Benchmark Interest Rate Under Scrutiny

While the recent Libor (London Interbank Offered Rate) scandal, resulting in a record £290-million fine being imposed on Barclays Plc and the ousting of CEO Robert Diamond, was initially viewed as a revelation, analysts have pointed out that concerns about possible interest rate manipulation were being voiced by a number of parties back in the first quarter of 2008. In March of that year the Bank for International Settlements (BIS) signaled that the benchmark for worldwide short term interest rates was being misstated. In April Citigroup analysts raised similar concerns, and the following month a strategist in Barclay’s employ made it known that the numbers being reported by banks was inaccurate, and yet, it appears that no action was taken at the time.

The breaking of the Libor scandal, or more accurately the British Banker’s Association (BBA) Libor scandal, has opened a veritable Pandora’s Box as investigations get underway to determine why stock market regulators and central banking authorities appeared to be ignorant of the problem – or if they were, in fact, kept in the dark. It has recently been reported that a number of financial firms, including Goldman Sachs Group and Morgan Stanley, may bring lawsuits against some of their biggest rivals which contribute to BBA data on which interest rates are set.

Libor is a benchmark interest rate used by banks when borrowing funds from other banks in the London Interbank market. Fixed on a daily basis by the BBA, Libor rates are derived from a group of participating financial institutions based on ten different currencies and fifteen different periods of time, ranging from overnight to one year. The resulting interest rate is published daily by Thomson Reuters at 11h30 London Time. Derivatives and other financial products tied to the Libor total at least US$350 trillion.

Libor is used as a reference rate for interest rate swaps, forward rate agreements, futures contracts, inflation swaps, floating rate notes, variable rate mortgages, syndicated loans and currencies, thereby providing the basis for some of the most liquid and active interest-rate markets in the world. In addition to the United Kingdom, countries relying on the Libor as a benchmark include the United States, Canada and Switzerland.