BLOCKCHAINIBOR

LIBOR, London Inter-bank Offered Rate, is an interest rate that is essentially the average rate that a group of banks estimate they would be charged if they were to borrow from other banks. It is essentially an estimate of the cost of funds for large banks operating in London.

Here’s how it works. Every day, the British Banker’s Association, BBA, sends out a survey to a select group of banks asking: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”. Every day the chosen bankers fall over themselves in laughter as they pull numbers out of their ass and type: “I [insert bank name], think I could borrow funds from my fellow bankers at [insert pulled-from-ass number] if i ask them nicely”. Send.

Eighteen (18) banks participate in this fiasco. All of them unstained beacons of integrity.

The BBA keeps clicking on the refresh button until all the responses are received in its inbox. Once it confirms all responses are in, it does the most important thing of the day, it pours filtered water into a kettle and boils the water to make a nice hot “cuppa tea”. No milk, 2 sugars. BBA is lactose intolerant.

It then goes around performing mundane tasks like calculating the LIBOR rate that the entire global financial system depends on. Calculating LIBOR is soooooo booooooring that BBA calls its buddy, the Intercontinental Exchange (ICE) to help with the calculation. ICE always turns down the offer of a hot cuppa tea. It keeps repeating the same joke to BBA that hot tea would make it lose its coolness. BBA always stares back blankly. It doesn’t get the joke.

Tea and joke over, BBA, in conjunction with ICE, takes all the surveyed rates and throws out the highest and lowest four and then calculates the mean of the remaining. By the time BBA and ICE are done calculating the average of ten numbers, they are so exhausted, they call a third buddy, Reuters, to send the result to the world.

Reuters is a messenger boy extraordinaire. No one delivers messages better than him. True story, Reuters used to deliver messages on foot, then he got a bicycle, then he went hi-tech and employed homing pigeons, then electric telegraphy and finally computers. A real trendsetter that one. Reuters married a Canadian named Thompson and they recently birthed an ugly child and gave him an appropriately ugly name, Refinitiv. Who does that to a child? I’m guessing parents who recognize their kid is ugly. Okay, I really should not call a child ugly, but I didn’t introduce the parents and I certainly didn’t ask them to procreate so… But I digress.

Back to LIBOR. Reuters carefully takes the calculated number from ICE. It’s a delicate number so he tries not to break it by screwing up the floating-point number accuracy. He then sends to the world.

Rinse and repeat every 24 hours. Or as they say in electro-ragga-dancehall, “rewind and come again”.

The finance world waits with bated breath for this number. as soon as it arrives, the axis of the earth’s rotation shifts a little. You see, almost every financial product depends on Libor. From credit cards, mortgages, car loans to student loans, the list of financial products whose costs is affected by LIBOR is endless. By endless I mean LIBOR underpins approximately USD$350 trillion in derivatives. Technically, $350 trillion is not endless but you get the point.

Some history. LIBOR came into widespread use in the 1970s. This was the decade when a certain handheld computer device was very popular. That device did not have the logo of an apple with a chunk bitten out of it. Nope, the logo on this device could possibly have started life as an apple but its owner must have been a little hungrier than Steve Jobs because he bit the apple in so many places it ended up looking like the map of the state of Texas. When the owner noticed this phenomenon, he slapped on two letters, T and I, on the deformed apple and called the company Texas Instruments.

That handheld device by Texas Instrument was in fact a calculator. Today, that calculator has a hard time passing itself of as a computer. However, in the 70s, it was the best thing going. There were no iPads, smartphones or even notebooks with excel spreadsheets. The calculator was the best thing available to calculate LIBOR then. Today, the world is completely different, yet LIBOR wants to pretend like it isn’t. It still wants to go the discotheque in bell bottom pants and platform shoes.

Disco may have died, but LIBOR is still dancing. In fact, it swings its waist so vigorously that the air it pushes affects financial markets around the globe. whoever coined the term “shake that money maker” was obvious talking about LIBOR.

LIBOR is a money maker for the banks that participate in setting its value. Never one to look away from free money, they all manipulated the rate at one point or another and reaped great rewards doing so. EVERY SINGLE ONE OF THEM. It’s a roll call of household names.

Bank of America
Bank of Tokyo-Mitsubishi UFJ
Barclays Bank
Citibank NA
Credit Agricole CIB
Credit Suisse
Deutsche Bank
HSBC
JP Morgan Chase
Lloyds Banking Group
Rabobank
Royal Bank of Canada
Société Générale
Sumitomo Mitsui Banking Corporation Europe Ltd
Norinchukin Bank
Royal Bank of Scotland
UBS AG
WestLB

Collusion was everywhere. Even ICAP, an inter-dealer broker was roped in. In the words of the author of the book of Revelation, “I wept and wept because no one was found who was worthy”. All over the world, regulators fined the banks billions of dollars. Some got away with lower fines. Others paid no fine by being the first to rat in the prisoner’s dilemma.

There is evidence that LIBOR was understated during the 2008 credit crisis that allowed the banks to appear more financially sound than they really were. It was financial fraud and manipulation like the world had never seen.

Yet LIBOR lives on even though it has been scheduled to be phased out by the end of 2021. One of the reasons being that there are long dated bonds and loans that have maturity well beyond 2021. It is not clear the legal implication of altering the underlying basis for those loan. Your brain may hate LIBOR but if you have an adjustable rate mortgage or student loan that’s based on it, your pocket may have a different opinion about switching to another index.

There are alternatives in use today including, Secured overnight financing rate (SOFR), Sterling Overnight Interbank Average Rate (SONIA), Swiss Average Rate Overnight (SARON) and the Tokyo Overnight Average Rate (TONAR).

Each one of those rates have varying degrees of adoption for many reasons. Most of those reasons are too boring for a really fun article like this. Instead I’ll throw in the possibility of a private blockchain filling the void that LIBOR will leave behind.

Now, I am the last person to support any private blockchain of any kind, but this might be the one use-case the world has been searching for. We could keep the methodology similar to the way LIBOR is calculated but this time we make it a collection of 50 banks. They all publish their rates on a private blockchain that only they can publish on but everyone in the world can see. Should they manipulate the rates, data scientists, gotcha-hunters, and really anyone can source them out. No need for a governance model because all the publishing parties are trusted.

Trust being loosely defined as the least untrustworthy of global banks.

The private blockchain will not absolutely stop the banks from forming cartels and manipulating the rates. We can only hope that the public exposure of publishing every component of the data will draw them closer to honesty than dishonesty. Maybe throw in a smart contract that penalizes any bank that clearly is indulging in manipulation. Other suggestions include incorporating an Internet of Things (IOT) device that shocks the banker if he puts in a fraudulent number. Who knows? Maybe we should just have the IOT device anyway just to punish them for their previous sins.

One thing we know for sure is that we can depend on Reuters to reliably deliver the data. Maybe we can have his ugly kid apply the shock treatment manually to the bankers prior to version 1.0 of the smart contract roll out. Just a thought.