Understanding the Libor Scanda

Understanding the Libor Scandal

The manipulation of interbank lending rates by a host of global financial institutions could have significant repercussions for financial markets, consumer loans, and regulatory policy.

Introduction

Beginning in 2012, an international investigation into the London Interbank Offered Rate, or Libor, revealed a widespread plot by multiple banks—notably Deutsche Bank, Barclays, UBS, Rabobank, and the Royal Bank of Scotland—to manipulate these interest rates for profit starting as far back as 2003. Investigations continue to implicate major institutions, exposing them to lawsuits and shaking trust in the global financial system.

Regulators in the United States, the UK, and the European Union have fined banks more than $9 billion for rigging Libor, which underpins over $300 trillion worth of loans worldwide. Since 2015, authorities in both the UK and the United States have brought criminal charges against individual traders and brokers for their role in manipulating rates, though the success of these prosecutions has been mixed. The scandal has sparked calls for deeper reform of the entire Libor rate-setting system, as well as harsher penalties for offending individuals and institutions, but so far change remains piecemeal.

What is Libor?

Libor is a benchmark interest rate based on the rates at which banks lend unsecured funds to each other on the London interbank market. Published daily, the rate was previously administered by the British Bankers’ Association (BBA). But in the aftermath of the scandal, Britain’s primary financial regulator, the Financial Conduct Authority (FCA), shifted supervision of Libor to a new entity, the ICE Benchmark Administration (IBA), an independent UK subsidiary of the private U.S.-based exchange operator Intercontinental Exchange, or ICE.

To calculate the Libor rate, a representative panel of global banks submit an estimate of their borrowing costs to the Thomson Reuters data collection service each morning at 11:00 a.m. The calculation agent throws out the highest and lowest 25 percent of submissions and then averages the remaining rates to determine Libor. Calculated for five different currencies—the U.S. dollar, the euro, the British pound sterling, the Japanese yen, and the Swiss franc—at seven different maturity lengths from overnight to one year, Libor is the most relied upon global benchmark for short-term interest rates. The rate for each currency is set by panels of between eleven and eighteen banks.

How does Libor affect global borrowing?

Many banks worldwide use Libor as a base rate for setting interest rates on consumer and corporate loans. Indeed, hundreds of trillions of dollars in securities and loans are linked to Libor, including government and corporate debt, as well as auto, student, and home loans, including over half of the United States’ flexible-rate mortgages. When Libor rises, rates and payments on loans often increase; likewise, they fall when Libor goes down. Libor is also used to “provide private-sector economists and central bankers with insights into market expectations of economic performance and interest rate developments,” explains the IBA, the new Libor administrator.

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