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Trade Group for Bankers Regulates a Key Rate

Iit was big news when the Barclays chairman, Marcus Agius, resigned Monday over his bank’s role in the Libor rate-fixing scandal. Less noticed was his other resignation that same day.

Robert Diamond, CEO of Barclays.
Jerome Favre | Bloomberg | Getty Images
Robert Diamond, CEO of Barclays.

Mr. Agius also quit as chairman of the British Bankers’ Association, or B.B.A., the powerful trade group that, among other things, oversees Libor.

Libor, short for the London interbank offered rate, is the interest rate that affects trillions of dollars’ worth of corporate and consumer loans each year. It is supposed to be a neutral figure that reflects how much it costs a bank to borrow money. But as Barclays has admitted, and other big banks may soon be forced to acknowledge, Libor has been manipulated — either to create a false impression of a bank’s health or to help bank traders game the financial markets.

However shocking the behavior by Barclays and possibly other banks might have been, the public, which has to pay interest based on rates set by Libor, is likely to be just as startled to learn that a vital financial benchmark is supervised not by government officials but by the bankers’ own trade association.

If there is one thing that the escalating Libor scandal has established, it is that bankers have a hard time regulating bankers — whether it be Barclays officials who did not stop employees from submitting spurious Libor rates or the committee within the bankers’ association that ultimately was unable to detect industry wrongdoing.

“The B.B.A. represents the interests of the big banks,” said Andrew Hilton, the director of the Center for the Study of Financial Innovation, a London-based research group that looks at financial issues. “It does not represent the interests of borrowers or the financial system at large.”

Barclays did not make Mr. Agius, who is leading the executive committee until a new chief executive is appointed, available for comment.

In the early days of Libor, starting in the late 1960s and into the 1980s, the fact that the rate banks used to borrow money was set and governed by a small group of like-minded bankers based in London was not seen as a problem. In fact, according to Minos A. Zombanakis, a former banker at Manufacturers Hanover who says he made the very first loan based on Libor by inventing the product on the fly, it was a sense of responsibility and trust between banks that underpinned the rate’s success.

Mr. Zombanakis, who is 85 years old and retired in his home country of Greece, recalls that first Libor loan — $80 million extended by a group of banks to Iran — as if it were yesterday.

“We had to fix a rate, so I called up all the banks and asked them to send to me by 11 a.m. their cost of money,” he said. “We got the rates, I made an average of them all and I named it the London interbank offer rate.”

For more than 15 years, the banks set the rate more or less as Mr. Zombanakis described — by throwing out the highest and lowest rates and compiling an average of the remaining ones.

Then, in 1986, the British Bankers’ Association was asked by its member banks to assist in the setting of the benchmark rate. It has overseen the process ever since, even as the club of gentlemen bankers making syndicated loans in the City of London evolved into the opaque and impersonal multitrillion-dollar interbank market.

Regulators estimate that the Libor rate now supports more than $500 trillion worth of transactions ranging from simple mortgages to risky derivatives.

According to the association’s Web site, the body within the trade group that has the “sole responsibility for all aspects of the functioning and development of bbalibor,” as the group refers to Libor, is called the foreign exchange and money markets committee. That committee is composed largely of bankers and financial professionals, according to association officials.

The committee meets at least every other month. The meetings are open to regulators and central bankers from around the world, although they do not attend on a regular basis.

In what would seem to be a conflict, the committee chairman is a representative from the panel of banks, which includes some of the world’s biggest institutions — like Barclays, Citigroup and UBS — that submits the rates that become the Libor average.

n recent years, as questions have been raised about the accuracy of Libor, the bankers’ association has taken steps to create a Chinese wall of sorts to separate its core lobbying function from its crucial role as an independent setter of interest rates.
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According to Brian Mairs, a spokesman for the association, the Libor oversight committee is now deemed to be independent from the association and is overseen by a board distinct from the association’s board from which Mr. Agius resigned this week.

And yet, the Libor committee’s ties to the trade association remain strong. Much of its work overseeing Libor is done by John Ewan, a senior association official who acts as secretary to the committee although he is not a member of it.

While the chairman of the Libor board is Gordon Pell, a former top executive at the Royal Bank of Scotland, the board also includes four senior association officials, including its departing chief executive, Angela Knight, and Mr. Ewan.

The association issued a statement last week saying it was “shocked” by the charges against Barclays and would begin discussions with the relevant authorities over how Libor should be supervised in the future.

In its report on the rate-fixing scandal, Britain’s main banking regulator, the Financial Services Authority, did not place direct blame on the association. The report said that once it became clear in 2007 that some banks were putting in false rates, the British Bankers’ Association committee conducted an investigation to assess whether the controls it had in place were sufficient.

Still, the group’s conclusion in 2008 that the contributing banks were “confident that their submissions reflect their perception of their true costs of borrowing,” stands in stark contrast to what regulators have discovered Barclays was doing at the time.

British and American regulators are continuing to investigate. Other big banks that are said to be under scrutiny include UBS and Royal Bank of Scotland.

Angus Armstrong, a former official at the British Treasury who is now director of research at National Institute of Economic and Social Research, a research organization, argues that the markets that use Libor have become too large and complex for the rate to be set and governed under the longstanding method. Central banks, he noted, use the rate as a benchmark when they intervene in the market, making it extremely important from a regulatory perspective.

“It is perhaps an anomaly that the B.B.A., an organization representing the banking industry, is solely responsible for overseeing an interest rate process that is of such wide importance,” Mr. Armstrong said.

With other banks soon to be implicated in the Libor scandal, it may be that the mutual trust that long underpinned the rate-setting process no longer holds. “I was surprised to see a bank like Barclays do this. In my time there was an ethic and you assumed that everyone was a gentleman,” Mr. Zombanakis, the Libor pioneer, said. “But I guess it was inevitable — as the market got bigger and bigger, things got out of control.”

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