ASIC’s court claims could shatter big banks’ reputations for good

Last week the corporate regulator ASIC announced that it is bringing a civil case in the Federal Court against National Australia Bank Ltd. (ASX: NAB) for alleged manipulation of Australia’s key interbank lending rate known as the bank bill swap rate (BBSW).

Legal proceedings have already been filed against Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) in what threatens to be a combustible issue with widespread consequences if the court finds in favour of ASIC’s statement of claims.

What is BBSW?

The BBSW is the overnight rate at which major Australian banks will lend to each other and is important to them in helping manage their balance sheet and interest rate risk on assets and liabilities held on their giant balance sheets.

The interest rates at which banks lend short-term loans to each other (primarily bank bills) are important as assets held on their balance sheet are mainly in the form of loans (mainly business and residential property) and securities which are mainly short-term debt in the form of bank bills or other money market instruments generally known as paper.

Liabilities will also be partly owed under the securities section of the balance sheet in the form of 90-day dated bank bills or other interbank loans for example. The majority of liabilities though will be in the form of deposits and other borrowings on wholesale funding markets.

ASIC is alleging that the NAB’s balance sheet management and treasury teams attempted to manage their interest rate risk by deliberately buying or selling large amounts of bank bills to influence the setting of the BBSW maybe as little as one or two basis points higher or lower.

If the BBSW rate was either higher or lower other NAB business units responsible for managing interest rate risk or parts of the balance sheet may gain larger revenues if they had a net long exposure to a higher BBSW and vice versa if they had a net short exposure.

The regulator citing evidence of various communications between separate NAB trading teams responsible for managing parts of the balance sheet or bank bill trading that allegedly show collusion in attempting to manipulate the BBSW for their bank’s and team’s financial benefit.

Effectively it is alleged the big banks were fighting each other in order to manage their interest rate risk rather than setting BBSW as an independent reference rate.

This is an allegation not dissimilar to the London Inter Bank Overnight Rate (LIBOR) scandal to hit European and global banks. This is where major banks and their employees have been found guilty on civil (resulting in multi-billion dollar fines) and criminal charges of fixing LIBOR by deliberately submitting false data to set the rate artificially high or low.

What could happen if the court finds in favour of ASIC?

Over time and due to the power the banks have over financial markets and money supply the overnight lending rates came to be used as a standard reference to other floating rate debt securities issued across financial markets with no relation to the interbank lending activities of the banks.

For example residential mortgage backed securities (RMBSs) and other collateralised debt obligations packaged up and sold to Australian retail investors in the form of managed funds such as those operated by Firstmac Ltd will pay an income a fixed margin above the BBSW. The margin and total income generally depending on the underlying securities time to maturity and credit quality, although the actual product has no relation to the banks other than using BBSW as floating rate of return reference point.

In effect then the alleged manipulation of the BBSW higher or lower could artificially effect the returns received by retail investors if only by a matter of low-single digit basis points.

For now ASIC is only seeking to prove charges of unconscionable conduct against the NAB in relation to direct counterparties of the banks who had opposite exposure to the BBSW to NAB at the time it allegedly sought to manipulate the BBSW.

It is also alleging misleading and deceptive conduct by NAB in representing to counterparties to BBSW that it was an objective and independent reference rate.

Evidently if ASIC is successful in proving its claims against the NAB or other banks there is the potential for reputation-wrecking consequences aside from the fines imposed.

This is certainly a court battle all bank shareholders should pay close attention to.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

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The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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