Skip to main content

LIBOR Scandal


All my Money and Banking students understand the importance of LIBOR (London Interbank Offered Rate) to the economy.  The vast majority of lending rates are determined by LIBOR, and central banks are trying to influence this key interest rate whenever they engage in monetary policy.  LIBOR also plays an important role in many derivative contracts. 

LIBOR is simply the rate that banks pay to borrow funds from other banks.  Some banks have insufficient reserves to back their deposits, whilst others have excess reserves.  These reserves are traded on the interbank market and the rate banks pay is LIBOR.  LIBOR is ultimately what banks pay to get their funds, which is why it is so closely connected to the rate borrowers pay. 

LIBOR is determined on a daily basis by the British Banking Association.  They conduct a daily survey asking major banks what they would pay to borrow funds in a reasonable market just before 11am.  The survey results are averaged to produce LIBOR.  Click here for further details.

However, it seems that some banks have been engaged in shady practices regarding this process.  Click here for the timeline.  Banks stand accused of two things.  First, there is a suggestion that derivative traders at some banks influenced their bank’s daily survey response so that they could make profitable trades based on this influence.  Second, it appears that banks understated their interbank borrowing costs during the height of the financial crisis in 2008.  This was either to make them appear healthier than they were or it was the result of political pressure, with politicians desirous to lower LIBOR and borrowing costs for businesses and consumers (click here for the Telegraph's coverage this issue).  

Popular posts from this blog

The Economics of Global Warming

The Berkeley Earth Project , an independent study of global warming, has found that the earth has become a degree warmer over the past half century.  However, the statistical uncertainty surrounding pre-1920 estimates makes it very hard to say much about long-term trends - click here for graph .  This is one of my concerns with the global warming debate - we simply don't have trustworthy long-run data which looks at temperature changes over the last millennium (or two).  My second concern with the global warming debate is that it is very hard to prove any sort of casual link between global warming and human activity.  The scientists may be able to show correlation between global warming and our production of carbon dioxides etc., but correlation is not causation. My third concern with the debate is  that those who are sceptical or agnostic are stereotyped as flat-earthers or intellectually-challenged crackpots.  This only stifles debate and the progress of science itself. 
Read more

Boom and Bust: A Global History of Financial Bubbles

Boom and Bust: A Global History of Financial Bubbles, co-authored with my colleague Will Quinn , is forthcoming in August. It is published by Cambridge University Press and is available for pre-order at Amazon , Barnes and Noble , Waterstones and Cambridge University Press . 
Read more

The Failure of Herstatt Bank

As an undergraduate, I was taught about the failure of Herstatt Bank in 1974 and Herstatt risk. This bank was only the 35th largest bank in Germany at the time so why would anyone be interested in studying its failure? Herstatt failed because of its involvement in risky foreign exchange business. When it closed its doors on 26 June 1974, counterparty banks (mainly in New York) had not received dollars due to them because of time-zone differences - this is known as settlement risk. The cross-jurisdictional implications of its failure resulted in the Bank for International Settlements setting up the Basel Committee on Banking Supervision and Herstatt's failure was a key reason for the establishment of real-time gross settlements systems, which ensures that payments between two banks are executed in real time. The Bank of England's Ben Norman has an interesting post on Herstatt over at the Bank's new blog ( Bank Underground ). As well as giving an excellent overview of
Read more