Libor – what is it and why does it matter?

Libor, the London inter-bank lending rate, is considered to be one of the most important interest rates in finance, upon which trillions of financial contracts rest, and the exposure of its rigging has shocked many beyond the world of finance. Here, the BBC explains some of the key facts.

  1. 1. What is Libor?


    A global benchmark interest rate used to set a range of financial deals. It is also a measure of trust in the financial system and the faith banks have in each other's financial health.
    Mortgages
    Loans
    Inter-bank
    lending
    Indicator
    of trust
    Reflects health
    of banks

  2. 2. Why is it important?


    The Libor, or London Interbank Offered Rate, is used to set a range of financial transactions worth an estimated $300 trillion.
    $300,000,000,000,000

    Which is equivalent to approximately four and a half times global GDP

    4.5 globe icons
  3. 3. How is it set?


    Every day a group of leading banks submit rates for 10 currencies and 15 lengths of loan ranging from overnight to 12 months.

    The most important is the three-month dollar Libor. The rates submitted are what the banks estimate they would pay other banks to borrow dollars for three months. This is a simple example of how it works.
     
    Banks submit their rates 1% 2% 3% 4%
    The top and bottom quartiles are discarded 1%
    2%
    3%
    4%
    An average is calculated of the remainder 2.5% This is Libor

  4. 4. How was it rigged?

    By traders


    Since the rates submitted are estimates not actual transactions it's relatively easy to submit false figures.

    Traders at several banks conspired to influence the Libor by getting colleagues to submit rates that were either higher or lower than their actual estimate.

    Banks

    bank a bank b bank c bank d
    1% 2% 3% 4%
    1%
    2%
    3%
    4%
    2.5% Lower average
    bank b bank c bank d bank a
    2% 3% 4% 5%
    2%
    3%
    4%
    5%
    3.5% Higher average

    Libor and the financial crisis


    At the height of the financial crisis in late 2007, many banks stopped lending to each other over concerns about their financial health with some banks submitting much higher rates than others.

    Barclays was one of those submitting much higher rates, attracting some media attention. This prompted comment that Barclays was in trouble.

    Following much internal debate and a controversial conversation with a Bank of England official, Barclays began to submit much lower rates. You can see this in the graph below which compares the Libor rate with those submitted by Barclays.

    Barclays' Libor 3-month sterling submissions vs daily Libor fix

    Graph showing difference between libor rate and Barclays' submissions

  5. 5. Consequences


    The Libor scandal has further undermined trust in banks. The deputy governor of the Bank of England called the Libor market a "cesspit".

    While those paying interest on loans would have benefited from lower Libor rates, savers and investors would have lost out.
    Regulators in Canada, US, Japan, Switzerland, Britain are investigating the rate rigging.
    Lawsuits have been launched by US municipalities, pension funds and hedge funds.

Note: The estimated figure for the value of transactions connected to Libor has been revised down from $800 trillion following new figures in the Wheatley report on 28 September 2012.

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