DCSIMG

Libor: How it works

  • by MARTIN FLANAGAN
 

The London inter-bank offered rate (Libor) is essentially an index of what banks expect to pay to borrow from one another, and a measure of trust in the financial system and the faith banks have in each other’s financial health.

It is used as a reference in handling more than $300 trillion in loans and transactions around the world. The rate is set daily by a panel which is overseen by the British Bankers’ Association. Banks submit their rates, which are totted-up and an average is taken, which becomes the Libor rate.

At the height of the financial crisis, many banks stopped lending to each other because of fears about their financial health.

Barclays was among those submitting higher rates than others and it was feared that this could be a reflection of its financial ill-health. Responding to these fears, the bank lowered its submissions to give the impression that its finances were fine.

Libor rigging was also carried out by other banks, with traders at several institutions conspiring to influence the rate by getting colleagues to submit rates that differed from their actual estimate in order to make the bank’s position look better than it was

The effect on the average consumer was said to have been minimal, because financial products, including mortgages, are usually pegged to the Bank of England base rate, rather than Libor. However, the FSA says that the rate “is fundamental to the operation of both UK and international financial markets”, and is a reflection of practices within banks generally.

 

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