LONDON Aug 8 Minos Zombanakis, born 86 years
ago on a Greek island, remembers the birth of the interest rate
benchmark now at the heart of a global rigging scandal well.
"I was, more or less, if you excuse the lack of modesty, the
one who started the whole thing," he laughs, speaking by
telephone from his village among citrus orchards in Crete.
Zombanakis was running the newly-opened London branch of
Manufacturer's Hanover, now part of JPMorgan, when the bank
organised one of the first syndicated loans pegged to what he
dubbed a London interbank offered rate (Libor) in 1969.
The $80 million loan, for the Shah of Iran, embodied the way
cross-border financial markets that had been effectively closed
since 1929 were being prised open - sowing the seeds for London
to flourish as a global financial centre.
The ambitious bankers of that era had little idea that the
rate they were using to price these loans would become a central
cog in the global financial system and a benchmark for $550
trillion in contracts ranging from interest rate derivatives to
home loans and credit cards.
Four decades on, that rate has been discredited by the
brazen attempts of traders to game it, by the banks that have
lied about their true costs of borrowing and by the regulators
accused of either condoning or failing to stop manipulation.
Libor, designed to reflect a bank's borrowing costs
accurately, burst into the headlines in June when Barclays
was fined a record $450 million for allowing traders to
rig it and its euro cousin Euribor and for low-balling rates
during the 2007/08 credit crunch. Other global banks are still
Even regulators admit privately they were taken aback by the
public and political backlash, which forced out four top
Barclays directors, sparked a fraud squad probe and a string of
reviews into what has been dubbed "the crime of the century".
Bankers working in London in the decades before the credit
crisis, when interbank funding dried up and speculation grew
that banks were being dishonest about their borrowing costs,
insist there was no hint of rigging in the early days.
Stanislas Yassukovich, a veteran banker who arrived in
London in the early 1960s with New York bank White, Weld & Co,
blames the modern bonus culture and emergence of "all singing,
all dancing" mega banks for destroying corporate loyalty.
Libor evolved to meet rising demand around the 1960s for
"Euro" currencies - offshore, stateless and often in dollars -
that swept London and allowed companies and countries to borrow,
deposit and repay while dodging domestic regulation and taxes.
The wave of oversees dollars was triggered in part by the
costs of the Vietnam War and U.S. trade deficit and fears the
Berlin blockade would prompt the United States to freeze Soviet
deposits on American soil. Those factors compounded longer term
concerns over the weight of U.S. regulation.
"Geopolitical forces, especially the Vietnam war, coincided
with the emergence of global trade imbalances and restrictive
legislation in the U.S. and resulted in the unexpected and
sudden creation of the Eurodollar market in London in the
1960s," says David Clark, another banking veteran and current
Chairman of the Wholesale Markets Brokers Association.
"It was from this start that syndicated lending and capital
markets recycled offshore dollars using floating interest rates
based on Libor."
Other countries played their part in creating Euro
currencies. But London, where many overseas banks had branches,
became the home of the loosely regulated Eurodollar.
Bankers such as Zombanakis, George Bolton, the chairman of
the Bank of London & South America (BOLSA), Bankers Trust
International chairman Evan Galbraith, who later became U.S.
ambassador to France, and Walter Shipley of Chemical Bank, were
among those who spotted the market's potential.
Former World Bank president James Wolfensohn has paid
tribute to the role played by the likes of Zombanakis, who
jostled with rivals to organise banks into consortia, sharing
the risks for massive syndicated loans funded through a series
of short-term deposits based on floating interest rates.
Loan requests poured in and financial markets took off.
"In the early days it was very much like a club," said
Yassukovich, a former chairman of the UK Securities Association,
a forerunner of Britain's Financial Services Authority
regulator, speaking from his retirement home in France.
Often the only force keeping eager bankers in check was when
the Governor of the Bank of England expressed his displeasure by
"raising an eyebrow": summoning a bank's manager if he saw
Overseas bankers often struggled with the traditions of the
City of London, where chairmen of discount houses - traditional
money brokers - strode around town in top hats. Soft, rather
than starched, collars were only tolerated on Mondays on the
assumption the weekend had been spent in the country.
But the old world ways were under threat as bankers
circumvented rules that capped the risk individual banks were
allowed to shoulder. Their syndicates offered loans with
interest rates that were renegotiated every three or six months
to reflect changing market conditions.
Zombanakis says he devised the formula whereby a group of
big "reference banks" within each syndicate would report their
funding costs shortly before a loan rollover date. The weighted
average, rounded to the nearest 1/8th percent plus a 'spread'
for profit, became the price of the loan for the next period.
He named this the London interbank offer rate, or Libor. The
formula, which now involves stripping out the highest and lowest
outliers, remains broadly similar today.
In the early days, there was no incentive to low-ball rates,
as this would have left a bank out of pocket. After all, banks
were lending money at those rates rather than borrowing it.
Zombanakis said any bank that submitted an unreasonably
inflated interest rate would be ejected from the syndicate - and
see a potentially valuable relationship with the borrower
But within a few years, Libor had evolved from a measure
used to price individual loans to a much broader benchmark for
deals worth hundreds of billions of dollars a year.
LET THE GAMES BEGIN
As client demand for loans surged, so did the market's
complexity. Trading began in instruments such as interest rate
swaps, foreign currency options and forward rate agreements.
Meanwhile, banks were borrowing ever more of their own
funding from credit markets, meaning they might have had an
incentive to push Libor rates lower.
To formalise the process of collecting interbank rates and
boost efficiency, transparency and governance, the British
Bankers Association (BBA), a trade body, backed by the Bank of
England, took control in 1986 and renamed it BBALibor.
Thomson Reuters, parent company of Reuters, has
been calculating and distributing the rates for the BBA since
2005, when it acquired previous calculating agent Telerate.
Those involved in BBALibor negotiations in the 1980s were
taken aback at the impact of the change to what suddenly became
a publicly available and widely used benchmark. It coincided
with the deregulation of financial markets known as the "Big
Bang", which spelt an end to London's quaint rules, late starts
and long lunches.
"Nobody realised how influential BBALibor was going to be,"
one banking official said, recalling the intense scrutiny as
soon as Libor rates were published at 11 a.m. "Trading rooms
would be watching and dissecting what rates people had been
putting in each day, looking for a major change in behaviour."
For as Libor became a benchmark for trillions of dollars
worth of derivatives, traders scented a new opportunity.
"In more recent times, there was a temptation to rig rates
because there is such a huge derivatives market with billions
and billions of pounds of trades linked to Libor," explains
David Potter, a former Midland Bank and Samuel Montagu director
whose long career in finance goes back to the 1960s. "So with
just a 0.001 percent tweak, that can make serious money."
It was an open secret by the 2008 crisis that bank were
understating borrowing rates.
In part, that was to avoid showing signs of financial stress
rather than to seek trading profits: the higher a bank's
borrowing costs, the more stretched the finances, the more
concerned the investors and customers, the more likely a bank
run and collapse.
Traders developed their own coping mechanisms.
"It was a bit like being behind the bicycle shed at school,"
noted one senior trader, who simply hedged Libor-linked
positions to protect against any loss. "There was very little to
gain by running to tell teacher."
Zombanakis, like many banking veterans, says the whole point
of Libor was lost when it became a funding benchmark for
everything from corporate borrowing and commodity trading to
home loans and credit cards.
"We started something which was practical and convenient. We
never had in mind that this rate would spread to mortgages and
things like that."