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Q&A Libor: the facts

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Written by:
02/07/2012
Barclays has been fined £290m for manipulating key interest rates, and the entire banking sector is now under scrutiny. What does it all mean, and how might you be affected?

What is Libor?

Libor is an interest rate based on what banks charge each other when they borrow money from one another. It stands for London Inter-Bank Offered Rate.

How is it calculated?

The data company Thomson Reuters collects sets the Libor rate on behalf of the British Banking Association. Every day at 11am, major banks submit the rates which they think they would be charged by other banks to borrow money over anything from one day to 12 months, in a numerous currencies. For sterling, 16 banks submit their rates, while for US dollars 18 banks are involved. For sterling, Thomson Reuters discards the top four and the bottom four estimates and works out an average of the remaining eight.

Why is Libor important?

Official Libor rates are used to price trillions of pounds worth of financial products globally.

Why was Barclays fined £290m?

Barclays traders were found to have manipulated Libor, under-or over-stating the rate periodically between 2005 and 2009, which would have meant that their financial counterparties paid more or earned less (or vice versa) than they should have done. Barclay’s rate submissions to Thomsons in isolation would have had a negligible effect on the official Libor rates calculated, but because Libor was then used to price trillions of pounds worth of products the implicationsare enormous – and very difficult to unravel.

Was Barclays alone in manipulating Libor?

Highly unlikely. The signs are that most, if not all of the major banks were involved. In blowing the whistle, UBS is hoping for lenience from the regulator. But it is effectively acknowledging its own guilt at the same time.

How does it affect me?

If you are one of the estimated 200,000 to 250,000 UK mortgage borrowers with a product directly linked to Libor during 2005 to 2009, it is likely that the interest rate you paid was affected by the manipulation. Most of the mortgages affected were sub-prime or buy-to-let deals, where the rate was typically set using a formula along the lines of ‘three-month Libor plus 1.5%’. Borrowers are unlikely to complain however, because, while in some instances Barclays traders pushed Libor up to enhance their profits, since 2007 the Libor rate was kept artificially low, meaning lower mortgage payments than should rightfully have been the case. Determining the exact rates that should have been paid is nigh-on impossible.

What about my savings?

Individual savers are unlikely to have been affected, as most savings rates set by banks and building societies have little or no relation to Libor. But big institutional savers such as local authorities and charities often deposit their savings in short-term arrangements which can be directly linked to Libor, and they will have been affected.

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