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What is LIBOR?

Libor is short for the London Interbank Offered Rate, a measure of the cost of borrowing between banks and a crucial benchmark for interest rates worldwide. It’s actually a collection of rates generated for 10 currencies across 15 different time periods, ranging from one day to one year. Libor rates are set each business day through a process overseen by the British Bankers’ Association.

Between seven and 18 large banks are asked what interest rate they would have to pay to borrow money for a certain period of time and in a certain currency. The responses are collected by Thomson Reuters, which removes a certain percentage of the highest and lowest figures before calculating the averages and creating the Libor quotes.

Interbank rates are measured elsewhere in the world through similar processes. For example, there’s also Japan’s Tokyo Interbank Offered Rate, or Tibor, and the Belgium-based Euro Interbank Offered Rate, or Euribor.

 This graphic explains in detail the LIBOR and the hullabaloo surrounding it.

 What is effected by the rate?

  • Derivatives: The Libor is often used to price financial instruments like swaps transactions and futures contracts. At least an estimated $350 trillion in derivatives and other financial products are tied to it.
  • Loans: To calculate interest rates, some lenders use the Libor as a base and add additional interest based on the borrower. When the Libor goes up, rates and payments on loans tied to it can rise as well
  • Mortgages: Of the mortgages in the United States that are adjustable-rate, about 45 percent of prime mortgages and 80 percent of subprime have interest rates based on the Libor.
  • Student Loans: About half of variable-rate private student loans are tied to the Libor.

 What Barclays did?

  • Between 2005 and 2007, employees in Barclays’ trading units convinced employees responsible for submitting Libor rates to alter the bank’s rates based on their derivatives trading positions to bolster their own profits.
  • Certain traders at Barclays coordinated with other banks to alter their rates as well.
  • Later, during the height of the financial crisis, Barclays submitted artificially low rates to give the impression that the bank could borrow money more cheaply and was healthier than it was.

The logic is similar to that of an insider trade in the stock market — if you have advance knowledge of information that will affect a security, you can make trades to profit from it

How big is the scandal?

Given Libor’s vast reach and the number of global firms that may be involved in its manipulation, the scandal is prompting calls for resignations, criminal prosecutions, and stricter regulation of the financial sector.

Barclays CEO Bob Diamond and chief operating officer Jerry del Missier annunced their resignations on Tuesday, following chairman Marcus Agius’s announcement a day prior. The bank has been hammered by politicians in the U.K. including Prime Minister David Cameron, who called its actions “a scandal” and “extremely serious.”

Civil suits have been filed in recent months by a wide variety of plaintiffs — ranging from mutual funds to individual traders to the city of Baltimore — claiming they lost profits on Libor-based securities due to banks’ artificial suppression of the rate. Defendants in the consolidated case include Bank of America  Citi, HSBC, JPMorgan and Credit Suisse.

The Consequences

On 27 June 2012, Barclays Bank was fined $200m by the Commodity Futures Trading Commission, $160 million by the United States Department of Justice and £59.5 million by the Financial Services Authority for attempted manipulation of the LIBOR and EURIBOR rates.

Barclays CEO Bob Diamond has announced his resignation in response to the bank’s interest-rate-fixing scandal. Diamond is set to testify on Wednesday before British lawmakers investigating the scandal. Meanwhile, similar probes around the world are in progress.

In the U.S., the Justice Department is conducting a criminal investigation, and officials in Switzerland and Canada are also looking into the issue.

In Japan, regulators temporarily suspended some transactions by UBS and Citi last year after finding that traders at both banks had attempted to influence Libor rates and the related Tokyo Interbank Offered Rate.

Regulators themselves, though, are also facing scrutiny. In a lengthy public statement released Tuesday, Barclays claimed it had alerted U.S. and U.K. authorities about suspicious Libor submissions by other banks in late 2008, and was “disappointed that no effective action was taken.”

The British Bankers Association, meanwhile, says it’s reviewing the process by which Libor is set.

This infographic explains who stands to lose from the scandal.