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What the LIBOR Scandal Means for Investors

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UBS (NYSE: UBS  ) is the latest bank to face consequences of this summer's LIBOR scandal, in which 16 banks were allegedly involved in manipulating the rate that sets interest rates for 10 currencies. The Swiss bank is expected to pay $450 million in fines and admit its involvement in reporting false rates to increase profits.

Although UBS is nearing a settlement agreement, don't expect this scandal to end quietly. This is a slow burn, not a flash fire, and investors, borrowers, and consumers alike would be wise to watch how it unfolds in several key areas.

New players
LIBOR, the London Interbank Offered Rate, was established in 1986 by the British Bankers' Association, which until now has also managed the rate. It's set daily, based on the rates that banks expect to pay when borrowing from each other. Some banks use LIBOR as a base rate for setting their own lending rates to customers, and add additional interest based on the borrower. When LIBOR goes up, so do those rates and payments on everything from credit cards to municipal bonds. There are $350 trillion in derivatives and other financial products tied to LIBOR.

In September, the association agreed to turn over control of the rate to regulators. Martin Wheatley, the managing director of the U.K.'s Financial Services Authority (FSA) has called LIBOR "no longer fit for purpose." Wheatley has proposed that a yet-to-be-created administrator post should assume control of the rate from the BBA, and that the current pool of 23 banks that set LIBOR should be expanded.  

Wheatley also evaluated the 50 largest banks in Britain on market expertise and participation and found Wells Fargo, Morgan Stanley and Goldman Sachs scored higher than several of the banks currently involved in rate-setting. While the three U.S. banks haven't commented on the findings, it's no leap to expect these three will be asked to take some role in the next incarnation of LIBOR.

UBS isn't the only bank facing a whopping fine. Barclays was also fined $450 million for its involvement, and Barclays' (NYSE: BCS  ) chief executive Bob Diamond and chairman Marcus Agius resigned as a result of the scandal. According to the U.K.'s Financial Services Authority, Barclay's LIBOR manipulation could date as far back as 2005.

At a hearing in Berlin this week, Deutsche Bank (NYSE: DB  ) executives said that the bank had set aside reserves for possible fines, but did not expect to have to pay U.S. claims. Deutsche Bank admitted in July that a "limited number" of staff were involved in the scandal, but reiterated in Berlin that no senior officials had "behaved inappropriately."  

The Royal Bank of Scotland  (NYSE: RBS  ) is expected to face fines from both U.S. and U.K. authorities. RBS Chief Executive Stephen Hester has said the bank wants to settle with regulators as soon as possible, and that the bank will face a "miserable day" when the fines are levied.

In a letter to Treasury Secretary Geithner, Senators Chuck Grassley (R-IA) and Mark Kick (R-IL) have called for an American-based interest rate index. (Fools know Senator Grassley from the Grassley Amendment in the STOCK Act.) CFTC Chairman Gensler has proposed LIBOR be tied to market transactions, rather than banks' estimates of its interbank borrowing costs.

It's clear from both the fines and the cross-Atlantic investigations that LIBOR won't be allowed to continue as-is. It might be abolished entirely, subject to transformation and transformative oversight, or abandoned by U.S. banks in favor of another index.

In the year ahead
The implications of LIBOR will be felt by investors during quarterly and annual earnings, and by consumers whose borrowing rates are tied to the rate. There will be more to come in the weeks and months ahead as the full impacts of a LIBOR revamp take hold. Also of interest will be the revolving door on senior executives implicated in the scandal, and at which companies they'll land.

At the end of a year of financial disasters, amid looming discussions of the fiscal cliff, and with confidence in banking at record lows, the promise of change is encouraging. Actual change would be astounding.

But for the 16 banks facing LIBOR investigations and lawsuits, the coming year looms large. Bank of America (NYSE: BAC  ) is one of the 16 banks facing LIBOR charges, and the Motley Fool has taken a hard look at the challenges facing the large bank. Download our special report today; it's free for Fools. 

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