LIBOR scandal

Q2) Effects of LIBOR scandal on the global financial market

Advantages from the scandal

It provided an impetus to reassess the structure of interbank loan reference rates. This led to the decline in the unsecured interbank loans to a gradual shift in secured loans. (McAndrews, Sarkar and Wang). The move towards central clearing of derivatives enforced by Dodd-Frank Act that minimizes the relevance of reference rates with the credit risk built in. this reduces the risk of one bank manipulating the others. Finally, limiting derivative exposures to a limited number of counterparties reduces interconnectivities of the financial institutions which protects the system from fraud should isolated defaults arise.

Disadvantages that arose from the scandal

Interbank unsecured funding has gradually been unpopular among the financial institutions. This reduces interbank lending which restricts availability of finance for investment among the banks. Second, term funding has been shifted to a short term period. This has raised speculations and tension among the long term LIBOR securities. Another disadvantage of the scandal is that public trust in the financial institutions eroded because the cartels that were formed manipulated the rates for their own gain. Also there were losers and gainers from the transaction, the companies that were never profited were on the losing side and they made big losses. Finally, limiting derivative exposures to a limited number of counterparties reduces interconnectivities of the financial institutions, which reduces the flow of funds between the institutions. It restricts the flow of capital and consequently the financial activity.