BREAKINGVIEWS:Libor fallout could trash UK bank earnings again

Thu Jun 28, 2012 11:56pm IST

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By George Hay

LONDON, June 28 (Reuters Breakingviews) - The Libor scandal is a red rag to compensation lawyers. For British banks, the affair threatens to force them into making hefty provisions that would trash earnings a second year in a row. And the pain could spread beyond the UK.

In 2011, UK lenders’ profit was savaged by multi-billion pound provisions to deal with the legal fallout from the misselling of useless insurance to protect mortgages from default. Now investors are rightly fearing another earnings bonfire following revelations that Barclays (BARC.L) and potentially other global banks have been manipulating the London Interbank Offered Rate. Barclays’ shares fell 15 percent on June 28, while Royal Bank of Scotland (RBS.L) fell 11 percent.

By swallowing a 290 million pound ($450 million) fine from U.S. and UK regulators, Barclays should have capped its direct pain in terms of public penalties. But in doing so, it has conceded that it did attempt to rig the Libor rate, which underpins the pricing of vast volumes of corporate lending and derivatives. That opens up a Pandora’s box of legal challenges from anyone who thinks they lost out by paying the wrong rate. These are highly likely to appear against Barclays and any other banks accused, according to a senior financial lawyer. For ambitious attorneys, the chance to take down a big bank would be a mouth-watering prospect.

Barclays’ main hope will be that this isn’t easy to prove. To obtain damages, the plaintiff would have to establish that a loss had occurred, not that Barclays’ intentions were bad. That means calling legions of expert witnesses who will be able to trace kinks in Libor rates.

Putting a figure on damages is also tough. Barclays is a counterparty on interest-rate derivatives with a notional value of 35.5 trillion pounds, according to Cenkos Securities. Proving even single-digit mispricings could yield damages in the billions of pounds. But the nature of complex derivatives contracts means assessing losses at this point may not be so simple.

Litigation is a credible threat and the numbers involved could be large. This is a terrible moment for banks to come under further pressure. Barclays’ return on equity in 2011 was only 7 percent, and it has hefty exposure to Spain. Meanwhile, Barclays and other UK banks will have to maintain high 10 percent core Tier 1 ratios even under new Basel III capital rules. The sell-off is rational.

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CONTEXT NEWS

- Barclays shares fell 15.5 percent to 179 pence on June 28. Royal Bank of Scotland shares fell 11.5 percent to 203 pence, and Lloyds Banking Group (LLOY.L) shares fell 3.9 percent to 28.8 pence.

- Reuters: UK drafts in fraud squad as fine hits Barclays [ID:nL6E8HSA5E]

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)

- For previous columns by the author, Reuters customers can click on [HAY/]

(Editing by Chris Hughes and Martin Langfield)

((george.hay@thomsonreuters.com)) Keywords: BREAKINGVIEWS LIBOR/

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