by Piet Coetzer

A crisis long in the making

Barclays Bank in the wake of an interest rate fixing scandal

Barclays Bank
Barclays.JPG
After resigning as chief executive of Barclays Bank in the wake of an interest rate fixing scandal, Robert Diamond was, last week, accused by United Kingdom (UK) legislators of “living in a parallel universe”. This is, however, only one of the symptoms of a crisis long in the making, that is now gripping the banking and wider financial sector in most of the so-called developed world and beyond. 
Barclays, the UK’s second-largest bank by assets and a majority shareholder in South Africa’s ABSA Bank, was fined a record £290 million last month for rigging the Libor rate (London Interbank Offered Rate) the global benchmark for the interest rate at which banks lend to one another. The practice, which has been going on for many years and believed to be wide spread, serves to create a false image of the financial health of banks.
And, it is not just Barclays that is involved. They were just the first to own up to the practice and claim they have indeed warned key politicians and regulators about what was happening some time ago.
At least 16 other banks are being investigated in the UK, the US, Japan, Canada, the European Union and Singapore and involve nine government agencies.
A high rate loan submission indicates a bank is struggling to borrow from other lenders. A low rate indicates the opposite.
What is at stake is the apparent collusion or conspiracy between banks to manipulate these rates to counter the free functioning of the market.
In South Africa, Finance Minister, Pravin Gordhan, also last, week accused banks and financial institutions of being “greedy monsters” seeking to maximise profits at all costs and to the detriment of ordinary people.
Until last week, few people outside the world of banking would even have been aware of Libor or its European equivalent, Euribor. Fewer still would have appreciated that it can exert a significant influence over their lives.
Many people have mortgages linked to these rates and fluctuations can affect the size of their home loan repayments. The manipulation of these rates also have a significant effect on investment and pension funds which buy complex financial products known as derivatives, linked to interest rates.
To add insult to injury, Diamond could be leaving Barclays with a pay-and-bonus severance package worth of up to £20 million. During his appearance at the Treasury select committee of the UK parliament last week, a member of the committee asked him whether the bank’s bonus culture had encouraged wrongdoing. “Individuals were remunerated just to look after No. 1,” she said.
Some critics of the present financial system, which largely depends on self-regulation, claim that the scandal was the inevitable consequence of a casino-style culture that has aggressively thrived throughout the system for some time now.
After decades of a soft, mostly hands-off approach to financial regulation Lord Turner, chairman of the UK’s Financial Services Authority, became the latest responsible authority to call for stricter regulation. The law should be tightened to tackle misbehaviour in banking, he said last week.
But it is unlikely that the massively strong financial sector lobby will take attempts at stronger regulation lying down. Senior figures in the industry warned last week against a “witch hunt” against banks that may lead to “knee jerk” regulation that damages an industry vital to economic recovery.
In his speech last week at a two-day conference on financial literacy in Pietermaritzburg, Minister Gordhan said the financial system and banks were in a moral and ethical crisis and accused them of “undisguised greed.”
Heart of the problem
The heart of the problem is, however, probably not just a question of too little regulation but more one of structural deficiencies and the nature of the relationship between governments and financial institutions.
Traditionally, over the centuries, bankers took deposits and lent them out, paying short-term depositors less than they charged for risky or less liquid loans. The risk was borne by banks, not depositors or the governments.
Over many years, and especially after the de-coupling of the American dollar as international currency instead of gold, the structure of banking changed. Debt pyramiding  soared and credit quality plunged into the toxic category of “liars’ loans,” as the value of money became increasingly “paper” based.
Way back during the early days of banking, in medieval times, wealthy bankers lent to kings and princes as their major customers. This relationship has since reversed. Now, banks in need rely on governments for funding. The risk has effectively moved onto the taxpayer as has happened with bank bailouts since the 2008 financial crisis caused by bad private-sector loans and gambles. Now it is happening in Europe where banks have to saved from going bankrupt.
As Bloomberg recently pointed out: “JPMorgan receives a government subsidy worth about $14 billion a year, according to research published by the International Monetary Fund and our own analysis of bank balance sheets. The money helps the bank pay big salaries and bonuses. More important[ly], it distorts markets, fueling crises such as the recent subprime-lending disaster and the sovereign-debt debacle that is now threatening to destroy the euro and sink the global economy.”
A system has also been allowed to develop where the profit of banks and investment funds no longer depend on astute, solid long-term investments. Financial markets have become dependent on risky derivative markets and electronically based so-called high-frequency trades, which now account for 70-80% of all equity trades.
Investment firms compete on the basis of speed, capturing gains on a fraction of a penny and, perhaps holding positions for only a few seconds, content with their daily earnings, they close out all positions at the end of each day.
In this sort of environment the temptation to manipulate basic factors like interest rates becomes just to big to resist.
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