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Question:


What is Libor?
-FinanceNerd


Answer:


Libor is the London Interbank Offered Rate, the average rate at which multinational banks make short-term loans to one another. Libor is calculated daily for loans of various terms, from one day to one year, and on 11 currencies, including the dollar, by the British Bankers Association based on rates reported by its 200-plus member firms. Libor is usually of interest only to bankers and finance nerds such as yourself, but it has been in the news lately because of criminal and/or regulatory investigations on three continents related to allegations that rates reported for Libor have been routinely manipulated. Manipulation would be quite easy because the method used to calculate Libor is essentially an honor system among bankers (insert your own punch line here). What are reported to the BBA are not rates on actual loans but estimates by bankers of the rates that their institutions would be charged.

 

Not only do bankers have the means to manipulate Libor rates; they have had the motive to do it since the global financial crisis that began in 2007. Back then, and to a lesser extent today, banks’ strength and even their solvency were in doubt. A well regarded sign that such doubts are justified and that a bank is at risk is an increase in the interest rates that it must pay for funds. With banks dropping like flies during the crisis – Bear Stearns, Lehman Brothers – the ones that were left had an incentive to understate the rates they were paying. If there had been hints that a bank’s borrowing costs were rising in such a climate, competitors and nonaligned traders would have smelled blood in the water and forced rates even higher. The chief accusation in the Libor scandal is that some banks, notably the British institution Barclays, indeed understated the rates they were paying. That may seem like an arcane factoid to anyone outside the banking industry or government, but any manipulation of Libor could have a serious impact on the finances of corporations, consumers and homeowners.

-Conrad de Aenlle



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