What Is London Inter-Bank offered Rate?

What is LIBOR?

LIBOR is an acronym for London Inter-Bank Offered Rate. It is the rate at which the largest financial forms borrow money from each other. According to Forbes (2012), LIBOR is most the important rate of the last decade. Moreover,

..it’s the standard rate of computing an interest rate in all the major currencies and in many different maturities. It is set in about 10 currencies and for each one there is one, three, six and twelve month maturity with many in between (Touryalai, 2012).  

The rate is managed by the BBA, or the British Bankers Association, and has been referred to as “the club of gentlemen bankers” (Rose & Sesia, 2014). The seems somewhat subjective, as the BBA surveys a group of banks daily by asking “If you were to borrow money this morning at [just prior to] 11 AM London time what you would have to pay for it?” The BBA reviews the submissions from the banks, excludes the top 25% and bottom 25% outliers and publishes the average of the remaining rates (for calculation, see Jones, 2012). The rate affects about $800 trillion dollars of contracts and financial instruments globally (Tourylai, 2012). According to a commentary in Forbes (2012), that’s more than half of the whole derivatives market! Perhaps more problematic, the rate is not regulated or overseen by any government or structured policy other than those set by the BBC.

1. Who is hurt and who benefits from the manipulation of LIBOR?

As mentioned earlier, several bank loans are bound to the LIBOR rate. Accordingly, those mortgages and small business loans given by said banks are based on LIBOR. If you borrow money and the loan you are approved for is tied to a manipulated-LIBOR rate, then the loan payments are manipulated and inaccurate also. To the extent that the LIBOR rate is manipulated (i.e., higher or lower) then the rate associated with the mortgage or small loan will be erroneous. Since LIBOR is accused of pushing rates lower, this should benefit the borrower. According to

Abrantes-Metz a writer for Forbes (WEB), “depending on how Libor may have been manipulated up or down will affect the different groups differently”. As an example:

if it is proven that the Libor rate was manipulated downward then consumers with auto loans and mortgages that are indexed against that rate will be paying less interest which is good for them. But if you have a 401(k) or a pension fund or bonds benchmarked to LIBOR you are getting paid less.

Thus the final result is case specific, but as I have learned thus far in this financial management course, individuals are both borrowers and lenders. In my opinion, the average person was hurt and banks, in part due to greed, clearly benefited. The reason is this, while individuals were paying less on loans now, they were also receiving much less on investments for the future. Based on the concepts of time valuation of money (e.g., Brigham & Erdhardt, 2012), this doesn’t quite balance in the favor of the consumer. Personally, I’d rather pay slightly more for a loan now, and receive a higher return for my investment maturing when I am retired and need the money (e.g., no other source of income).