What is the Libor Anyway?

The London interbank lending rate is a benchmark interest rate used to set a range of financial deals. It is perhaps one of the most important interest rates in the financial world and is considered to reflect the general health of the financial sector.

How is it set?

The rate is calculated quite simply. Each day a number of banks submit rates for 10 currencies and 15 lengths of loans ranging from one month to one year.  The top four and bottom four estimates are discarded and the average of the remainder is calculated. This is the Libor. A low interest rate (1%) would indicate that bankers are somewhat positive about lending.  A high interest rate (5%) conveys reluctance on behalf of banks to lend, signalling poor banking health or uncertainty. In 2007, post Lehman Brothers collapse; inter bank lending ground to a halt, amplifying the effects of financial crisis.

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Why is it important?

Mortgage lenders, credit card agencies and other financial firms set their rates with the Libor in mind. The price of your mortgage and the savings rate offered by your bank are therefore linked to this inter bank lending rate. The Libor exerts influence over $300 trillion worth of derivatives and other financial products. So you can imagine the implications of tinkering with this lending rate.

The Libor Scandal

In 2012, a rumour emerged that several large banks including Barclays, HSBC, Citigroup and RBS, rigged the Libor from 2007 to 2011. This rumour was subsequently confirmed as it became apparent that individual traders used online chatrooms to manipulate the 3 month Libor. To date fines of up to £3.7 billion have been levied on a number of banks and several law suits have been filed. But do ‘slap wrist’ fines actually work to reduce corruption? After all some large financial institutions like JPMorganChase& Co  appear to remain engaged in  immoral behaviour, despite having  received a record $13 billion fine last year for misleading investors during the subprime mortgage crisis.

The financial sector is an important ingredient for economic growth. Extending credit to businesses and loans to home makers, it greases the wheels of capitalism and consumerism. The Libor, acting as an indicator of overall bank health, is crucial to those seeking to allocate resources i.e. avail of a mortgage or save. Artificially fixing the Libor is not only fraudulent and unethical but it also has the potential to distort actual market conditions. Those with the capacity to benefit most from a low Libor are those paying interest on loans, while the losers tend to be savers and investors. Signalling to us that banks are healthy when clearly they are not should be cause for concern. Its significance is akin to a doctor telling a dead patient’s family that he/she is alive and well, over the monotonous buzz of the flat line.

 By Brian O’Toole

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