Libor: the vital number for every banker

Q What is Libor?
A The London interbank offered rate (Libor) is set daily for 10 major currencies and for 15 borrowing periods, ranging from overnight loans to 12 months. It is set by the British Bankers’ Association, after speaking to 16 banks and studying their data on the cost and price of lending to each other, and then crunched by Thomson Reuters by removing the outliers at the top and bottom of the range. The process begins at 7am and the rate is flashed onto traders’ screens at 11.30am.

Q What were the findings of the Financial Services Authority?
A It said Barclays set artificially low rates during the financial crisis to make it appear healthier after senior management concerns over “negative media comment”

It also took into account requests from its own interest rate derivatives traders. They gained from shifts in Libor.

Barclays also sought to influence Euribor submissions of other banks which contributed to the rate-setting process.

Q Barclays traders shouted “just tell him to keep it, to put it low” and similar comments. What did it do wrong?

A It broke so-called Chinese Walls, which were built to avoid a conflict of interest between the traders and the “submitters” whose job it was to report daily rates. The two sides worked together for years to make the rates submitted suit the traders’ and the bank’s purposes. Barclays also gave a misleading impression of the cost of bank borrowing and failed to reflect the financial stress it faced during the crisis. In one communication a trader admitted that borrowing costs are actually higher than shown by Libor, saying: The “true cost of money is anything from five to 15 basis points higher”. A basis point is equal to 0.01 percentage point.

Q So has Barclays been referred to the City of London Police?
A No, the trades are not covered by the Financial Services and Markets Act while the FSA said there was no evidence of criminal conduct.

Q Who else is looking at Libor?
A Barclays will not be prosecuted in the US but authorities there, as well as Japan’s Financial Services Authority and competition bodies in Switzerland and Canada are looking at other lenders. Other major global banks, including Citigroup, HSBC, Royal Bank of Scotland and UBS, have been approached by authorities investigating how Libor is set. No bank or trader has been criminally charged in the Libor probes.

Q How much does Libor matter to the markets?
A It was once dubbed “the most important number in the world” because it underpins $10 trillion in loans to consumers and companies and another $350 trillion in derivatives. In the derivatives market, Libor is used in the pricing of the interest-rate swaps market, where two parties swap floating- and fixed-rate interest payments.

Q Why does this matter to consumers?
A Libor is used to help calculate the interest rates on a range of products, from mortgages, credit cards and loans to complex derivatives. During the crisis people looked at the rate for a measure on the confidence of the banking sector.

Q Has Libor worked well?
A Doubts about the rates arose at the crisis peak, when Libor remained relatively low despite the fact that the interbank market it is meant to represent had dried up, with banks too scared to lend to each other. Today, vast injections of liquidity by central banks have also distorted Libor. Other rates, such as Eonia and Sonia, are now also used to set the charges on overnight unsecured lending in euros and Sterling. But another reason why Libor has lost its potency is the rise of secured interbank funding