Translated from the French by Tim Gupwell
Can a banker be trusted? This is indeed the question one is obliged to ask in the light of the “LIBOR affair” which broke in April 2008 and saw a dramatic turn of events four years later, on the 27th June, when the British bank Barclays was publicly condemned to pay an exceptionally large fine, equivalent to 365 million Euros, for having manipulated the family of rates known as LIBOR, determined daily at the time by Barclays plus 15 other banks, and today by 17 others.
The process for determining these LIBOR rates, applying to dollar-denominated loans, consists of contacting a certain number of banks on a daily basis, and asking them what rate the other banks charge them to lend over a variety of short-term durations (one month, three months, six months, a year) and merging together this information, having eliminated the most extreme values, to produce a rate that constitutes the reference, the floating rate determined by the ‘market’. A consumer loan could for example be defined as ‘6 month LIBOR plus 50 basis points’, one basis point being a hundredth of one percent.
With regard to what is asked of them to determine the LIBOR rates, banks are far from indifferent; the information demanded of them is in fact extremely sensitive as far as they are concerned. The reason for this is the following: the rate charged by a bank for lending includes a risk premium – which, when things are going badly, may account for the greater part of the rate – which generally reflects with a great deal of accuracy the degree of confidence that other lenders have of its capacity, not only to pay back the amount borrowed, but also to pay back the interest payments which have been contractually promised. The more there is a perception of a risk of non-repayment, the more the premium included in the rate charged will be elevated.
By being entirely candid about the interest rates it is charged for loans, a bank therefore reveals the confidence that its peers have in it. The issue would be relatively unimportant if it were not for the existence of a financial derivative instrument called a Credit-default Swap (CDS), which allows a lender to insure itself against the risk on non-payment, but which a simple speculator can also acquire in order to bet on the financial deterioration of a firm’s situation , meaning that if it seems to be in difficulty, its competitors will have the possibility, not only of betting on its downfall, but also, in so doing, of contributing to its downfall (something seen in particular in 2008). The reason for this is that the markets (and ‘economic science’) consider that a bet – even though entirely motivated by the pursuit of profits – nonetheless constitutes nothing more than a neutral appreciation of an objective risk. Consequently, it is essential, for the survival of a firm in difficulty, to conceal to the greatest extent possible the exact value of the rates charged by peers who are prepared to lend to it.
In a context like that of the determination of LIBOR rates, a bank playing by the rules of the game, will find itself – if the economic situation deteriorates – in the totally unmanageable situation of triggering its own extinction if it supplies honest information to the British Bankers’ Association (BBA), which is responsible for the centralization of the data. By revealing that the risk premium in the rate charged by its peers has increased, it is effectively offering its jugular to its competitors who would like to bet on its downfall. How can it therefore be criticized for lying, when it is clear that telling the truth would inevitably lead to its collapse?
It is obvious therefore that the way in which the LIBOR rates had been defined contained a blatant error of logic: it encouraged the firms involved to lie the moment the economic context ceased to be ideal. This highlights the fact – as is unfortunately so often the case in finance – that the issue had only been imperfectly conceptualized by the parties involved, confirming one again that, in the vast majority of cases, the incompetence of bankers constitutes a more serious danger than their deliberate destructive tendencies. Of course, we find it much more exciting to invoke the malevolence of the participants, rather than being forced to acknowledge their stupidity, but facts nevertheless remain the facts.
Is this to say that we can never trust a banker? The answer, viewed in the light of the ‘LIBOR affair’ would seem to be yes. But the framework in which the LIBOR rates are determined puts the banks in an impossible situation when the economic situation worsens, since for them telling the truth means compromising their very existence.
Would it not be better, then, to candidly acknowledge our incapacity to correctly conceptualize the problems posed by finance?
For the LIBOR, the question which the bank being questioned has to answer to determine the rates is, “what rate do the other banks (‘the market’) charge you?” When it answers, a bank can either tell the truth, or lie. For the EURIBOR, the rate applying to the Euro, the question posed is different, “What is the interbank rate charged by a quality bank to another quality bank?” It is clear that in this case, to the question, “have you told the truth or a lie?” the answer will always be the same “ I thought I had told the truth, but if I didn’t it is not because I lied but because I was badly informed!” There will never be any fraudsters, only incompetents.
Is that really any better? I doubt it: it is in accordance with the spirit of the particular philosophy that has modified commercial law over recent years. Fraud has now been excluded; there remains only the clumsy – whose bonuses are contractually guaranteed. The bankruptcy of the French-Belgian bank Dexia is one recent example.
Thus, the question has to be posed in different terms. Could one trust a banker if the fact that he told the truth was not the equivalent of obliging him to commit financial suicide?