Weaknesses in Kibor mechanism identified

August 1, 2012

Weaknesses in Kibor mechanism identified
KARACHI: As global financial markets continue to reverberate with the Barclays Libor-fixing scandal, some of the largest banks in Pakistan are also suspected of colluding to fix the Karachi Interbank Offer Rate (Kibor) and manipulate other money market-related interest rates.
“There has been some level of distortion in the Kibor mechanism operating in the financial sector in Pakistan,” said former State Bank of Pakistan (SBP) governor Dr Muhammad Yaqub. “Banks do not treat all their clients equally; they lend on higher rates but do not offer positive rates of return to depositors. In order to earn higher profits, banks influence and determine market rates, especially the Kibor.”
In a series of briefings provided to The News, past and present bankers, Treasury and Finance Ministry officials as well as financial sector analysts have sounded the alarm about existing procedures and regulations and said that there are chances of a Barclays-like incident occurring in Pakistan as well.
However, given the sensitivity of the issue, many refused to be identified. “The big five banks operating in Pakistan are already involved in interest rate manipulation and work together to clandestinely influence the overnight rates, which enables them to lend to small banks at higher interest rates,” said a former ministry insider.
The way financial intermediation works is that the central bank sets a rate at which it will lend money to banks (discount rate) and this forms the basis for the structuring of other interest rates. Since bigger banks have larger deposit bases and lower mobilisation costs, they usually have liquidity in excess of their requirements. In the interbank market, this money is lent to other banks at slightly over the discount rate. And the average rate of lending by 17 banks on any given day is the rate advertised as Kibor.
Banks then use this rate as a reference and structure their loans to businesses and consumers at rates above Kibor, depending on the creditworthiness of the individual or corporate.But the efficiency of this system is predicated on fairplay.
Since the biggest players in the market are operating as a cartel, the cost of borrowing is continually rising, enabling banks to pad their bottomline at the expense of the borrower, backgrounds interviews with experts and former bankers revealed.
According to the former ministry official, this rigging is not just limited to the Kibor rate but has also spilled over in the bidding for government treasuries such as Pakistan Investment Bonds (PIBs) and treasury bills (T-bills).
“The dealers set prices after checking with each other, which strictly speaking, constitutes insider trading. You can see the element of manipulation by dealers in the intra-trading sessions at the money market,” he said. “Since the deals take place over the counter and not on the screen (as happens at the stock exchange, where the sellers and the buyers see the fluctuations in indices), these dealers can influence rates to make the maximum profit in the short term.”
The problem, according to eminent economist Dr Meekal Ahmed, has to do with the opaqueness of the process. “The mechanism for [setting the] Kibor is not transparent here,” he said. “Banks are engaged in anti-competitive practices and openly compromise the interest of depositors. The SBP must ensure an enabling and competitive environment for banks and should also discourage cartelisation and monopolies with regard to interest rate determination.”
But others who’ve worked closely with the banking regulator say that the SBP has never focused on anti-competition practices and has, instead, relied on prudential regulations. For its part, the SBP insists that the rules it has devised in conjunction with the FMAP for the setting of Kibor rates are foolproof [see box].
As expected, the view has its advocates within the banking circles. But significantly, barring MCB Bank, none of the Big Five approached for this story were willing to comment.
“The regulatory framework has become more stringent over the years and the SBP is doing a commendable job,” said Qasim Nadeem, vice president, Treasury and FX group, MCB Bank. “[Manipulating Kibor rates] is nearly impossible. There is a mechanism which eliminates the highest and lowest rates while determining the Kibor, which ensures the elimination of collusive offers/ bids and minimizes the chances of any distortion or manipulation,” he added.
Nadeem is equally vehement in his defence of the transparency in OMOs. “Since [the sale of T-Bills] caters to a bigger market, which includes banks, mutual funds and other financial institutions, and the criteria for fixing the rates is very strict, there are even fewer chances of distortion in rates.”
Dr. Salman Shah, former adviser to the prime minister on finance, and Ahsan Mehanti, a senior analyst at Arif Habib Corporation, are other believers. “There is no concrete evidence to suggest that banks are collaborating to manipulate, influence or rig interest rates,” averred Shah.
Meanwhile, Mehanti insisted that the central bank is on the right path to making the money market more stable and vibrant. Others among the banking circles think that Pakistan’s relatively small-sized financial sector makes it easier to monitor, thereby eliminating the possibility of a Barclays episode being replicated in Pakistan. Furthermore, they argue, effective patrolling by international stakeholders such as the IFIs should also reduce the chances. But others are less complacent.
Khurram Schezad, who is the head of research at InvestCap, thinks Pakistan lacks the tools required to even detect malpractices. “In an emerging market like Pakistan, there are no proper mechanisms to detect such malpractices within the system,” he said. “Europe and the US have developed financial markets where every transaction is documented so they can easily catch frauds. Even though the SBP is performing above average in terms of regulation, it will take more time to sense and identify such scams even if they exist.”
Meanwhile, the Competition Commission of Pakistan, which is supposed to be the watchdog as far as anti-competition practices are concerned, insists that interest rates fall within the regulatory purview of SBP.
“Whether banks are posting the rates, which correspond to their actual cost of borrowing is something the SBP can look into,” said the commission is a statement issued to The News. “Also, the regulatory reporting errors (if any) can be looked into by the SBP for any suspected market abuse.”
According to the commission, it will only step in once it has facts proving cartelization, and not on the basis of hearsay. “The CCP is not an advisory body to the SBP. However, it can issue policy-notes on aspects of commercial activities, affecting the state of competition in Pakistan and express publicly its opinion with respect to such issues,” it wrote in its statement.

KARACHI: As global financial markets continue to reverberate with the Barclays Libor-fixing scandal, some of the largest banks in Pakistan are also suspected of colluding to fix the Karachi Interbank Offer Rate (Kibor) and manipulate other money market-related interest rates.
“There has been some level of distortion in the Kibor mechanism operating in the financial sector in Pakistan,” said former State Bank of Pakistan (SBP) governor Dr Muhammad Yaqub. “Banks do not treat all their clients equally; they lend on higher rates but do not offer positive rates of return to depositors. In order to earn higher profits, banks influence and determine market rates, especially the Kibor.”
In a series of briefings provided to The News, past and present bankers, Treasury and Finance Ministry officials as well as financial sector analysts have sounded the alarm about existing procedures and regulations and said that there are chances of a Barclays-like incident occurring in Pakistan as well.
However, given the sensitivity of the issue, many refused to be identified. “The big five banks operating in Pakistan are already involved in interest rate manipulation and work together to clandestinely influence the overnight rates, which enables them to lend to small banks at higher interest rates,” said a former ministry insider.
The way financial intermediation works is that the central bank sets a rate at which it will lend money to banks (discount rate) and this forms the basis for the structuring of other interest rates. Since bigger banks have larger deposit bases and lower mobilisation costs, they usually have liquidity in excess of their requirements. In the interbank market, this money is lent to other banks at slightly over the discount rate. And the average rate of lending by 17 banks on any given day is the rate advertised as Kibor.
Banks then use this rate as a reference and structure their loans to businesses and consumers at rates above

Kibor, depending on the creditworthiness of the individual or corporate.But the efficiency of this system is predicated on fairplay.
Since the biggest players in the market are operating as a cartel, the cost of borrowing is continually rising, enabling banks to pad their bottomline at the expense of the borrower, backgrounds interviews with experts and former bankers revealed.
According to the former ministry official, this rigging is not just limited to the Kibor rate but has also spilled over in the bidding for government treasuries such as Pakistan Investment Bonds (PIBs) and treasury bills (T-bills).
“The dealers set prices after checking with each other, which strictly speaking, constitutes insider trading. You can see the element of manipulation by dealers in the intra-trading sessions at the money market,” he said. “Since the deals take place over the counter and not on the screen (as happens at the stock exchange, where the sellers and the buyers see the fluctuations in indices), these dealers can influence rates to make the maximum profit in the short term.”
The problem, according to eminent economist Dr Meekal Ahmed, has to do with the opaqueness of the process. “The mechanism for [setting the] Kibor is not transparent here,” he said. “Banks are engaged in anti-competitive practices and openly compromise the interest of depositors. The SBP must ensure an enabling and competitive environment for banks and should also discourage cartelisation and monopolies with regard to interest rate determination.”
But others who’ve worked closely with the banking regulator say that the SBP has never focused on anti-competition practices and has, instead, relied on prudential regulations. For its part, the SBP insists that the rules it has devised in conjunction with the FMAP for the setting of Kibor rates are foolproof [see box].
As expected, the view has its advocates within the banking circles. But significantly, barring MCB Bank, none of the Big Five approached for this story were willing to comment.
“The regulatory framework has become more stringent over the years and the SBP is doing a commendable job,” said Qasim Nadeem, vice president, Treasury and FX group, MCB Bank. “[Manipulating Kibor rates] is nearly impossible. There is a mechanism which eliminates the highest and lowest rates while determining the Kibor, which ensures the elimination of collusive offers/ bids and minimizes the chances of any distortion or manipulation,” he added.
Nadeem is equally vehement in his defence of the transparency in OMOs. “Since [the sale of T-Bills] caters to a bigger market, which includes banks, mutual funds and other financial institutions, and the criteria for fixing the rates is very strict, there are even fewer chances of distortion in rates.”
Dr. Salman Shah, former adviser to the prime minister on finance, and Ahsan Mehanti, a senior analyst at Arif Habib Corporation, are other believers. “There is no concrete evidence to suggest that banks are collaborating to manipulate, influence or rig interest rates,” averred Shah.
Meanwhile, Mehanti insisted that the central bank is on the right path to making the money market more stable and vibrant. Others among the banking circles think that Pakistan’s relatively small-sized financial sector makes it easier to monitor, thereby eliminating the possibility of a Barclays episode being replicated in Pakistan. Furthermore, they argue, effective patrolling by international stakeholders such as the IFIs should also reduce the chances. But others are less complacent.
Khurram Schezad, who is the head of research at InvestCap, thinks Pakistan lacks the tools required to even detect malpractices. “In an emerging market like Pakistan, there are no proper mechanisms to detect such malpractices within the system,” he said. “Europe and the US have developed financial markets where every transaction is documented so they can easily catch frauds. Even though the SBP is performing above average in terms of regulation, it will take more time to sense and identify such scams even if they exist.”
Meanwhile, the Competition Commission of Pakistan, which is supposed to be the watchdog as far as anti-competition practices are concerned, insists that interest rates fall within the regulatory purview of SBP.
“Whether banks are posting the rates, which correspond to their actual cost of borrowing is something the SBP can look into,” said the commission is a statement issued to The News. “Also, the regulatory reporting errors (if any) can be looked into by the SBP for any suspected market abuse.”
According to the commission, it will only step in once it has facts proving cartelization, and not on the basis of hearsay. “The CCP is not an advisory body to the SBP. However, it can issue policy-notes on aspects of commercial activities, affecting the state of competition in Pakistan and express publicly its opinion with respect to such issues,” it wrote in its statement.