Wednesday, 11 July 2012

LIBOR: The Syndication of Banks

Commonly known in the finance world, LIBOR is one of the main interest rates used in many calculations around the globe for all kinds of financial products. I believe one stat I read stated it is included in 800 trillion dollars’ worth of financial engineering.

However, most don’t know what all the fuss is about so I’ll quickly go through the basics. It’s already been summed up in many worthy publications which I’ll link below – but here is my take on it. The London Interbank Offered Rate (LIBOR) is an interest rate that is calculated for 10 different currencies and 15 borrowing periods. Each currency has a panel of banks that report their interbank lending rate, and this is reported to the British Bankers Association, which then reports to Thomson Reuters for the daily calculation. The rate is released around 11 am London time. 

Traders realized that if they could falsely manipulate the LIBOR rate, millions could be made even with a move of 0.01%. So, in accordance with bankers, some banks reported false interbank interest rates being charged in order to lower the LIBOR rate. I should reiterate quite a few banks engaged in this activity. For example the Royal Bank of Scotland reported lower interbank rates than healthier Banks even though it had been locked out of financial markets due to its financial condition.  Since LIBOR is used as the basis in most financial transactions, banks could then borrow money with lower interest rates and lend it out at higher rates. Also, trader’s having knowledge of what the LIBOR rate would be in the future allows more accurate predictions when deciding whether to buy or sell any financial instrument from any type of derivative to deciding whether to buy/short shares in a bank before reporting.

Why is this big deal? Well, the Economist labeled the lot of deviants Banksters while the Washington Post compared the dealings to that of a cartel. The comparisons are actually quite deserved, as these institutions should be competing with each other for business, not manipulate business through syndication. Adding to this, LIBOR was supposed to be a rate used as a basis for financial transaction – a non-biased number.  The whole process will now be placed under review as it has been corrupted.

How does it affect you? Well, if you contribute to any pension fund, have a mortgage, student loan, or are involved in almost anything that involves the stock market – you have been affected somehow. It will be really difficult to gauge the true cost of what has transpired, but the biggest cost has been market confidence – which has already been in free fall since 2008.

Simplistically, this is what has occupied the news outlets headlines over the past few weeks.

Here's some sources that go into far better detail: 
Telegraph             Washington Post            Economic Times            The Economist           Business Insider (thanks Reddit) 


David Warner said...

This is really a productive article and I acquire a lot of legitimate points through your article. LIBOR is a good interest rate to calculate the currency differential and borrow rates. I am working on this technique to find out the result and it is so helpful for me. I am bookmarking your page prlog for you next productive post.

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