The real danger of the Barclays scandal
The latest upheaval moves world banks closer to losing control over themselves.
As the rate rigging scandal at Barclays exploded over the past couple of weeks, Canadian financial institutions - from chartered banks to insurance companies - received calls from federal regulators. They were touching base to ascertain which ones might have what degree of leverage to the latest disgrace in the banking business.
It may take a while for the damage — and the scope — of the situation to be fully understood. That said, it's a pretty safe bet that Britain's third largest bank wasn't the only one during the global financial crisis tinkering with rates to make it look as though its borrowing cost was lower than it was.
Those actions, which have cost Barclays a $450 million fine, a credit downgrade and the resignation of its chairman, CEO and chief operating officer, have a direct effect on Libor. That's the London Interbank Offered Rate, the rate at which British banks charge one another for loans. It's also a global benchmark, a reference point for a whole range of securities and derivatives sold around the world.
For example, financial products from adjustable-rate mortgages to private student loans and variable-rate credit cards are linked to the Libor rate. When Libor goes up, associated interest rates and monthly loan payments can also rise. When Libor goes down, adjustable-rate loan payments might also be lowered. (Fixed-rate loans are not directly impacted.)
As testimony from (now former) Barclays CEO Robert Diamond strongly implies, his bank was by no means the only one to thumb its nose at the rules.
"This isn't just Barclays," Diamond told a recent hearing of the British Parliament's Treasury Select Committee. "Throughout 2007 and 2008, no institution of the 16 banks reporting three-month dollar Libor was at the higher end more consistently than Barclays. Barclays was getting questions about why it was always high and we were saying, 'We are high because we were reporting at where we were borrowing money.' "
Further investigation is likely to prove his allegations.
Nearly 20 other major financial institutions are now being probed by regulators around the world. Canada's Competition Bureau is looking at the Canadian operations of half a dozen foreign banks, including HSBC Bank, Royal Bank of Scotland, Deutsche Bank, JP Morgan Chase and Citibank.
And in one of the biggest Libor class actions so far, the mayor and city council of Baltimore is suing Royal Bank of Canada along with about 20 other big institutions over alleged losses from holding securities based on Libor.
Diamond's comments underscore the fact that Libor, the benchmark for more than $360 trillion (U.S.) of global securities, has stopped being an accurate reflection of banks' borrowing costs.
His remarks have also set off another round of political anxiety, which inevitably translates into demands to toughen regulations and teach everyone a lesson. In Europe, banks are bracing for a new wave of regulation, something that's already under review in the U.S. in the wake of recent trading losses at J.P. Morgan.
The problem, however, is not that there's any shortage of rules that apply to financial institutions.
In fact, Britain's financial regulator warned Barclays several months ago that its culture was too aggressive and must change.
Barclays' compliance department also failed to act on three separate internal warnings between 2007 and 2008 about conflicts of interest and "patently false" submissions by its staff to the panel that sets the benchmark interest rate. At no point was this fact flagged to internal auditors, which is considered standard practice in such instances.
No amount of regulation, however, can change the industry culture that's at the root of the repeated failures, losses and scandals. The staggering risks are fuelled by rewards — salaries, bonuses, status and promotion are all the purview of those who take the greatest risks and bend the rules the furthest.
Furthermore, global banking has become such a sophisticated and complex area, it's often very difficult to keep pace with products that are cooked up in the equivalent of financial meth labs. And if regulators crack down on one set of products or practices, the banks quickly morph their products in a new direction — it becomes an innate part of the cat-and-mouse game to design something that slips through cracks in the rules.
But what the banks seem to miss in all this is the long-term damage — and cost — of squandering their reputations and eroding public trust. Without credibility and trust, banks will steadily lose their social license to operate - and control over their operations will be placed into the hands of regulators and custodians of the public good. If they consistently refuse to behave responsibly, that's the only option left for governments.
And that's ultimately the most costly outcome for everyone.
MSN.ca Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.