LIBOR - How does it affect us?Posted on: 09 July 2012 by Nick McBreen
Nick McBreen explains how the interbank rate-fixing scandal will ultimately impact on your mortgage and savings.
It's dominating the headlines at the moment in the national press, not just the financial press, but what exactly is LIBOR and what does the recently revealed rate-fixing scandal involving Barclays mean for us? Is it an issue confined to the banking world, or does it have wider implications?
To begin with, LIBOR, or BBALIBOR to give it its full moniker, stands for the British Bankers' Association's London Interbank Offered Rate, the British Bankers' Association (BBA) being a trade association. The LIBOR rate calculations began in 1986 (1). The BBA Libor website describes the rate in the following terms: 'A benchmark giving an indication of the average rate at which a leading bank can obtain unsecured funding in the London interbank market for a given period, in a given currency' (1).
What this means, generally speaking, is that it is the average interest rate at which banks can borrow large amounts from other banks, in the London market. It's also the main benchmark for global short-term interest rates. Each bank submits its rate daily and the average is calculated by Thomson-Reuters.
There is a LIBOR calculated every weekday for 10 different currencies over 15 different lending periods, so there are a total of 150 LIBORs every weekday (1). The importance of LIBOR can be seen by the back-up arrangements it has. Interestingly, it is coordinated by only two people working from a small London office, but there are dedicated back-up phone lines and two back-up offices, should anything go wrong with the main office (3).
The reason it is important to us, and not just to banks, is because the LIBOR rate is intended to represent the real cost of money to banks, which then has an effect on mortgage and savings rates. It helps to set the cost of borrowing for individuals and businesses and a smooth and transparent flow of money between banking institutions is the life-blood of any market led economy and the businesses that contribute to the host nation’s economic fortunes. If one, or more, banks manipulate their individual interest rate, this can skew the LIBOR rate, leading to either falsely inflated, or falsely deflated borrowing costs.
Barclays has been fined by the Financial Services Authority for manipulating the LIBOR rate; for sending both higher and lower rates than reality. Other banks, including the Royal Bank of Scotland, are being investigated for the same matter. The FSA claims that this was going on between 2005 and 2009 (2).
There is around $10 trillion in different financial products, including mortgages, student loans and business loans 'pegged' to LIBOR. Approximately half of all adjustable-rate mortgages in the US are determined by the LIBOR level, which gives you an idea of how serious and far-reaching any manipulation of the rate is (3).
So what next? At present, no one is certain. Barclays have been fined a record amount by the Financial Services Authority and US authorities - a total of £290 million. Barclays chairman, Marcus Agius, resigned on Monday the 2nd July, followed shortly by the resignation of Bob Diamond, the bank's chief executive on Tuesday the 3rd July. The Guardian reported on Wednesday 4th July that Barclays share price had fallen by almost 2% ahead of Bob Diamond's appearance in front of the select committee (2).
There are now calls by the Labour party for an independent inquiry into the affair, Bob Diamond appeared in front of a parliamentary select committee on Wednesday 4th July, and the most recent revelation has been the raising of the question as to how much involvement the Bank of England had and how much awareness they had of what was happening to the LIBOR rate (2). The Deputy Governor of the Bank of England, Paul Tucker has requested an audience with the parliamentary select committee to tell his side of the story (2).
All that remains to be said is watch this space for further developments; we will keep you informed.
1. BBA Libor
2. The Guardian
3. London Review of Books
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