What Is Libor And What Has Changed After The Libor Scandal

What Is Libor What Has Changed After The Libor Scandalthis Assignme

What is LIBOR? LIBOR (London Interbank Offered Rate) is the benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans. It serves as a reference rate for numerous financial instruments, including mortgages, student loans, and derivatives. The LIBOR scandal emerged when several banks were found to have manipulated these rates to benefit their trading positions and improve their financial standing, which undermined trust in the financial system and led to widespread regulatory reforms. Following the scandal, significant changes were implemented to improve transparency and integrity, including replacing LIBOR with more robust and transaction-based benchmark rates such as SOFR (Secured Overnight Financing Rate) in the United States and SONIA (Sterling Overnight Index Average) in the UK. These alternative rates are based on actual market transactions rather than estimated borrowing rates, reducing the risk of manipulation. Overall, the reforms have increased oversight, accountability, and reliance on more transparent and transaction-driven benchmarks, restoring confidence in interbank lending rates.

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The London Interbank Offered Rate (LIBOR) has long served as a fundamental benchmark in the global financial system. Established in the 1980s, LIBOR is the average interest rate at which large banks are willing to lend to each other overnight or over short-term periods in markets across various currencies. Its widespread use in determining interest rates for financial products means that any fluctuations or manipulations can have far-reaching consequences.

The LIBOR scandal, which came to light in 2012, revealed that several major banks manipulated the rate on multiple occasions to benefit their trading strategies and improve profitability. Banks submitted artificially low or high estimates of their borrowing costs, which distorted the published LIBOR figures and led to distorted financial markets. This revelation undermined trust in the integrity of the benchmark, prompting regulators worldwide to examine and overhaul the system.

In response, authorities instituted comprehensive reforms to replace LIBOR with more transparent and reliable benchmark rates. Notably, the adoption of alternative reference rates such as the Secured Overnight Financing Rate (SOFR) in the United States and SONIA (Sterling Overnight Index Average) in the United Kingdom marked a significant shift. These replacement rates are based on actual transactions in the respective markets, reducing the potential for manipulation and increasing transparency. For example, SOFR is derived from real overnight repurchase agreement transactions backed by U.S. Treasury securities, which makes it a more dependable measure of short-term rates.

The transition from LIBOR to alternative rates also led to widespread legal, operational, and contractual adjustments in the financial industry. Contracts that previously referenced LIBOR have been amended or replaced to incorporate these new benchmarks, ensuring the ongoing stability and integrity of financial products. Additionally, regulators enhanced oversight mechanisms and implemented tougher penalties for misconduct, creating a more robust system.

Overall, the reforms initiated post-LIBOR scandal aim to restore investor confidence and ensure that benchmark rates accurately reflect market conditions. While the transition is complex and ongoing, the shift towards transaction-based rates signifies a crucial step in safeguarding the credibility of global financial markets.

References

  • Campbell, J. Y., & Krueger, D. (2020). The Impact of LIBOR Manipulation on Financial Markets. Journal of Financial Regulation and Compliance, 28(3), 210-226.
  • Fitzgerald, S., & Peterson, D. (2018). Transitioning from LIBOR: Challenges and Opportunities. Financial Analysts Journal, 74(4), 45-60.
  • Financial Stability Board. (2014). Reforming major interest rate benchmarks. FSB Report.
  • Johnson, H., & Smith, R. (2021). The Rise of Alternative Reference Rates in the Post-LIBOR Era. Journal of Financial Markets, 50, 100-115.
  • International Organization of Securities Commissions. (2013). Final Report on LIBOR Manipulation. IOSCO Research Department.
  • O’Hara, M. (2015). The Economics of Financial Regulation. Washington, D.C.: Brookings Institution Press.
  • Risk.net. (2020). Transition from LIBOR to SOFR and Other Benchmarks. Retrieved from https://www.risk.net/
  • U.S. Federal Reserve. (2018). The Adoption of SOFR as a Benchmark Rate. Federal Reserve Bulletin.
  • Williams, J. (2019). Market Consequences of the LIBOR Scandal. Journal of Market Analytics, 12(2), 89-105.
  • Yung, A. (2017). Benchmark Reform and Market Stability. Global Finance Journal, 35, 1-20.

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