Friday, 6 July 2012

Self-interest and the banks

So why did bankers rig an internal banking rate, well very simply it was in there interest to do so. Actually it will have been in there short term interest to do so.

Before I continue I must admit my starting premise and this is we all act as self-interested individual. We do not operate in either perfect knowledge or wholly freely therefor we act in a limited rational way in the furtherance of our own or perceived self-interest.

So let us look at the starting question again; why did investment bankers rig the interbank rate? Answer, it was in there self-interest at that time. What does that mean, well as they saw it they would get a reward that outweigh the risk of losing their licence to trade and cause a scandal that would harm there means of making a living.

Wow! That reward must have been high. Actually I doubt it; the banks did in the end manipulate this rate to ensure there continuation (thus the risk was much reduced) but before this stage the rigging had already become systematic and the reward at individual banker (the achievement of targets and the reward for doing so) could simply not out weight the risk.  

So what can we conclude from the fact they did. One that they value the risk of being caught, very low; two that the punishment for bad behaviour must have either been no existent or very lenient; I suspect it was a combination of poor monitoring both internal / external and a very lenient punishment for  unacceptable behaviour and hear we have the nub of the issue.

Clearly the banks rewarded risky behaviour (again acting in there limited self-interest) and sought out and promoted risk taking individuals – actually this is untrue. I expect they did seek out risk taking individuals and rewarded successes but more importantly they must have stopped asking questions and demoted people unwilling to take extreme risks in the sight of others. Therefore you have an environment in which risk is rewarded and ill behaviour not punished whilst those unwilling to act in such a manner (for whatever reason) were side lined.

As you can see no memo insisting on the rigging of libor was required, indeed no knowledge of it in the higher Escalon’s would ever be heard, as no one wanted to know or sought to know. Simply by rewarding risk and not punishing ill behaviour an organisation will guarantee some law is eventually broken, as more and more risk will have to be taken to achieve increasing targets. This is the problem with limited self-interested rationality, it is often short sighted and often lacking in prudence, epically when the organisations does not punish ill doing. 

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