UK regulator admits negligence on Libor, but says it wasn't it job to spot manipulation

The Guardian reports that the UK's Financial Service Authority admits that there was widespread knowledge of Libor manipulation among its employees, but says it wasn't a major regulatory failure because it wasn't its job to intervene.

Please re-read the highlighted text as it summarizes why financial regulators by themselves are not up to the task of exerting adequate discipline to control banker behavior or bank risk taking.

Financial regulators are not up to the task because of the way their job is defined.

Regular readers know that financial regulators do not express an opinion over any of the bank's security or loan exposures.

They do not do this because this would involve them in the allocation of capital across the financial markets.  It would also make them responsible for the performance of the banks.

Regular readers know that this definition of what is not the regulators' responsibility is not bad.  The reason it is not bad is there is a financial market participant who is suppose to care about the risk that a bank is taking with its various exposures.

The financial market participant responsible for exerting discipline on the banks over the risks they take and discouraging bad banker behavior are the investors.

However, investors cannot do this job so long as the banks remain opaque "black boxes" where only the financial regulators have access to all the useful, relevant information in an appropriate, timely manner.

As your humble blogger has said repeatedly since the beginning of the financial crisis, banks are currently not subjected to any market discipline because they operate behind a veil of opacity.

By requiring the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, banks become subject to market discipline.

They become subject to market discipline because investors can independently assess the risk the banks are taking and adjust the amount and pricing of their investments in the banks to reflect this risk.  In addition, investors can catch bad behavior like the manipulation of Libor and other benchmark interest rates.

Staff at the chief City regulator should be cleared of negligence despite failing to spot clues that banks were manipulating interest rates to generate millions of pounds in bonuses and profits, an internal report into the Libor rigging scandal has ruled. 

The Financial Services Authority said staff did not have responsibility for monitoring Libor submissions, which were collected and published by a separate regulator, the British Banking Authority. 

An internal audit of 97,000 documents also found that 26 items related to Libor fixing and only two phone calls with Barclays gave a clear indication that the practice was widespread across the industry. 

The documents referred to artificially lowering the key interbank lending rate, a practice that made banks appear more secure during the financial crisis but also suggested that Libor was being manipulated by traders for profit at other times....

Andrew Tyrie, the Tory MP who heads the Treasury select committee, said the report showed the FSA was slow to act. 

"The FSA has admitted it had 26 warnings that this appalling practice was taking place. It also had other information that, taken cumulatively, ought to have set alarm bells ringing.
"It is concerning that no action was taken; that it wasn't tells us something may have been amiss at the FSA."...

Actually, what it says is that the veil of opacity hiding the banks' activities prevented interested market participants from having access to the useful, relevant information in an appropriate, timely manner.

The London interbank rate (Libor) was collated by the British Bankers Association from submissions by UK banks. Unknown to most people outside a small group in the City, traders would set the rate according to their own requirements. 

In the three years before the financial crash it became commonplace for them to lift rates to increase profits and bonuses. Following the collapse of Northern Rock and the onset of the credit crunch, when banks were fearful of lending to each other and Libor was soaring as a result, bank rate setters came under pressure from traders and senior executives to depress rates supplied to the BBA. 

Between January 2005 and June 2009, Barclays derivatives traders made 257 requests to fix Libor and Euribor, the eurozone's equivalent. ... 

Turner said: "There are important lessons to be learnt about effective handling of information. A particularly important lesson is the need to have staff focused on conduct issues even when the world rightly assumes that the biggest immediate concerns are prudential; and vice versa. The new 'twin peaks' model of regulation will deliver this."

The important lesson is that regulators should not have a monopoly on all the useful, relevant information in an appropriate, timely manner when it comes to banks.

Banks should be required to provide ultra transparency.

The new 'twin peaks' model of regulation will not solve the problem as regulators are not responsible for approving or disapproving the individual exposures on and off a bank's balance sheet.