Libor-gate Explained: Why Barclays’ Scandal Matters
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The Fiscal Times
July 6, 2012

The scandal surrounding Barclays PLC has already created turmoil in the British banking giant’s executive suite – but it could reach much further before it’s resolved. Barclays chairman Marcus Agius resigned on Monday, but then agreed to stay on as the company searches for a replacement for CEO Bob Diamond, who abruptly resigned under pressure the following day. Chief Operating Officer Jerry del Missier also stepped down. Many more heads could roll if the rate-rigging scandal mushrooms, but even as it is, the investigations into Barclays and other banks manipulation of a key interest rate called Libor has wide-reaching implications for the financial sector – and for millions of businesses and consumers in the U.S. and abroad. Here, a guide to the scandal and its potential fallout.

What Is Libor?
The London Interbank Offered Rate, or Libor, is a key short-term interest rate that reflects the rates that banks get when they borrow from each other day-to-day. The interbank borrowing is done by financial institutions looking to make profits or cover short-term liquidity shortfalls. The British Bankers’ Association actually tracks a range of rates calculated daily for 10 major currencies and 15 borrowing periods – from overnight to 12-month loans – so 150 numbers are published every day: the overnight euro rate, the two-week Yen rate, the 3-month New Zealand dollar rate, the 12-month U.S. dollar rate, etc.

How Is the Libor Rate Set?
Thomson Reuters calculates and publishes the rate for the British Bankers’ Association every day just after 11 a.m. The calculation of U.S. Dollar Libor is based on data submitted every day, except for bank holidays, from a panel of 16 major financial institutions. The banks are asked to base their submission on this question: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?” Thomson Reuters throws out the top and bottom quarter of submissions and averages the remaining eight to get the published rates. That process, however, means that Libor is based on the rates banks report they could get, not actual rates on real loans.

Why Does Libor Matter?
Libor “is used to set interest rates on $350 trillion of dollars and euros of loans and other obligations globally,” portfolio manager Michael Lewitt of Cumberland Advisors wrote in a note to clients this week. That’s about $50,000 worth of financial instruments for every person on Earth. Libor plays a key role in global financial markets, underpinning the interest-rate derivatives traded by large institutions. And in addition to reflecting the rates that banks get from each other, Libor is also used to determine rates for some types of loans to consumers and businesses. “Adjustable-rate mortgages, student loans, some credit cards as well as small-business loans and corporate bond offerings can all be pegged to Libor,” says Greg McBride, senior financial analyst at Bankrate.com. In the United States, though, Libor is not the primary index for most loans, McBride notes.Still, if Libor is used as a global benchmark, the rate-rigging scandal calls into question the reliability of that benchmark – an issue that had also gotten attention during the financial crisis – and could potentially affect the interest rates many consumers pay.

What Did Barclays Do?
Last week, Barclays settled charges that it manipulated the Libor rate, and a similar rate called Euribor, for its own benefit by submitting falsified numbers as far back as 2005. According to the Financial Services Authority, Barclays derivatives traders routinely asked for submitters to help them profit from their trades by sending in numbers that were either higher or lower than they should have been. The regulator’s report says Barclays submitted inaccurate rates “on numerous occasions” between January 2005 and July 2008 at the behest of at least 14 Barclays derivatives traders. “Barclays could have benefitted from this misconduct to the detriment of other market participants. Where Barclays acted in concert with other banks, the risk of manipulation increased materially,” according to the FSA. At times, the Barclays traders also tried to influence the submissions of other banks, and passed along requests from their counterparts to Barclays submitters. After a Barclays submission was lower, as requested, one of those outside traders emailed their contact: “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger.”

Executive Editor Yuval Rosenberg oversees coverage of business, the economy, technology and Wall Street. A former web editor at WNYC, Fortune and Newsweek, he also writes on a wide range of subjects.