LIBOR

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The London Interbank Offered Rate (LIBOR) is the interest rate that banks charge each other to borrow short-term on the London interbank market. LIBOR is also the broader financial world's benchmark for setting short-term interest rates for products like variable-rate mortgages and corporate loans.

Brief background

LIBOR was launched in 1986 by the British Bankers Association (BBA), which employs a reference panel of bankers to reset the LIBOR rate at 11:00 am GMT daily. LIBOR loans are priced in Eurodollars - U.S. dollars in foreign hands - and can mature in as little as 24 hours. It is used as a reference rate for key financial products like interest rate swaps, short-term interest rate futures, credit default swaps and forex rates.[1]

Futures and options contracts on the LIBOR are a key component of the CME Group interest rate products suite, and are especially attractive to fixed interest money managers looking to hedge their short-term interest rate risk.[2] The CME lists 12 consecutive one-month LIBOR futures contracts that trade most actively near the quarterly expiration months of CME Eurodollar futures. More than 1.5 million LIBOR futures contracts trade daily on the CME.

Recent Controversies

In February 2012, more than a dozen traders and brokers in London and Asia lost their jobs, were suspended or were put on leave, as a result of a probe into the LIBOR system which alleged manipulation by major institutions, including Deutsche Bank, JPMorgan Chase, Royal Bank of Scotland and Citigroup. Inter-dealer broker Icap also suspended one employee and put two on administrative leave following the allegations.[3] U.S. and UK regulators requested information from Icap, as well as two other major inter-dealer brokers, Tullet Prebon and RP Martin, hoping to uncover data regarding information sharing among brokers, hedge funds and banks.[4]

In 2008, U.S. bankers and investors complained that the LIBOR rate remained higher than it should have been, and charged that the way it is calculated is somehow flawed.[5] The rate spiked again in late April 2008 on news that the BBA was investigating whether banks had, in fact, been deliberately under-reporting the interbank rates they had been paying.[6]

Some observers pointed to the widening spread between LIBOR and the overnight indexed swap (OIS) rate - an indicator of expected central bank interest rates - as evidence that LIBOR is too high. Others said credit fears are not the problem, since banks' credit-default swap (CDS) premiums had been falling. As a result, the Bank of England in April 2008 introduced a Special Liquidity Scheme allowing banks to swap asset-backed securities for 9-month treasury bills to raise liquidity in the LIBOR market.

References

  1. BBA LIBOR - Frequently asked questions. BBA.
  2. CME LIBOR Futures. CME Group.
  3. Libor investigaton: traders fired and suspended - report. Telegraph.
  4. Brokers suspended in Libor inquiry. Financial Times.
  5. Understanding LIBOR. A Dash of Insight.
  6. Bankers' trust. The Economist.