LIBOR or LIE-MORE?

Author :Chakhsu Agarwal , NMIMS

The recent London Interbank Offered Rate (LIBOR) scandal has cost Barclays heavily with its top 3 officials including the CEO Bob Diamond resigning from the firm. Before digging into the LIBOR scandal, let us first get an insight into what LIBOR is all about. 

What is LIBOR?

 LIBOR, or the London Interbank Offered Rate, is the average interest rate estimated by leading banks in London. The Banks charge this rate for lending credit to other banks in the London Interbank Market. Libor is calculated and published by Thomson Reuters on behalf of the British Banker’s Association (BBA) after 11:00 AM (and generally around 11:45 AM) each day (London time). LIBOR is calculated by BBA daily wherein they survey 16 large banks. The BBA, then surveys different banks’ interbank interest rate quotes. The rate at which each bank submits must be formed from that bank’s perception of its cost of funds in the interbank market.

The top four and bottom four values of the quotes are discarded and the remaining interest rate quotes are averaged to form the daily LIBOR. LIBOR rates are provided for period up to 12 months. LIBOR rates are provided in 10 currencies namely US dollar, euro, Japanese yen, Swiss franc , Canadian dollar, Australian dollar, Swedish Krona, Danish kroner , New Zealand Dollar. There are ten LIBOR panels, one for each of the ten currencies for which the rate is determined. Each panel is composed of at least eight contributor banks, chosen for their reputation and their perceived expertise in a given currency.

Why is Libor significant?

Not only does LIBOR provide information about the cost of borrowing in different currencies, it actually influences it. Banks look at it every day to figure out what they should charge for not just home loans, but car loans, commercial loans, credit cards. LIBOR ends up almost everywhere. Variable interest rates are often quoted as LIBOR + a percentage. For example, a loan that was LIBOR + 5% would charge 10% interest when the LIBOR is 5% and they would get charged 7%, when the LIBOR is 2%. So deals on trillions of dollars around the world are done based on this number.

What is the LIBOR scandal?

The inquiry into the suspected LIBOR scandal started over the allegations of Interest Rate Manipulation during 2008 sub-prime crisis. In order to stimulate the economic activity and show rosier than actual picture of banks, banks showed lower than actual interest rates. The lower interest rates therefore resulted in lower LIBOR and thus shored up the confidence and increased lending. Allegations of Libor rigging are not new but for the first time it has come to the surface that LIBOR manipulations were sanctified by the officials. As Libor is the average of the interest quotes by different banks, so rigging of Libor would have involved many banks. In the wake of investigation over the phone conversation Diamond had with Paul Tucker, the Deputy Governor of bank of England, Barclays decided to come clean about Libor fixing and settle ahead of the other banks which were also under investigation. They launched an internal investigation which cost 100 million pounds and in its report to regulators claimed that they had official sanction to lower the interest rates. But their strategy backfired politicians and regulators quickly turning against the bank as public outrage rose and were fined $455 million by US regulators for rigging the Libor rates. The CEO of Barclays, Bob Diamond, had to bear the brunt by resigning from their respective jobs.

The BBA is currently undertaking a review of the way LIBOR is set and will publish its findings shortly.  The FSA is working to support market-led reviews of existing arrangements, with the goal of ensuring such arrangements continue to command the confidence of all stakeholders. Once the investigations are over, it would more clear as if any other banks were also involved in this scandal.