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An article relating to this blog post on Finextra:

Libor reform sparks market data tender scramble

Market data firms and index compilers are set to go to tender for the right to administer a souped-up version of the tainted London Interbank Offered Rate (Libor).

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The Psychology of LIBOR abuse

I’ve briefly touched on this topic previously, but I recently gave an after-dinner speech at a fraud event in London and two of my fellow speakers happened to talk about the importance of considering the psychological aspect of fraud. In particular, we were discussing rogue-trading and market abuse and what makes traders actually end up acting in such an unlawful way. With the recent news regarding the FSA’s desire to remove the over-reliance on unchecked ‘human’ input when setting the LIBOR rate, it once again got me thinking about the psychology of a fraudster.

Depending on your outlook, you’ll either see all fraudsters as criminal low-life or some as victims of circumstance. Your view will probably also be tinted by the type of fraud committed and how closely it resembles ‘traditional’ criminal activity. I don’t think anyone would argue that a guy looking over people’s shoulders in order to get their pin number is simply a criminal; however, what if a trader takes a punt on a trade that doesn’t pay off and tries digging themselves out of a mess by doubling up on their mistake – are they an unfortunate victim of circumstance or simply another crook? In the case of the trader, it’s certainly not a premeditated act of fraud, and their subsequent illicit activity is a desperate attempt to keep their managers happy in a highly pressured environment.

Unfortunately, in these circumstances, there is a chance the fraudster may end up costing their employers billions of pounds worth of losses, or in the worst case, bankruptcy – but this is almost certainly not what they had in mind when they woke up that morning. Understanding why people commit fraud is as important as being able to detect it when it happens. If we can understand fraudster’s motivations we have the opportunity to prevent them from going down that route in the first place. Certainly, as a bank, it’s critical that an environment of honesty and propriety is promoted from the board right down to junior staff. Such an environment should not look to severely punish traders for making a mistake, and should embrace an open culture where people understand they are able to own up to things without fear of losing their jobs.

In the case of the LIBOR scandal, what drove the traders to submit falsified numbers? Well, at first sight it seems fairly simple – a desire to manipulate the rate to their commercial advantage depending on the nature of their current trading positions. However, if this was the case, are we to believe that so many traders are happy to treat a critical instrument that directly affects people’s mortgage payments, loan agreements and so forth, with such disdain? I’m not so sure. The problem to me is something much more deep-rooted, and is a reflection of the human condition. Traders, as with all humans, have a desire to be accepted by their peers and seen to be successful at whatever they apply themselves to. They want to be seen to be making the most money, working for the best bank, driving the best car and generally excelling at whatever it is they’ve been tasked with.

Typically, humans will have a limit to which they’re prepared to see their actions – even if benefiting themselves - having negative effects on others. At this point, most people will stop acting in their own self-interest due to their desire to avoid feeling substantial ‘guilt’ down the line. Now, why are these traders not concerned with feeling guilty about their actions? Virtually all humans are coded with that emotion, so it’s unavoidable. The only way to avoid it is to convince yourself that what you’re doing is right, and that ultimately there will be no significant negative effects to others.

Here lies the motivation for LIBOR abuse – the institutions responsible had ‘conditioned’ their traders to make them feel good about abusing the rate; after all, they could make money on it, and cheaper borrowing rates could make the banks look healthier than they actually were. At the end of the day, these traders no longer saw this as a form of illegal abuse, and more of a healthy necessity, from which they might also make some money. When reflecting on this you must ask yourself ‘did the traders’ behaviour come from their own desires or was their behaviour manipulated by the environment they were working in?’ Whether it is the individual or the system in which they are operating, hopefully the exposure of LIBOR abuse will see a change in psychology among traders.


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