On Wednesday, former Barclay’s CEO, Bob Diamond, underwent a grilling by the UK’s Treasury Select Committee, focused on gaining a greater perspective regarding Diamond’s, and Barclays’, involvement in the London Interbank Offered Rate (LIBOR) manipulation scandal that has rocked the global financial community since the economic crash. The panel was assembled after an exhaustive international investigation ending with fines imposed upon Barclays totaling nearly one half of a billion dollars for attempted market manipulation of the LIBOR and EURIBOR rates. The fury over the investigation’s results also facilitated the resignations of key members of Barclays’ executive team this past week, including Diamond himself.
LIBOR is actually relatively new for the financial industry and seldom discussed outside of the financial community. Yet, the daily LIBOR rates do have a world-wide influence in every person’s life as people apply for loans, business seed money, along with the potential solvency of their own banks. In order understand the rationale behind the record setting fine, it’s important to understand the history of LIBOR, what it does, and how it impacts you.
LIBOR is a concept that began in the mid-1980s when new products were introduced to the financial sector, including interest rate swaps, foreign currency options, and forward rate agreements. Seeing the opportunity and risks, the BBA (British Banker’s Association) partnered with organizations, including the Bank of England, to establish various working groups dedicated to develop measurement standards for the new product offerings thereby creating a clearinghouse for competitors to list their daily rates. The culmination of the London banking industry’s efforts is the LIBOR.
The BBA libor’s website posts a basic definition of LIBOR as, “The rate at which an individual contributor panel bank could borrow funds, were it to do so by asking for and then accepting interbank offers in reasonable market size, just prior to 11.00 am London time.”
Currently, the BBA, advised by the Foreign Exchange and Money Markets Committee, utilizes data from a reference panel of 6 to 18 contributor banks for each of the 10 currencies included in LIBOR calculations. The calculation is the mean of the 50% middle values of the panel banks and used as the daily benchmark for interbank lending. The actual trading rate does not necessarily mirror the LIBOR and will fluctuate throughout the trading day.
The LIBOR is used as a benchmark for a variety of financial transactions including, but not limited to, currency exchange rates and identifying potential liquidity challenges, both institutional and sovereign.
For example, when credit challenges hit some of the yen contributor banks in the 1990’s, the yen LIBOR took a hit. If a bank consistently posts LIBOR rates outside of the mean, analysts begin taking a closer look at the bank and speculation on liquidity problems starts to surface which can make it more difficult, and expensive, for an individual bank to conduct business with other banks. A systemic failure raises the LIBOR and places additional stress on central banks which makes it more difficult for nations to conduct financial transactions with each other.
It’s also used in numerous institutional lending decisions and personal lending rates. For example, the LIBOR dollar rate in the United States has as an index for ARM mortgages. GBP LIBOR has been used to index the UK’s ARM mortgage equivalent.
The recent fines Barclays received were in response to a lengthy investigation surrounding Barclays’ attempts to manipulate the LIBOR in their favor. This type of manipulation, if left alone, has a major impact on the overall stability of the banking system and, eventually, filters down to each citizen in the form of the availability of loans along with the rates we are charged.
Had Barclays chosen to stick with the three principles of their Quaker founders, honesty, integrity, and plain dealing, they would not have found themselves in the cross-hairs of a multi-national investigation and nearly $1/2 billion in fines.
LIBOR really is a BFD.