The latest banking scandal to make the headlines in the UK was brought about by traders looking to profit by fixing lending rates known as Libor, resulting in a £290m fine for Barclays and the resignation of its chairman Marcus Agius.
The scandal puts another dent into the reputation of major banks and has led to the Prime Minister announcing a parliamentary enquiry into the Libor-fixing scandal.
As the fallout continues and other banks including Royal Bank of Scotland and HSBC are subjects of an investigation, Which? explains how Libor works, why it is so important and what Barclays did.
Update on 4 July 2012: Chancellor George Osborne was incorrect when he named HSBC as a bank under investigation for rate-rigging. The bank has, so far, not been accused of any wrong-doing.
What is Libor?
Libor stands for the London Inter Bank Offered Rate, and is the interest rate at which banks lend money to each other. The Libor rate is updated every day by Thomson Reuters, taking an average from the figures sent in by member banks.
Libor is the most widely used benchmark for short-term interest rates and it is used in the US as well as the UK as a measure of interbank interest rates.
What are the different kinds of Libor?
Libor is calculated daily in 10 currencies and 15 lending periods, resulting in various categories of Libor rates. Libor is used as a reference rate for sterling, US dollar, euro, Japanese yen, Swiss franc, Australian dollar and Canadian dollar, among others.
The lending periods, or maturities, include overnight, one week, one month, three months, six months and one year.
Why is Libor important?
Libor is important because it’s the primary benchmark for short-term interest rates worldwide, so it dictates the cost at which banks, institutions and investors can borrow money.
Banks typically lend out money to corporations at a certain percentage over the Libor rate. A large company with a strong credit rating would be able to borrow at a lower rate over Libor than a smaller, less stable company.
What else is Libor used for?
Libor is also used as a barometer to measure the health of financial markets as it illustrates how much companies trust each other to be able to pay back their money. This effects individuals too, as the rate influences the price of mortgage and personal loan agreements that a lender would offer you.
The sterling three-month Libor rate helps determine where lenders set mortgage rates for consumers and can also effect the amount they are willing to lend. Some mortgage deals are Libor-linked instead of tracking the bank rate or the lender’s SVR.
What did Barclays do?
Barclays was fined £290m for attempting to manipulate the rate of Libor. The Financial Services Authority (FSA) found Barclays’ traders to have lied about the interest rates other banks were charging for its loans on occasions between 2005 and 2009.
By reporting a lower interest rate than Barclays was actually receiving, it could give the impression that it was less risky than it actually was. A higher reading would have mislead investors as it artificially creates more attractive trading profits.
Are any other banks accused of doing the same?
Regulators in the UK and US are currently investigating the conduct of 20 other banking institutions. Barclays was the first to be fined, but it has emerged that at the end of 2011, Royal Bank of Scotland (RBS) fired four traders over manipulation of Libor.
Which? has called on the government to answer tough questions on rate-rigging and banking reform this week.
Which? chief executive Peter Vicary-Smith said: ‘Banks and bankers will continue to be seen as untouchable unless individuals are held to account for their actions and the culture of banking is changed for good.’