What is Libor, again?
It’s the London interbank offered rate. Unless you’re in finance, you probably first heard of Libor early in the financial crisis. It’s a “reference rate” – that is, it’s a number based on the average interest rate demanded by major banks for short-term loans to other banks in the London market. That makes Libor a thermometer for measuring anxiety in the global financial system. When banks feel good, Libor is low because banks will lend to each other over short periods (such as one or three months) very cheaply. But when confidence wanes, as it did during the financial crisis, Libor spikes.
Why the fuss over one bank? Interest rates are set in markets. Surely, Libor is determined by hundreds and hundreds of trades.
That’s the problem: Libor isn’t set in a market. It’s calculated through a poll overseen by the British Bankers’ Association.
Each day, participating banks are asked how much it would cost them to borrow money from other banks. On behalf of the bankers’ association, Thomson Reuters works out an average based on the responses. The sample size generally is less than 20 banks.
That leaves the system open to manipulation. In a settlement last week with U.S. and British authorities, Barclays admitted that it regularly lied when it submitted its interbank borrowing rates. In 2007 through 2009, it would present a lower rate to create the impression that it was healthier than it was. Barclays would also base its Libor submissions on requests from individual traders in London who stood to gain from higher or lower settings.
Was Barclays acting alone?
Financial regulators and competition watchdogs on three continents are investigating the rate-setting practices of nearly 20 banks, including Royal Bank of Canada. Only Barclays has admitted wrongdoing, agreeing to a settlement worth the equivalent of $453-million (U.S.). Japanese officials have found that staff at Citigroup and UBS attempted to manipulate Tibor, an interbank rate set in Tokyo that is similar to Libor.
Are the rates I’m paying on my car loan and mortgage higher because of all of this?
It’s possible, but probably not. Libor is the benchmark for more than $360-trillion (U.S.) in securities. That includes some bonds that are backed by things like student loans and mortgages. And there’s a link between the rates those bonds pay and the rates that banks charge consumers to borrow money. But that’s not a major factor in Canada, and even if it was, it would take a concerted, systematic effort in London to affect the average borrower.
Still, this is a serious issue. The abuse of Libor undermines confidence in the financial system, and makes big-money investors wary of dealing with banks. If that money retreats, lenders would look for ways to make up for those lost trading profits. That could affect your mortgage and car loan.Report Typo/Error