Understanding the Libor Scandal
Barclays bank agreed in late June to pay $453 million to U.S. and UK regulators (Reuters) to settle allegations that it had systematically manipulated the London Interbank Offered Rate, or Libor, between 2005 and 2009. It also fined Barclays for “misconduct” related to the European equivalent of the Libor, the Euro Interbank Offered Rate. The Libor scandal has already claimed the jobs of high-profile bankers (Guardian) at Barclays, including CEO Robert Diamond, and the ongoing international investigation—of which the UK and U.S. settlements were a part—into the manipulation of interbank offered rates is expected to implicate other banks and their leaders in the weeks and months ahead.
What is the Libor?
The London Interbank Offered Rate—the Libor—is a benchmark interest rate based on the rates at which banks lend unsecured funds to each other on the London interbank market. The Libor is published daily by the British Bankers’ Association (BBA). Each morning, global banks submit their borrowing costs to the Thomson Reuters data collection service. The calculation agent throws out the highest and lowest 25 percent of submissions and then averages the remaining rates to determine the Libor. Calculated for fifteen different maturities and ten different currencies, the Libor is considered the most critical global benchmark for short-term interest rates. Eighteen banks submit rates for the U.S. dollar Libor.
How does the Libor affect borrowing globally?
Many banks worldwide use Libor as a base rate for setting interest rates on consumer and corporate loans. When the Libor rises, rates and payments on loans often increase; they fall when the Libor goes down. The Libor is also used as a base rate on financial markets for a number of derivatives instruments, including futures contracts, options, and swaps. The Libor “is used for an increasing range of retail products such as mortgages and college loans,” while also being used as “the basis for settlement of interest rate contracts on many of the world’s major futures and options exchanges,” explains the BBA. Some 45 percent of adjustable-rate prime mortgages and 80 percent of adjustable-rate subprime mortgages are based on the Libor, while half of variable-rate private student loans are set to the Libor, according to the New York Times. Over $800 trillion in securities and loans are linked to the Libor, including auto and home loans (WSJ), says the U.S. Commodities Futures Trading Commission.