What Is The Barclays Libor Rigging Scandal
Barclays has been on the front page of all the newspapers over the Libor rigging scanda, but many people don't understand exactly why.
We understand that bankers have been allegedly making our loans and mortgages more expensiveto make more money for themselves. But how does it affect us?
We asked David Buik from BGC Partners to explain the scandal.
What is the Libor?
Libor stands for London Inter-Bank Offered Rate and basically, it was a yardstick which was developed by the regulators and the Bank of England which started to be used around 1985.
The Libor priced the loans made to either building societies - essentially to you and I - or commercial loans to small companies.
Normally, the smallest number of banks used to get to this rate is seven - and it could be as many as 14, depending on the size of the rate. What they tried to do was to get a fair assessment by getting some big banks, some medium-sized banks and some small banks. They added up the numbers and divided by the number of participants and that was Libor.
It was normally decided around midday every day with the understanding and the absolute acquiescence of the Bank of England.
The Libor Fixing Scandal
The Libor rate is used as the benchmark for trillions of loans, mortgages and financial products traded around the world.
Barclays trades in these products, so in attempting to fix the Libor rate, they are rigging the market in its favour. As a result, they made bigger profits and traded at an advantage over others.
But during the credit crunch, banks became concerned about lending to one another and the Libor rate rose significantly. The more likely a bank was to collapse, the higher the rate they were charged to borrow.
Barclays Senior Management told staff to lie, saying that they could borrow at lower interest rates than they could, in order to show the bank in a better light than it actually was.
A derivative is a synthetic opinion of a physical instrument.
So, if I lend you £1million, that's cash, so I'd have to give you a cheque or use notes, or make a banker's payment. When that's lent from one bank to another, that's usually an interest rate, guaranteed for a period of however long it's lent.
A derivative is an option whereby a fixed period of interest rate is payable against receiving variable interest rate - in other words LIBOR - and it's calculated exactly on the date when the loan or deposit matures.
So there's no passing of cash, there's the passing of a margin, somewhere between 1% and 20% depending on the risk.
When you think interest rates are going to fall (but you're not quite sure), you hedge it against the Futures market, which is another derivative which you can buy or sell.
So if you see something and you think that interest rates are going to fall from five to four but you're not 100% sure, and you find a market in the Futures market saying 4.5, you take a 0.5% profit.
The Interest Swap or Swap Scandal
Banks are alleged to have bullied, cajoled or suggested their customers into hedging the cost of either their foreign exchange or the cost of their interest rates in borrowing money to do a business transaction.
A lot of people feel that it's been unnecessarily sold to small and medium-sized enterprises which didn't actually need it for good, old-fashioned greed.