Saturday, October 16, 2010

Guido uncovers Anglo-Irish Bank fraud?

Guido has a very interesting story about the recently-bailed-out Irish bank seemingly providing fraudulent marks to its (less-savvy) customers.

The two circled figures for 3-month yields in the accompanying image, the actual DIBOR at 6.22000% and the figure claimed by the bank of 6.5000%, are supposed to be the same by definition.

Like mortgages, money market transactions have interest rates based on an official index (LIBOR, DIBOR, the Bank of England Base Rate) added to a spread agreed between the parties, which covers the risk to and the profit for the bank. The bank will borrow at the index rate and lend at a slightly higher one, which is perfectly sound business. Just like someone with great credit and a lot of equity will only pay a small amount more than the base rate on their mortgage, so a good corporate customer will get a tighter spread; a new or less-creditworthy customer will have to pay more to borrow.

The problem in this case is that, according to those figures, Anglo-Irish has simply lied about the index rates in order to cream off a bit more from borrowers. This is equivalent to your mortgage provider claiming that the Bank of England base rate is 1.5%, when it's really 0.5%, and therefore your mortgage is an extra £250 per month - that extra £250 doesn't pay down your debt any faster, nor is it a cost to the bank. They're still borrowing at the index rate, so the extra is pure profit without having to worry about pesky contractual obligations - you'd agreed how much you'd pay them, and they're taking more without authorisation or legal authority. Fraud, basically.

The article suggests that this was only done for less aware customers - a professional would likely have other sources of DIBOR marks and would spot the difference, but a naive customer might just accept the bank's numbers without asking, and that might double the desk's profits - if you're getting 28 basis points (1% of 1%) from lying about the index and offering a spread of 25bp, then more than half of the total profit is from the fraud. Now, if the market was uncertain, borrowers might happily pay a 53bp spread - but charging them that while telling them that it's 25bp is surely illegal.

It'll be interesting to see how that one plays out...

- KoW

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