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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?
Three banks have been fined a total of £1.62 billion over their part in the Libor-rigging debacle.
The scandal has left financial markets reeling and one again called into question the ethics of the banking industry.
But what exactly is Libor, and why are the banks in so much trouble for manipulating it?
What is Libor?
Every morning banks work out how much money they need to borrow from their peers to plug any holes in their balance sheets. Or, if they have an excess of available cash, how much they can afford to lend.
What Libor – the London Inter-Bank Offered Rate – does is formally measure the cost of this inter-bank lending, setting out the average rate banks pay to borrow from one another.
How is Libor calculated?
There are 150 different Libor rates calculated on a daily basis by Thomson Reuters for 15 borrowing periods ranging from overnight to 12 months, spanning 10 different currencies.
These rates are calculated based on data submitted by a panel of major banks – the number of banks on the panel varies according to the currency. The UK’s sterling rate, for example, is based on submissions from 16 banks, while the US dollar rate, on the other hand, is calculated using a panel of 18.
Each bank is asked the same question: ‘At what rate could you borrow funds, were you to do so, by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11am?’
So basically, if you need to borrow cash from your fellow banker friends, how much would they charge you for it?
Once the rates are submitted, the four highest and four lowest rates are ignored, and those left are used to calculate the Libor rate which, along with the individual rates submitted by each bank, are then published before midday UK time every weekday.
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