The most recent scandal to hit the front pages sees Barclays bank taking it's turn to be dragged through the mud in relation to the rigged fixing of the London Interbank Offered Rate (LIBOR). But how could this happen and what does this actually mean for the average joe on the street. Not much.
LIBOR and EURIBOR (European Interbank Offered Rate) are Benchmark reference rates used to price a variety of global financial products, including interest rate derivative contracts. They are generally not used to price consumer financial products such as variable rate mortgages, credit cards or savings accounts, and these are generally based directly on the bank of England base rate. The setting process for LIBOR and EURIBOR operate similarly in principle but slightly differently in practice. LIBOR is published on behalf of the British Bankers association and Euribor is published on behalf of the European banking federation.
Both are calculated from the rate at which selected banks report they can borrow money in the market. Those banks are selected by the BBA and EBF, respectively, and each bank contributes rate submissions each day. These submissions are a subjective evaluation of rates at which money may be available to that bank in the interbank market. Until February of 2011, the U.S. dollar LIBOR panel consisted of 16 banks, and the rate calculation for each maturity excluded the highest four and An average of the remaining eight submissions was taken to produce the final benchmark rates. Throughout the relevant period, the EURIBOR panel consisted of at least 40 banks, and the rate calculation excluded the highest 15 percent and the lowest 15 percent of all the submissions collated. A rounded average of the remaining submissions was taken to produce the final benchmark rates. Every bank has a number of submitters who are responsible for sending their bank's benchmark rate submissions to the relevant benchmark rate publisher.
It's an unintended feature of the interbank rate setting process that because the rates submitted by each bank are public information, they've been used by the media and others as a proxy for the liquidity of the submitting banks. Crudely, if a submitted rate is high relative to others, it has, on occasion, been incorrectly assumed that it's more difficult for that bank to raise money in the market. It is important to understand to that although the primary purposes of the setting process is to set the rate, the secondary feature also exists. In short getting to the bottom of the Libor scandal will take time as the corruptive nature doesn't only sit with Barclays Bank but the numerous other Banks involved in the scandal and more so the British government. The media may have been scare mongers but government should not have encouraged Barclays et al to act in such a manner. Worse though is that they did.
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