Banking Law Prof Blog

BBA Announces Libor Reforms - What's the Impact?

Today, the British Bankers Association (BBA) announced two measures to strengthen Libor as well as calling for comment on several other possible changes.  Libor (the London Interbank Offered Rate) is the most widely referenced interest rate index in the world, used as the benchmark for $350 Trillion in interest rate swaps and $10 trillion in loans.

Libor originated in 1985.  It is the interest rate participant banks in the London market report that they would be charged by other banks if they sought to borrow funds on an unsecured basis.  Libor is set at 11:00 A.M. UK time in 10 currencies for 15 maturities.  The four most significant Libor currencies are: U.S. dollar, Sterling, Euro, and Yen.  Data is compiled and calculated by Reuters for BBA.  BBA's oversight committee for Libor is the Foreign Exchange and Money Market Committee; it is composed of selected participant banks.  BBA asks for volunteer banks active in the London market in the relevant currencies and in "reasonable amounts" and then establishes panels of banks for each currency, which report interest rates they "perceive" they would be charged.

The following striking facts about Libor highlight the fact that this benchmark interest rate was not originally intended -- nor is it presently constructed in a way that lends itself -- to such global importance:

• The British Bankers Association is not a government agency but an unregulated, voluntary trade association.
• Banks volunteer to join a panel of banks and voluntarily report the interest rates they would expect to pay.  Until now, reporting has been more or less on the "honor system" to report accurately.
• BBA and Libor are focused on the London market, yet this benchmark interest rate is used world-wide.  Of course, a risk premium and premiums for other factors are expected to be added on top of any benchmark rate.

Previous complaints about Libor:

• Beginning in about August 2007, as the U.S. subprime mortgage market crisis developed, concerns about the accuracy of Libor began to be expressed.  Reporting banks had an incentive to understate the interest rate they said they would be charged because if they reported a high interest rate, the market would conclude that their financial condition was distressed.
• In November 2007, the Bank of England reported that the actual cost of interbank borrowing was higher than Libor indicated.
• In March 2008, the Bank for International Settlements warned that banks could be understating their borrowing costs to appear to be in stronger financial condition.
• In April 2008, BBA announced a "fast-track" review of Libor, stating that any members deliberately misreporting interest rates would be banned.
• While European banks are concerned that Libor may be understating interest rates, some U.S. critics contend that Libor is actually too high because UK banks are risk averse and there is an inadequate supply of dollars in the London market.

Today's recommendations to strengthen Libor:

• BBA announced that it would require discrepancies between interest rates reported and those actually paid to be reviewed by the oversight committee -- and justified by the reporting bank if they were found to be inaccurate.  In my opinion, this change is long overdue.  Given the hundreds of trillions of dollars in exposure and the world wide use of this benchmark, it can no longer be an unverified number.
• BBA intends to widen membership of the Foreign Exchange and Money Market Committee and increase the size of currency panels -- including more U.S. perspective. This may or may not be necessary since Libor is clearly derived from the London market and includes global financial institutions that also have a significant U.S. presence already.  Perhaps we simply need to recognize that Libor is a London-market-based index and adjust with additional premiums as appropriate -- or choose another index.

BBA REQUESTS FOR COMMENT:

• Should there be additional dollar benchmark fixes?  In addition to the 11:00 A.M. fix of the U.S. Dollar Libor, should there be another London fix later in the day, after the U.S. financial markets have opened?  Would two fixes present insurmountable legal issues because of the vast number of existing contracts that reference the 11:00 A.M. fix?  Would two fixes create market confusion?
• Should there be an additional European dollar index to capture U.S. Dollar trading in Europe even though the majority of Euro dollar trading takes place in London?
• What about continuous, real time interest-rate reporting?
• Is it appropriate to reduce the stigma that comes from reporting high interest rates by moving to anonymous reporting?  Currently BBA reports each reporting institution and the rates it reports.  In my opinion, any move to anonymous reporting would undermine transparency, as well as accuracy -- and would be detrimental.

My suggestions for thought:

• Are these concerns about Libor limited to the current period of market instability generally?
• Now that global financial markets have become aware of the limitations inherent in relying on a London-market-based benchmark, should new benchmarks be created or selected?  Is it enough to recognize Libor for what it is and add other compensating factors or premiums?
• Where are the regulators?  I note that among the "stakeholders" BBA consulted before announcing these reforms today, we see participant and non-participant financial institutions, hedge funds, money market funds, and brokers -- but no government agencies or central banks.
• The global nature of financial markets requires that we study these Libor (or interest-rate bench mark) issues together with other key issues impacting our global financial interactions, including global capital requirements and Basel II, as well as regulatory structures such as those raised in the U.S. by the recent Paulson Report.

(ag) June 10, 2008, in Economy

Two Recent Supreme Court Cases on Money Laundering Issues

Karen Neeley, one of Texas' best banking lawyers, recently called my attention to two recent U.S. Supreme Court cases.  Here's what she has to say:

"The Supreme Court decided two money-laundering cases on June 2, 2008. These cases do not relate to cases against financial institutions or Suspicious Activity Reports, but rather relate to the burden imposed on prosecutors in money-laundering cases. Although it is too early to tell the impact these cases will have on other contexts of money-laundering, the Court’s rulings are instructive of how it will interpret certain requirements in the federal money-laundering statutes."

"In Cuellar v. United States, the Court held that money-laundering cannot be proven merely by showing funds were concealed during transportation. Rather, the government must show the purpose of transporting the funds was "to conceal or disguise the nature, location, the source, the ownership, or the control" of the funds. Furthermore, the Court observed that the government is not required to prove a defendant attempted to create an appearance of legitimate wealth. Even though the defendant concealed money in a hidden, specialized compartment in his car, bundled it in plastic bags sealed with duct tape, and used animal hair to mask any scent from drugs, the Court found there was not sufficient evidence to show a purpose, plan, or "design" for transporting concealed funds. The bottom-line of this case is that conviction for transporting laundered money requires proof of the purpose, not the effect, of the transportation is to conceal the nature, location, source, ownership, or control of the money."

"The other money-laundering case decided on June 2nd, United States v. Santos, relates to the term "proceeds" and its interpretation in the money-laundering statutes. The Supreme Court decided the term "proceeds" means "profits" but not "receipts." Therefore, paying off winners and employees in an illegal gambling operation did not qualify as money-laundering because there was no proof the pay-offs were made with profits from an illegal operation. Because the term "proceeds" is not defined in the statute, the term’s ordinary meaning has been defined as both "receipts" and "profits," and the money-laundering statutes make sense under either definition, the Court applied the rule of lenity, which instructs the statute be read in favor of the defendant."

Karen Neeley practices banking law with Cox Smith's Financial Institutions Practice Group, in the Austin office.

(ag) June 10, 2008, in BSA/AML

Call for Papers - Treasury's Blueprint for a Modernized financial Regulatory Structure

Download u_of_m_call_for_papers.doc

The University of Memphis Cecil C. Humphreys School of Law announces a call for papers relating to the Treasury's Blueprint for a Modernized Financial Regulatory Structure.  This is a very timely opportunity!

(ag) May 23, 2008, in Federal Banking Agencies

Another Rate Cut & More Liquidity Issues

The Federal Open Market Committee (FOMC) reduced the target federal funds rate another 25 basis points to 2% on Wednesday. 

Dallas Federal Reserve Bank President Richard Fisher and Philadelphia Federal Reserve Bank Charles Prosser opposed this rate cut.

Link to FOMC Statement:  http://www.federalreserve.gov/newsevents/press/monetary/20080430a.htm

The Federal Reserve continues to battle the liquidity crunch in other ways as well.  Today, the Federal Reserve announced an increase in the amounts auctioned to eligible depository institutions under its biweekly Term Auction Facility (TAF) from $50 billion to $75 billion, beginning with the auction on May 5. This increase will bring the amounts outstanding under the TAF to $150 billion.  In response to the global nature of the liquidity crisis, the Swiss National Bank and the European Central Bank are working in cooperation with the Federal Reserve.

Link:  http://www.federalreserve.gov/newsevents/press/monetary/20080502a.htm

(ag) May 2, 2008, in Economy/Interest Rates

Thank You for Expressions of Condolence

Thank you for your understanding and concern during the last illness and passing of my mother on Friday, April 25.  --Ann

Suspicious Activity Report News

FDIC Financial Institution Letter FIL-32-2008 (April 10, 2008) notifies banks that they can access the Financial Crimes Enforcement Network (FinCEN) publication "The SAR Activity Report by the Numbers."

Highlights of the report include the following:
1.  During 2007, Depository Institutions filed 324,694 SARs, down from more than 500,000 in both 2005 and 2006.
2.  In the first six months of 2007, Check Kiting filings increased 58% from the corresponding six months in 2006.
3.  Mortgage Loan Fraud SARs increased 35% from 2006.
4.  Identity Theft SARs are increasing.
5.  Texas depository institutions ranked third in number of filings for 2007, behind California at #1 (740,553 SARs) and New York (341,426).  Texas depository institutions filed 191,600 SARs in 2007).

List of top 10 categories of SARs for 2007:
1.  BSA/Structuring/Money Laundering - 48.02%
2.  Check Fraud - 10.54%
3.  Other - 8.87%
4.  Counterfeit Check - 4.93%
5.  Credit Card Fraud - 4.79%
6.  Mortgage Loan Fraud - 3.90%
7.  Check Kiting - 3.34%
8.  Identity Theft - 2.41%
9.  False Statement - 2.38%
10.  Defalcation/Embezzlement - 1.91%

Link to FinCEN Report:  http://www.fincen.gov/sars/sar_by_numb_09.pdf

(ag) April 22, 2008, in BSA/AML

LIBOR - Is It Reliable & What Does It Say About the Current Financial Crisis?

A disturbing article in the WSJ last week suggested that the London inter-bank offered rate (Libor) may be less than fully reliable because some troubled banks may not be reporting the high interest rates they must pay to secure loans from other banks.  Libor is calculated daily on the basis of information reported from banks worldwide.  Troubled banks might have been reporting that they are paying a lower interest rate than they actually are because they don't want to 'fess up that their financial condition is so bad that they must pay an extremely high rate to borrow funds from other banks.

Libor is the base rate for calculating the interest on all sorts of loans, so if Libor is reported to be artificially low, then borrowers whose loans bear interest at Libor plus a specified percentage rate will be paying an artificially low rate.  That would be good for borrowers in the short run, but if there's a readjustment of Libor those borrowers could get hit with a sudden increase and the economy would suffer commensurately.  In addition, if Libor is artificially low, it misrepresents the severity of the financial crisis because it hides the fact that, in actuality, more banks are having to pay a substantial risk premium because of their troubled condition than we can see reflected in Libor.

Link to April 16, 2008, Wall Street Journal Page 1 Article, "Bankers Cast Doubt on Key Rate Amid Crisis" by Carrick Mollenkamp:  http://online.wsj.com/article/SB120831164167818299.html?mod=todays_us_page_one

In response to concerns about Libor, the British Bankers' Association (BBA) which oversees Libor "fast-tracked" an investigation into Libor accuracy. 

(ag) April 22, 2008, in Economy

Hedge Funds Driving Up the Price of Gasoline & Other Commodities

My Corporate Governance class at the Texas Tech University School of Law was discussing Institutional Investors, including hedge funds, as a potential monitor for the boards of directors of publicly traded companies.  In the course of the discussion, we also talked about a big negative impact hedge funds and pensions funds are having on the current price of gasoline, corn, and other basic commodities.

Thanks to Tadd Tobkin for this controversial article which raises the argument that even Calpers, which most people think of as one of the most socially concerned institutional investors, must assume some blame for the fact that food prices in third world countries have risen to the point that people are starving -- a result of institutional investors "pushing a wall of money  into the $200bn  commodity index funds."

(ag) April 16, 2008, in Economy

Texas Steps Out with a NEW ID THEFT MEASURE

The 2007 Texas Legislature passed a bill establishing a new Closed Account Notification System ("CANS") -- the first example of this type of anti-ID theft measure in the U.S. 

The Texas Department of Banking administers CANS, which launched on March 1, 2008.  In an effort to combat identity theft, financial institutions such as banks and credit unions operating in Texas are required to submit information, at the request of their customer, concerning suspected compromised deposit accounts to a secure electronic notification system which then alerts all of the major check verification companies to the potential fraudulent activity.

Other states and the federal banking agencies will be watching this new system. 

Thanks to Stefan L. Jouret, with the law firm of Donovan Hatem LLP, Boston, MA, for calling this to my attention.

Link to Texas Dept. of Banking information about CANS: http://webarchive.loc.gov/lcwa0015/20080703181753/http://www.banking.state.tx.us//cve/memo03-18-08.htm

(ag) April 15, 2008, in Identity Theft

Fish Don't Know They Are Wet

Federal Reserve Governor Kevin Warsh delivered a speech entitled "Financial Market Turmoil and the Federal Reserve:  The Plot Thickens" to the New York University School of Law Global Economic Policy Forum today.

Warsh identifies excessive liquidity as the root cause of our current financial problems. He says,

"Some believe the story of the current market turmoil began in August, and will end when the housing market stabilizes. But, in my view, the narrative actually began in a seemingly more benign time with underpinnings more fundamental than the value of the housing stock. Financial institutions and other market participants grew increasingly dependent on the extraordinary liquidity around them. When liquidity faltered, the weaknesses of the existing architecture abruptly revealed itself."

"A metaphor, perhaps, is instructive: Fish don't know they are wet. And they don't learn unless their memories are long or the water is gone."

My take:  With all due respect, excessive liquidity is only one factor in a deepening disaster.  Warsh concludes this speech with a call to make liquidity a key consideration in the proposed reorganization of the financial regulatory structure.  I'm just not sure what that means, but here's what he says: 

"A new financial architecture, born of the forces of creative destruction, is early in the process of construction with the aid of the Federal Reserve and other public authorities. But for the new paradigmatic architecture to be enduring, market-supplied liquidity must come to predominate."

My take again:  ?????

(ag) April 14, 2008, in Economy

IRS Stats

Today's WSJ carries an article worth noting on Page B3:  "IRS Corporate Tax Audits Fall," by Jesse Drucker.  Surprisingly, the rate at which the IRS audits large corporations hit a 20-year low in 2007.  The audit rate for small businesses, however, is sharply increasing. 

(ag) April 14, 2008, in Economy

Economic News - Bad to Worse

Thanks to Sally Thompson for this intriguing look at the question, "Are Bernanke's Hands Tied? -- Eight Reasons Why the U.S. May Be in Worse Trouble Than You Think."

Link:  http://www.currencytrading.net/2008/are-bernankes-hands-tied-8-reasons-the-us-may-be-in-worse-trouble-than-you-think/

(ag) April 14, 2008, in Economy

Excessive Executive Compensation

All the scoop on current issues in Executive Compensation: 

http://www.nytimes.com/2008/04/06/business/06comp.html?_r=1&scp=2&sq=executive+compensation&st=nyt&oref=slogin

(ag) April 9, 2008, in Economy

OCC's Views on FHA Housing Stabilization & Homeownership Retention Act of 2008

Comptroller John Dugan presented the agency's views on the FHA Housing Stabilization and Homeownership Act of 2008 before Congress today.  This is basically a voluntary loan workout program with the lender taking a write-down and the borrower getting a refinanced FHA-guaranteed loan at the reduced principal amount. 

Link:  http://www.occ.gov/ftp/release/2008-38.htm

(ag) April 9, 2008, in Congress/Lending Issues

Housing Bubble? What Bubble?

Alan Greenspan denies all.  He claims that "the U.S. bubble was close to median world experience and the evidence that monetary policy added to the bubble is statistically very fragile."  He makes this disclaimer with a straight face, although under his leadership, the Federal Reserve reduced interest rates from 6.5% in late 2000 to 1% in June 2003 -- and kept rates at 1% through May 2004.  At 1%, it's almost like giving money away instead of lending it.

Link:  http://www.cnbc.com/id/23948760

(ag) March 7, 2008, in Economy