Q&A: Libor rate and the regulators

UBS sign UBS is the latest bank to be hit with fines by international regulators, and others may follow

Swiss banking giant UBS has been hit hard for attempting to rig the inter-bank lending rate Libor.

It is the second major bank to fall foul of the regulators after Barclays was ordered to pay $450m to UK and US authorities in the summer, and others may well follow.

But what exactly is Libor, and why is it so important? Here we take a closer look at the issues involved:

Why do banks lend to each other in the first place?

Banks lend to each other on a short-term basis, either to make a profit or to cover any shortfalls in cash.

For example, a bank may find at the end of a certain day that more customers have made withdrawals than deposits, so it borrows from its rivals to cover the shortfall.

Conversely, banks with a cash surplus can make extra profits by lending funds to a rival. The average rate of interest paid by the banks in such interbank lending is called the London Interbank Offered Rate (Libor).

What exactly is Libor, and how is it calculated?

Libor measures the average rate that banks have to pay to borrow from their rivals for a specific period of time - be it a few weeks, months or up to a year.

It is calculated on a daily basis by the British Bankers' Association from estimates submitted by the major international banks based in London, and represents the interest rate they must pay in order to borrow cash from other banks.

The rate each bank has to pay is in part a reflection of its financial strength, as viewed by its rivals - effectively how much it is trusted.

Every day, 16 banks submit the interest rate that they are charged to borrow money. The four highest rates and the four lowest rates are ignored. The average of the eight remaining rates makes up the Libor rate.

A bank has to pay a higher interest rate to borrow funds if other lending banks have less confidence in it.

This means that the Libor rate gives an indication of the health of the wider banking sector. Libor has a European equivalent called Euribor, which plays the same role for banks based in the eurozone.

Why is Libor so important?

The Financial Services Authority (FSA) says Libor and Euribor are "benchmark reference rates fundamental to the operation of both UK and international financial markets".

The prices of trillions of pounds worth of financial transactions around the world are set according to Libor.

Among them, financial swap deals worth £225tn are indexed to Libor, as are loans totalling about £6.4tn, the British Bankers' Association says.

Libor, and the interest rate swap deals that are based on them, also provide an important indicator of the markets' expectations about the overnight interest rates likely to be set by the world's big central banks - the Bank of England, the US Federal Reserve, the European Central Bank - in the future.

Since the credit crunch first began in 2007, Libor has became an indicator of the financial stress that the major London-based banks found themselves in.

Ironically, the interbank lending market on which Libor is based has actually become far less important because the banks have been much less willing to lend each other money.

Does Libor affect my mortgage?

Some mortgages are directly linked to the Libor rate, although typically this is only the case for very big mortgage borrowers, such as corporations and property developers.

But even for those mortgages that aren't directly linked, Libor still influences the interest rate that banks charge their mortgage or loan customers.

That's because the Libor rate reflects the actual interest rate that the banks have to pay when they borrow money from the markets.

What happened at UBS?

The Swiss bank admitted its staff had rigged its Libor rate submissions for two main purposes.

First, traders manipulated submissions with the express purpose of boosting profits. In fact, according to the FSA, the bank gave traders themselves responsibility for submitting rates to the British Bankers' Association.

UBS also said its traders had colluded with counterparts at other banks, with the FSA saying the bank's Tokyo office had gone as far as paying intermediaries to help rig Libor.

Second, the bank accepted staff had deliberately lowered its submissions during the financial crisis to give the impression it was able to borrow money more cheaply than it actually could. This created the impression that other banks had more confidence in UBS than they did in reality.

The FSA said rigging Libor submissions at UBS was widespread and involved at least 45 people.

What happened at Barclays?

Staff at Barclays filed misleading figures for interbank borrowings they made.

First, between 2005 and 2008 - and sometimes working with traders at other banks - they tried to influence the Libor rate, so as to try to boost their profits.

Then between 2007 and 2009, at the peak of the global banking crisis, Barclays filed artificially low figures. This was to try and hide the level of financial stress under which Barclays was operating.

The bank's chief executive Bob Diamond was forced to resign from his job, along with Barclays chairman Marcus Agius and chief operating officer Jerry del Missier.

What investigations are now underway?

Investigations are continuing across the banking industry, so more evidence is likely to emerge.

The FSA and US regulators, along with counterparts is Canada, Japan in Switzerland, are continuing to look into Libor manipulation. There are at least a dozen other banks being investigated, including Citigroup and RBS.

The Serious Fraud Office is also considering bringing criminal prosecutions in the UK.

Meanwhile, lawsuits have been launched by US municipalities, pension funds and hedge funds.

More on This Story

More Business stories

RSS

Business Live

  1.  
    Saudi oil Via Email Roderick Macsween

    "As a former employee of Saudi Aramco of 25 years' standing and still consulting on a worldwide basis on their behalf, I can state without fear of contradiction that the wellhead cost per barrel of oil - irrespective of grade, i.e. heavy, light or extra light , averages out at between $6 to $8 per barrel.

     
  2.  
    10:30: House prices
    houses

    As standard, house prices in London are well ahead of the rest of the country. The Land Registry says average property values increased by 16.3% in December compared with a year earlier to £464,936. The east and south east also both saw steep rises in property values: up 10.3% and 10.8% respectively.

     
  3.  
    10:15: Paper review
    papers

    The Wall St Journal has a story on Standard Chartered chief executive Peter Sands feeling the pressure, telling senior executives at the bank they have "just a few months" to reverse the fortunes of the bank. The Times leads on Bank of England Governor Mark Carney's warning over German austerity plans. The FT says Goldman Sachs and France's SocGen may invest in peer-to-peer lending and The Telegraph reports on trouble for part of the government's foreign aid programme.

     
  4.  
    Shell earnings Via Twitter Victoria Fritz Business reporter, BBC News

    tweets: Expect a BIG backlash from environmental groups.@Shell has just announced that it WILL drill in the Arctic this yr after legal battles

     
  5.  
    Shell earnings Via Twitter Kamal Ahmed BBC Business editor

    tweets: Breaking; Shell announces it will drill in Alaska this year after delays. Needs to get the right permits - but wants to go ahead

     
  6.  
    09:44: House prices

    House prices grew by 0.6% in December, according to the Land Registry, which bases its index on house sale completions. That means house prices year on year grew by 7% nationally to £177,776 - just £3,372 below the last peak in house prices of £181,138 seen in November 2007.

     
  7.  
    09:31: Deutsche earnings

    Deutsche Bank says it expects operating cost cuts to continue in 2015 as fines loom. Its chief financial officer, Stefan Krause said: "We should see a decrease in the underlying cost base coming." Regulatory charges - finance people prefer that term to fines and being sued - are expected to increase in some areas, he said. "We have litigation settlements of the bank as well as other banks (and that) influences the operational risk map and that one is for sure going to increase," he added. "We regretfully can't give you a better outlook."

     
  8.  
    09:16: Market update

    Hong Kong and mainland Chinese stocks closed lower, in line with sharp declines across most Asian share markets. The Nikkei 225 index at the Tokyo Stock Exchange fell 189.51 points, or 1.06% to 17,606.22. The benchmark Hang Seng Index fell 1.07%, or 265.96 points, to 24,595.85. Analysts said the drop was down to declines on Wall Street and concerns that China's market regulator will clamp down on margin trading, which has helped to fuel a recent rally.

     
  9.  
    Saudi oil Via Email

    Benjamin Higgins says "about $15 a barrel". Tristan McCooey, goes with "about 3 dollars per barrel ". Dr Ian McCormick asks: "Isn't it about $4?" All good contributions.

     
  10.  
    08:45: Deutsche earnings
    dbk

    Deutsche Bank has reported a surprise pre-tax profit of €253m in the three months to the end of 2014, helped by an unexpected drop in litigation costs and a rise in trading revenue at its investment bank. Germany's largest lender was able to postpone major legal expenses in the quarter because a number of major cases have yet to be settled, but the threat of future fines still hangs over the lender, frustrating management's efforts to boost profit.

     
  11.  
    Shell earnings Kamal Ahmed BBC Business editor

    As the first of the major oil companies to report its figures for last year, Shell plays the role of the canary in the coal mine - or on the oil rig. After a rather sickly 2013, profits are actually up. But the impact of the low oil price is clearly biting. The company announced that it would be cutting investment over the next three years in new exploration and the development of oil and gas fields, a move that will raise fresh concerns about its business in the North Sea.

     
  12.  
    08:19: House prices
    The sun illuminates property in the historic city centre of Bath

    Nationwide says house price growth got off to a weak start in January with property values up just 0.3% in the month and 3.8% higher than the same month a year earlier. That marks the lowest rates of house price growth for 14 months.

     
  13.  
    Saudi oil Via Email Neil Carter, Business live reader from Devon

    "In the eighties it was one to three dollars a barrel. Today I expect that it is in the region of six to eight dollars. Some newer fields may have higher costs due to higher exploration and extraction costs, so maybe ten to twenty dollars a barrel."

     
  14.  
    07:55: Diageo results Radio 5 live

    "The results today show we are seeing a pick up in momentum," Diageo's John Kennedy tells Radio 5 live breakfast. "If you look at the overall picture... we've seen an emerging market slowdown... but the big developed markets... are performing well despite a muted recovery particularly in Europe." India is performing strongly, as is Mexico, he adds.

     
  15.  
    07:51: Diageo results
    guinness

    Distillers Diageo say profit for the six months to the end of December dropped to £1.36bn from £1.65bn as the pound strengthened and they suffered "lower income from associates and joint ventures".

     
  16.  
    07:41: Shell earnings

    Shell's has also pulled $15bn of investment in oil exploration over the next three years. It says organic capital investment in 2015 is expected to be lower than 2014 levels. "Shell has options to further reduce spending, but we are not over-reacting to current low oil prices and keeping our best opportunities on the table," it adds.

     
  17.  
    07:24: New fund BBC Radio 4

    Nigel Wilson, chief executive of asset manager and insurer Legal & General, says the firm will put £1.5bn for a new infrastructure fund in the UK on Today. "We are very long-term investors - 20, 30, 40, 50, years," he says. Longer-term financing from fund managers like him are the future rather than shorter-term bank lending, he says. Will £1.5bn be enough? He's attracting outside investors and will borrow money to grow the fund to about £25bn.

     
  18.  
    07:15: Royal Mail chairman
    mail

    Donald Brydon will step down as chairman of Royal Mail, the company says. The company is looking for a new one. Mr Brydon will carry on until the firm's annual meeting in the summer.

     
  19.  
    07:10: Shell earnings

    Shell has reported full year earnings (on a current cost of supply basis) of $19bn compared with $16.7bn a year earlier. Fourth quarter earnings were also higher at $4.2bn compared with $2.2bn for the same quarter a year ago.

     
  20.  
    06:58: Eurozone union BBC Radio 4

    Bank of England Governor Mark Carney yesterday said the eurozone needs fiscal union to manage monetary union. James Bevan, an asset manager CCLA, tells Today "a root cause of the problem is absence of growth," low money rates alone won't get growth going.

     
  21.  
    06:48: Shell results
    Car lights are seen streaking past an oil rig extracting petroleum

    Some discussion here on the business livepage as to just how cheap it really is to extract oil in Saudi Arabia. So we thought we'd open it up to the floor. How much do you think it costs Saudi Arabia - per barrel - to extract oil from the ground. Send your answers to bizlivepage@bbc.co.uk or tweet @bbcbbusiness. Usual rules apply: no peeking at the internet.

     
  22.  
    06:38: Shell results Radio 5 live

    How does the lower oil price affect alternative ways of exploring for oil such as shale? Michael Hewson of CMC markets tells Wake Up to Money shale oil exploration is largely dead in the water. Getting shale oil out of the ground is still far more expensive than getting oil out of the ground in Saudi Arabia, he says. What pushed up Saudi Arabia's oil extraction costs was the welfare programme the country introduced when the Arab Spring broke out in 2011. He adds Saudi Arabia can live with a low oil price for a long time.

     
  23.  
    06:23: Shell results Radio 5 live

    "I think there is a good chance that we could see a reduction in [Shell's] dividend and that could affect pension funds here in the UK," Michael Hewson of CMC markets tells Wake Up to Money. He doesn't see that happening just yet, but if the oil price continues to fall, or stays low for a long time, then he thinks it is unavoidable.

     
  24.  
    06:11: Shell results Radio 5 live

    Michael Hewson of CMC markets tells Wake Up to Money he expects Shell's revenues will be slightly lower when it publishes results later this morning. He is, naturally, interested in how Shell is coping with the lower oil price. He doesn't think "we've hit bottom yet" in terms of oil prices. "The Saudi's have still got their foot to the floor in terms of market share," he says. "The low hanging fruit in terms of getting oil of out the ground is gone," he adds.

     
  25.  
    06:01: Apple analysis
    apple

    Apple caught up with Samsung as the world's biggest smartphone seller in the fourth quarter of 2014, thanks to booming sales of its new iPhone 6, market researcher Strategy Analytics said. Strategy Analytics said Apple flogged 74.5 million handsets in the fourth quarter, compared to 51 million a year ago. Samsung shifted the same number, which for them was a reduction from 86 million the previous year.

     
  26.  
    06:01: Matthew West Business Reporter

    Morning. Do get in touch at bizlivepage@bbc.co.uk or tweet us @bbcbusiness.

     
  27.  
    06:00: Howard Mustoe Business reporter

    Good morning everyone. Overnight, McDonald's has said Don Thompson will retire as chief executive of the fast food firm to be replaced by British-born Steve Easterbrook, the company's current chief brand officer. We have house price data from the Land Registry at 09:30 and Shell's results to look forward to. Stay tuned.

     

Features

From BBC Capital

Programmes

  • A person wears a mask at the Vevcani Carnival in MacedoniaThe Travel Show Watch

    The masked Balkan carnival attracting thousands to the streets of Vevcani

Copyright © 2015 BBC. The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.