In June 2012 it was discovered that Barclays had rigged Libor between 2006-2012 and, as a result, Barclays were punished by UK and US competition authorities. Below is a summary of the Libor scandal.
Why do Banks Borrow Money From Each Other?
Banks like Barclays and Lloyds want to make money and maximize their profits. Banks’ principal money making scheme is to lend money to consumers and charge them interest. But banks may sometimes have too much money because they may receive more money from their savers than they lend to borrowers. If banks have too much money they are not maximizing their profits because they could make even more money by lending more. At the same time, other banks may not have enough money because they may want to lend more money to borrowers than they receive from their savers. If banks do not have enough money they will need to borrow money from someone other than their savers. Banks with too much money will therefore lend money to banks who do not have enough money.
Banks buy and sell money from each other on the inter-bank market. Banks who have too much money will supply money and banks who do not have enough money will demand money on the inter-bank market. The price that banks charge each other to borrow money on the inter-bank market is the Libor (London inter-bank offer rate).
How is Libor Set?
Libor is set daily by the British Bankers’ Association (BBA) who ask banks like Barclays and Lloyds how much money they want to borrow/lend and at what rate. At the end of the discussion, the BBA set Libor to reflect the average cost of borrowing between banks.
Libor and Loans to Consumers
Because banks want to maximize their profits, if they borrow money from other banks and pay the Libor rate of interest then they must charge borrowers an interest rate that is even higher to make a profit. For example, if Barclays borrowed money from other banks at a Libor rate of 4% then Barclays must charge their own borrowers more than 4% to make a profit.
Many loans that banks give to borrowers may be linked to Libor so if Libor rises, banks charge higher rates of interest to borrowers. Libor underpins trillions of £s worth of loans and financial contracts. So banks have an incentive to rig Libor because if they can strategically manipulate and raise Libor then they can charge higher interest rates to borrowers and increase profits.
Barclays and Libor
A bunch of rogue Barclays traders basically rigged the Libor rate in such a way so as to increase their own money/bonuses. Barclays’ rogue traders manipulated Libor by overvaluing/undervaluing Barclays’ money demand and/or supply on the inter-bank market. Barclays basically raised Libor when they wanted to charge higher interest rates on mortgages and decreased Libor during the credit crisis to make Barclays look stronger than its rivals.
Ultimately, the UK banking regulator the Financial Services Authority (FSA) fined Barclays £59.5 million, The US Department of Commerce fined Barclays £120 million and the Commodity Futures Trading Commission fined Barclays £128 million meaning a total fine of £290 million.
A day after the fines, Barclays’ share prices fell by 15% and a few days later Barclays’ boss Bob Diamond resigned. Barclays’ reputation was seriously damaged as a result of the Libor scandal.