efficiency, transparency and governance, the British Bankers Association (BBA), a trade body, backed by the Bank of England, took control in 1986 and renamed it BBALibor.
Thomson Reuters, parent company of Reuters, has been calculating and distributing the rates for the BBA since 2005, when it acquired previous calculating agent Telerate.
Those involved in BBALibor negotiations in the 1980s were taken aback at the impact of the change to what suddenly became a publicly available and widely used benchmark. It coincided with the deregulation of financial markets known as the “Big Bang”, which spelt an end to London’s quaint rules, late starts and long lunches.
“Nobody realised how influential BBALibor was going to be,” one banking official said, recalling the intense scrutiny as soon as Libor rates were published at 11 a.m. “Trading rooms would be watching and dissecting what rates people had been putting in each day, looking for a major change in behaviour.”
For as Libor became a benchmark for trillions of dollars worth of derivatives, traders scented a new opportunity.
“In more recent times, there was a temptation to rig rates because there is such a huge derivatives market with billions and billions of pounds of trades linked to Libor,” explains David Potter, a former Midland Bank and Samuel Montagu director whose long career in finance goes back to the 1960s. “So with just a 0.001 per cent tweak, that can make serious money.”
It was an open secret by the 2008 crisis that bank were understating borrowing rates.
In part, that was to avoid showing signs of financial stress rather than to seek trading profits: the higher a bank’s borrowing costs, the more stretched the finances, the more concerned the investors and customers, the more likely a bank run and collapse.
Traders developed their own coping mechanisms.
“It was a bit like being behind the bicycle shed at school,” noted one senior trader, who simply hedged Libor-linked positions to protect against any loss. “There was very little to gain by running to tell teacher.”
Zombanakis, like many banking veterans, says the whole point of Libor was lost when it became a funding benchmark for everything from corporate borrowing and commodity trading to home loans and credit cards.
“We started something which was practical and convenient. We never had in mind that this rate would spread to mortgages and things like that.”
(Reporting by Kirstin Ridley and Huw Jones, Editing by Alexander Smith and Matthew Tostevin)
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