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What is the “LIBOR scandal”?

LIBOR is short for the London interbank offered rate, the average interest rate a group of big banks would expect to pay to borrow money from each other. LIBOR is an interest rate “benchmark,” which means that interest rates on loans and investments tied to the LIBOR will follow its movement up and down. Though not all adjustable rate loans are tied to the LIBOR—some, for example, are tied to the Prime Rate—it is a very widely used benchmark, affecting interest rates worldwide on trillions of dollars in mortgages, private student loans, credit cards, other types of credit and investments.

Since LIBOR is not based on the market (supply and demand) but rather on the rates that participating banks report, banks have an opportunity (and sometimes an incentive) to manipulate LIBOR. If banks lie and report a higher or lower borrowing rate than is true, consumers could pay more (or less) for the money they borrow and investors could earn less (or more) than they should.

In June 2012, Barclays, a major bank, agreed to pay $450 million to settle accusations it had lied in an attempt to manipulate LIBOR to make money (through a better trading position) and to give the impression that the bank was stronger than it really was (the lower the rate reported, the more creditworthy the bank appears and the more confidence there appears to be in the financial system). Another 15 to 20 banks participating in LIBOR also came under investigation for rigging rates amid accusations that LIBOR manipulation had been happening since the early ‘90s.

The LIBOR manipulation that became publicized in 2012 probably helped average borrowers, as well as certain types of investors, by nudging rates downward. But for every winner there’s a loser, and some consumer and institutional investors likely experienced lower returns on their money.

Consumers, as a whole, lose anytime banks play by their own rules. This is another example of why many consumers and advocates argue for banking reforms and stricter regulation of our financial institutions.

 

Tags/Keywords

financial, interest rates


 
 
 
 

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