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Average rate at which bank loans to one another.

LIBOR is the rate at which banks borrow funds from other banks in the London interbank market.

It is usually abbreviated to LIBOR or to BBA Libor (for British Bankers’ association Libor).

Background:It was established in 1986 by BBA.

It has 5 types of Stakeholders.It has total members 223.64 nations represented LIBOR.It has 15 types of Maturities.

Need for LIBOR

At the start of the nineteen eighties there was a growing need amongst the financial institutions in London for a benchmark for lending rates. This benchmark was particularly needed in order to calculate prices for financial products such as interest swaps and options. Under the leadership of the British bankers' association (BBA) a number of steps were taken from 1984 onwards which led in 1986 to the publication of the first LIBOR interest rates (BBALIBOR).

Panel Banks

Panel Banks: Panel banks are the contributor banks of LIBOR.

SELECTION of PANEL BANKS:

The selection is made every year by the ICE Benchmark Administration (IBA) with assistance from the Foreign Exchange and Money Markets Committee (FX&MMC).

Contributor banks have been selected for currency panels in line with three guiding principles: 1. Scale of market activity2. Credit rating3. Perceived expertise in the currency concerned

Process

A panel is made up for each currency consisting of at least 8 and a maximum of 16 banks which are deemed to be representative for the London money market.

Thomas Reuters: Thomson Reuters is the designated calculation agent for BBA (British Bankers’ Association) LIBOR. Data submitted by panel banks into the BBA LIBOR process is received and processed by Thomson Reuters and the data is calculated using guidelines provided by the "LIBOR Panel Banks and Users Group" ("LPBAUG").

Each LIBOR contributor bank has an application installed allowing that institution to confidentially submit rates which links directly to a rate setting team at Thomson Reuters. 

A bank cannot see other contributor rates during the submission window - this is only possible after final publication of the BBA LIBOR data.

Thomson Reuters run a collection of automated and manual tests on the submitted rates before they are sent to the calculation engine, and after calculation the data is released to the market via Thomson Reuters and other licensed data vendors. (the financial press, including the wall street journal and financial times publish BBALIBOR data from the previous day and Bloomberg etc).

Example

LIBOR Currencies

Originally (in 1986) LIBOR was published for 3 currencies: 1. US dollar2. pound sterling .3. Japanese yen.

The number of LIBOR currencies grew to a maximum of 16. A number of these currencies merged into the euro in 2000. Now, there are 150 Libor rates, spanning ten currencies. The 5 major currencies are given below:

American dollar - USD LIBORBritish pound sterling - GBP LIBOREuropean euro - EUR LIBORJapanese yen - JPY LIBORSwiss franc - CHF LIBOR

LIBOR Maturities

LIBOR publish rates for maturities from 1 day to 12 months. The 15 different maturities given below:

• 1 day (Overnight)

• 1 week

• 2 weeks

• 1 month

• 2 months

• 3 months

• 4 months

• 5 months

• 6 months

• 7 months

• 8 months

• 9 months

• 10 months

• 11 months

• 12 months

The significance of the LIBOR interest rates

LIBOR is viewed as the most important benchmark in the world for short-term interest rates.

On the professional financial markets LIBOR is used as the base rate for a large number of financial products such as futures, options and swaps.

Banks also use the LIBOR interest rates as the base rate when setting the interest rates for loans, savings and mortgages.

The fact that LIBOR is often treated as the base rate for other products is the reason why LIBOR interest rates are monitored with great interest by a large number of professionals and private individuals worldwide.

LIBOR SCAM

The scandal arose when it was discovered that banks were falsely inflating and deflating their rates

Libor is used in the U.S derivative market, an attempt to manipulate U.S derivatives markets and thus a violation of American law.

In June 2012, multiple criminal settlements by the Barclays bank revealed significant fraud and collusion by member banks connected to the rate submissions, leading to the scandal.

Since students loans, financial derivatives and other financial products often rely on libor as a referenced rate, the manipulation of submissions used to calculate those rates can have significant negative impact on consumers and financial markets worldwide.

BARCLAYS SCAM

2005 ; Barclays tried to manipulate the Libor2007 ; Barclays manipulate rates to show good credit quality of

bank2008 ; Barclays officers reported , bank not reporting correct

rates 2009; BBA circulated guidelines submission of rates , which

Barclays does not follow2011 ; RBS sacked 11 employees for attempt of manipulating the

LIBOR2012 ; Barclays agreed and penalty has been charged .While in

2010 they committed they are following new fundamental rules

EFFECTS OF LIBOR SCAM

It can have negative effect on consumers and financial markets worldwide

The rates banks pay to borrow money affect how much they charge for customers for loans and mortgages.

LIBOR AS REFERENCE RATE

Libor is used as reference rate to mitigate the risk associated with loans and other derivatives

E.g euro dollars:Rate at which bank borrow from each other is linked to rate at which banks borrow deposits

Risk passed to borrowers: If Libor increases, banks charge high interest rate to borrowers

Libor is more useful for loans, don’t need to sell in secondary markets

PRIVATE STUDENT LOAN

These loans not backed by govt.security but are tied to libor e.g rate will be charged as:

Libor + 2% or libor +3% ->depend upon creditworthiness

If libor is high,student will make high payment

If libor is low,student will make low payment

IMPACT ON MORTGAGEWhen interest rate on mortgage is linked to

reference rate,it is called adjustible rate mortgage(ARM)

You pay fixed interest rate for a fixed period after which adjust mortgage according to current libor.

Flavours of ARM:One year ARM:fixed payment for one year after

which mortgage rate reset according to libor5/1 ARM:fixed payment for 5 years after which reset

mortgage for one year terms until it paid off

IMPACT ON MORTGAGEIF libor increases,mortgage rate reset and high

payment will be paidIf libor decreses,mortgage rate reset and low

payments will be paidIn this way,libor changing rate will not be

devastating for lenderE.g. Borrower can be charged on floating rates:Libor+2%libor+7% :subprime mortgage(risky)so little

changes in libor can charge high payment to borrowers

IMPACT ON SAVINGSLibor is widely affective factor to saving

interest ratesIf libor increases,banks offer high interest

rate to saving accounts to motivate and keep their customers(depositors)

If libor falls,banks offer low interest rate to their saving customers

IMPACT OF LIBOR GLOBALLYMany banks worldwide use libor to adjust interest

rate of consumer and corporate loansOver $800 trillion in securities and loans are

linked to libor included auto and consumer loans45% of adjustible-rate prime mortgages and 80%

of adjustible sub-prime mortgages are linked to libor and half of variable rate student loans are linked to libor

When libor increases, rate or payments on loans increases and vice versa