Libor, also known as the “London interbank offered rate,” is one of the most important numbers in the world of finance. But it's one we know little about - at least until the past few weeks, as newspapers have been filled with stories about Barclays bank in England fixing the rate to its advantage from 2006 to 2008.
This scandal has left investors wondering what Libor is and how it affects the global economy - and, more importantly, how it'll effect Canadians.
Here’s the Libor lowdown:
What is Libor?
Much like the Prime Rate in Canada, Libor is the interest rate banks use worldwide to borrow from each other. London is mentioned in its name because the benchmark is set in that city. If the bank has a good financial record it can get a loan close to Libor, and the opposite holds true for banks not doing as well. Essentially, it's one of the main rates used to determine the borrowing costs for trillions of dollars in loans, such as mortgages, student loans and credit card accounts. They all fluctuate when Libor does. Rates are adjusted annually or quarterly.
How does Libor affect Canadians?
Canadians banks use this benchmark rate to trade with financial institutions worldwide. If any of these trades took place between 2006 and 2008, when the Barclays fixing scandal is suspected, this would affect the rate consumers were offered for their loans. According to The Wall Street Journal, the total value of the securities and derivatives that are affected worldwide is about US $800-trillion, including more than US $350-trillion in interest-rate swaps and US $10-trillion in loans.
Which Canadians banks are affected?
Royal Bank of Canada is already part of a class action lawsuit launched by the city of Baltimore. It’s alleged RBC, along with 20 other banks, caused the city losses from holding securities based on Libor. RBC claims its innocence.
In a statement it says, “We have determined that RBC acted in accordance with the British Bankers’ Association requirement that our LIBOR submissions accurately reflected our perception of our cost of funds and that we did not collude with other banks.”
Why was Libor created?
In the 1980s, banks started looking for a standard benchmark to calculate the prices on an array of financial products, and the British Bankers’ Association, an industry trade group, began publishing Libor on January 1, 1986. The idea was that instead of constantly haggling over the interest rates that would be charged for different types of loans, banks would have a uniform benchmark. Libor covers 10 currencies and 15 maturities.
How is Libor used?
Banks such as Citigroup, JPMorgan Chase, Bank of America, Barclays, and UBS of Switzerland estimate how much interest they will pay to borrow money on a short-term basis from other institutions. While the process is still overseen by the British Bankers’ Association, the calculations are now performed by Thomson Reuters.
How does this affect everyday Canadians?
If Barclays is found guilty of fixing the rate, Canadians whose loans or investments were affected by Libor may have a case to sue.
The difficulty will be suing a bank in England for securities bought in Canada. In the end, this could be yet another hard lesson of the financial crisis.