Just what the world needs today: another financial scandal involving banks and your money! An investigation initiated in 2007 has culminated in a nearly half billion dollar fine from Barclay’s and the possibility of an ever-expanding scandal.
The London Interbank Offered Rate (also known as LIBOR) is a common benchmark for financial instruments based upon the cost of borrowing between large banks around the world. If you read financial headlines, the last time you may have been thinking about LIBOR rate was in 2008 when the cost for borrowing between banks went through the roof. But, whether or not you’re following LIBOR, it’s not obscure. In fact, LIBOR is linked to more than $700 trillion in financial instruments around the world including adjustable mortgages, student loans, and car loans.
It turns out that Barclay’s (and quite probably other banks) were padding their own wallets leading up to the financial crisis by boosting LIBOR rates. This meant that derivatives on their books were paying off for the banks. They could also collect more on the loans they issued linked to LIBOR. It made their operations more profitable, possibly at the expense of your loan costs if you had adjustable rate loans. Another big victim may have been your local government as many municipalities have contracts tied to LIBOR.
That’s not all! Just as it helped to boost the LIBOR in 2007, it was very useful to report lower LIBOR rates amidst the global meltdown. Why? Well, lower borrowing meant you might be a stronger financial institution. This is a good thing if you’re trying to stay in business and prevent a bank run. Again, this goes back to the bank’s profitability with little regard for the victims of such a scam. And fudge those numbers they did!
How, you may ask, could they get away with this? LIBOR is managed based upon a glorified honor system. Banks are expected to look in the mirror each day and report their inter-bank borrowing costs. This self-reporting system seems to have lots of cracks, and many are saying that Barclay’s getting caught is just the tip of the iceberg.
Want to learn more? Here are some resources that further explore this unfolding topic:
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LIBOR for Mortals Marketplace Radio
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The Rotten Heart of Finance The Economist
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Infographic: The LIBOR Scandal Explained AccountingDegree.net via BusinessInsider.com
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