LIBOR is a main global benchmark interest rate. It stands for London InterBank Offered Rate. This rate represents how much banks actually charge each other for loans based on one year, six months, three months, one month, and overnight timeframes. Banks all over the world use this benchmark rate. Reuters news service publishes this critical rate every day at 11 am. They do this in five different currencies of the U.S. dollar, the Euro, British Pound, Swiss franc, and Japanese yen.
Historically the BBA British Bankers Association oversaw and compiled this rate. The IBA ICE Benchmark Administration assumed this responsibility on August 1st of 2014. They figure up this rate using contributor bank submissions. In every currency for which they calculate it there are between 11 and 18 contributing banks who act as an oversight board.
LIBOR does more than provide a rate for the interbank loans. It is utilized as a bank guide for their setting of credit card rates, interest only mortgages, and adjustable rate loans. Bank lenders add in between one and two points to make money. An incredible $10 trillion in loans are determined at least in part by this interbank rate.
Besides these uses, this rate also serves as a base price for credit default swaps and interest rate swaps. These contracts are a type of insurance in case loans default. The swaps also created the 2008 financial crisis. Hedge funds and banks believed that risk did not exist in the mortgage backed securities because they were protected by this insurance.
The problem arose as the subprime mortgages that underlay the mortgage backed securities started defaulting. AIG and other insurance companies discovered they did not have enough cash available to pay off the swaps. In order to save all swap holders from bankruptcy, the Federal Reserve was forced to rescue AIG with a bailout. Despite the fact that these swaps were supposed to be dispersed after the financial crisis, the LIBOR rate remains the basis on over $350 trillion of such credit default swaps.
Banks created LIBOR in the 1980s in response to a demand for a standard interest rate to establish derivatives. The original rate came out in 1986 in the three currencies the U.S. dollar, British pound, and Japanese yen. The BBA later expanded it to include the additional currencies of Swiss franc and Euro.
A scandal plagued the LIBOR rate starting in 2012. The British Bankers’ Association figured out the rate using its panel of banks that acted as representatives from every one of the currencies involved. BBA queried the banks about the rate they would charge in the set currencies for different amounts of time. The BBA’s downfall was that they believed the rates the banks provided them with were true.
This unraveled in 2012 as British bank Barclays became charged with deliberately providing lower rates to the BBA then the ones they actually received from 2005 to 2009. They suffered a $450 million fine and the CEO Bob Diamond had to resign. When Diamond went down he told authorities the majority of other banks engaged in the same practice and that the Bank of England was aware.
The reasons that Barclays and others were lying about their rate was for better profits. Lower rates made the banks look stronger and more attractive to borrowers than banks with higher rates. The end result had three bankers found guilty of manipulating rates in 2015 while six others were acquitted of their charges in 2016. The guilty bankers all worked for Rabobank. The rate was taken away from the British Bankers Association and given over to the care of the ICE Benchmark Administration because of the scandal.