Libor Lending Rate scandal.

Another week! Another banking scandal!  The latest in the long line is that of the manipulation of the key bank lending rate known as LIBOR.

What is LIBOR?

Banks lend to each other on a short term basis, so as to make a profit, to cover any short term cash shortfalls.  For example, at the end of a banking day, it may well become apparent that more people have withdrawn cash from the bank than deposited it.  As a consequence, that bank borrows from another bank.  The banks with cash to spare, can then lend their surplus cash to other banks and make extra profits.

What is the LIBOR Rate? 

This rate measures how much a bank has to pay to borrow money from its rivals.

How is it calculated?

Every morning, bankers will sit down and work out how much money they need to borrow from other banks to plug holes in their balance sheet, or if they have excess cash, how much they can afford to lend.  The LIBOR ie, the London Inter-Bank Offered Rate, formally measures that cost of inter-bank lending, setting out the average rate banks pay to borrow from one another.

There are 150 different LBIOR rates calculated every day from Thomson Reuters, for different periods, ranging from one day right through to 12 months, and spanning different currencies.  They are calculated based on data submitted by a panel of major banks.  The UK Sterling rate is based on submissions from 16 banks, whilst the Dollar rate, is calculated by a panel of 18.  Each of the banks are asked the question: “At what rate could you borrow funds were you to do so by asking for and accepting inter-bank offers to a reasonable market size just prior to 11.00am?”

That information is then taken, and the four highest and the four lowest are ignored and the rest is left to calculate the rate.

So why is the LIBOR Rate Important?

It is important, because it is an indication as to the reflection of their rivals perception of  financial strength of the bank.   This is because the higher the interest a bank has to pay to borrow funds, the less confidence the bank lending them money has in it.

Following on from that, the lower the LIBOR rate, the more healthy the banking sector would appear to be.  The LIBOR is important to the financial services market, because trillions of pounds worth of financial transactions are set according to LIBOR.  They include financial swap deals and loans.

Does this Affect Me and My Mortgage?

Some mortgages are linked to LIBOR to set mortgage rates.  It is considered to be a much more accurate reflection of the health of markets, than the Bank of England rate.

Many of you will wonder why your mortgage rate goes up when the Bank of England base rate is so very low.   That is the reason.

So what did Barclays do and why did they do it?  

Barclays tried to work with traders at other banks to influence the rate, so as to boost their profits. During the banking crisis, between 2007 and 2009, it manipulated its rate so that the bank looked healthier than it actually was.

The consequence of those actions are that many financial products such as credit cards and loans could have been made much more expensive, because of the manipulation of the rate.

How will I ever know whether I have been overcharged?

The answer is you probably won’t.  To try and work how much extra or less you have paid as a consequence of this, and possibly other bank’s actions, would prove impossible to the man on the street.

In the US a  head of steam is already building with potential litigation, costing the banks billions of pounds.

Legal cases and class actions are lead by the city of Baltimore in New York and a lawsuit by the broker, Charles Schwab in California.

They are being brought against the world’s biggest banks, with Barclays, RBS, HSBC and Lloyds Banking Group, acting as defendants.

Those proceedings highlight the difference in the bank’s reported LIBOR rates and the real costs between 2007 and 2010, as it was reflected in credit defaults, swaps etc.

Commentators have stated that even if mispricing was only 0.05% over the period, then claims against Barclays could amount to £70b and £80b against RBS.  Whether or not that is accurate remains to be seen.  Barclays have made provisions of over £100m for LIBOR in its first quarter results, and therefore, they don’t appear to be as worried about the problem.

It remains to be seen whether consumers will be able to bring any claims.  To show that any market manipulation has had an effect on your mortgage will be extremely difficult.  The admission by Barclays that they had attempted to manipulate rates, does not necessarily mean that they were entirely successfully in doing so.


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