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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

In the LIBOR manipulation scandal, several banks' submitters adjusted their reported borrowing rates to benefit derivatives positions or to appear healthier. Which feature of the LIBOR process most enabled this behavior?

The key enabler was that LIBOR was based on panel banks' self-reported estimates of borrowing costs rather than observed transactions. Such submissions were hard to verify, so submitters could shade them to benefit trading positions or reputation.

  1. ARates were set by a central clearing counterparty from executed trades
  2. BRates were computed from regulated exchange futures prices
  3. CRates were based on panel banks' self-reported estimates rather than observed transactionsCorrect
  4. DRates were fixed by the central bank each day

Explanation

LIBOR relied on submissions of estimated borrowing costs from panel banks, which were unverifiable and open to manipulation, especially where submitters sat near traders. Transaction-based, exchange or central-bank rates would not have the same weakness.

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