What is the Libor scandal and how does it affect you?
Confidence in UK banks has once again been rocked with the news that British traders have been rigging the key interest rates at which banks lend to each other.
At the end of June, Barclays was fined £290 million for fixing its rates, a scandal that has forced three of its bosses, including chief executive Bob Diamond, to resign and prompted the Serious Fraud Office to launch a full-scale inquiry.
So what is the furore all about and how does it affect you?
What is Libor?
The London Inter Bank Offer Rate (Libor) is the rate of interest at which banks lend to one another. It is calculated every day and is based on submissions from a panel of leading City of London banks.
Each morning, the panel members tell the British Bankers' Association (BBA) how much interest they believe they would need to pay to borrow from fellow banks over a range of specified time periods.
The UK sterling rate is based on submissions from 16 banks - the top and bottom four rates are excluded and an average is calculated from the eight remaining submissions.
Libor is the world's primary benchmark of short-term interest rates and influences the price of trillions of pounds of financial transactions every year.
Why did Barclays rig the rates?
Each bank's submission to the BBA is also important because it provides an indication of its perceived financial strength. The lower the rate it is able to quote, the stronger it is deemed to be and, consequently, the cheaper it is for it to borrow.
Between 2007 and 2009 - the height of the financial crisis - regulators found that Barclays traders had submitted artificially low figures in an attempt to conceal the liquidity problems the bank was facing. From 2005 to 2008, traders had also manipulated rates in order to boost their profits.
Who else is involved?
It is thought the Barclays case is just the tip of the iceberg and that numerous banks in the UK and overseas have been playing the same game.
Earlier this year, and prior to Barclays' landmark fine, both UBS and the Royal Bank of Scotland took action against staff involved in rate-rigging.
The Serious Fraud Office is now conducting an industry-wide investigation, while the Financial Services Authority states that it "continues to pursue a number of other significant cross-border investigations in this area".
Has it affected my mortgage?
Without down-playing the scandal, the good news is that the vast majority of borrowers will not have been affected.
Ray Boulger, senior technical manager at mortgage adviser John Charcol, estimates that only 2% of mortgages currently being repaid will have a direct link to Libor, and those would have typically been sub-prime, buy-to-let or from a private bank.
It could be argued that the Libor-rigging affected retail banks' own funding costs and thereby indirectly had an impact on the pricing of their mortgages and loans.
However, Boulger is not convinced and stresses that in the later stages the low-balling of Libor rates would have pushed rates down, not up. "The impact on the borrower would have been marginal if anything, and if it had it would have been beneficial."
What about my savings?
Savers with money in ordinary savings accounts with banks and building society shouldn't worry that rates have been depressed by Libor rate-rigging. The interest paid on deposits are linked to the Bank of England base rate, not Libor.
The London Inter-Bank Offer Rate is the rate at which banks lend to each other over the short term from overnight to five years. The LIBOR market enables banks to cover temporary shortages of capital by borrowing from banks with surpluses and vice versa and reduces the need for each bank to hold large quantities of liquid assets (cash), enabling it to release funds for more profitable lending. LIBOR rates are used to determine interest rates on many types of loan and credit products such as credit cards, adjustable rate mortgages and business loans.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.