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Q&A: what is Libor and what did the banks do to it?
Over a billion pounds has been handed out in fines over the Libor scandal, but what exactly is it?
This process was first introduced by the British Banker’s Assocation (BBA) in 1986, and is overseen by the Foreign Exchange and Money Markets Committee.
What does Libor show?
When a bank lends money to a customer, it will assess the risk they pose and price the loan accordingly. The riskier you appear, the more you will have to pay.
The way banks lend to one another is no different – when a bank is charged a higher rate it means other banks have less confidence in it.
As the average rate, therefore, Libor reflects the strength of the banking sector as a whole, and as the BBA puts it ‘acts as a barometer of how global markets are reacting to the prevailing conditions’.
So during the credit crunch, for example, when confidence in the banking sector was at its lowest, Libor shot up to an all-time high.
What else is Libor used for?
A number of financial products use Libor as a benchmark against which they price products.
So, just as you might take out a mortgage with an interest rate linked to movements in the Bank of England base rate or invest in a fund that follows the FTSE 100, there are financial products available that track changes in Libor.
Complex derivative products used by professional traders in the multi-trillion-pound bond and currency markets are commonly priced using Libor.
So, what did the banks do?
More about this:
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