In response to the recent LIBOR fixing scandal, we prepared an internal knowledge sharing brief.

1. LIBOR... in 5mins
In response to the recent LIBOR fixing
scandal, we prepared an internal
knowledge sharing brief.
www.bsgdelivers.com // @bsguk Chuka Madukwe
July 2012
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2. The basics
The London Inter-Bank Offer Rate (LIBOR)
According to the British Banker’s Association (BBA), LIBOR serves as a
benchmark giving an indication of the average rate at which a leading
bank can obtain unsecured funding.
LIBOR is calculated daily by the BBA. Each morning, the leading banks
inform the BBA the rate at which they borrowed funds the preceding
evening. LIBOR is an aggregation of those rates.
In other words, it an aggregated rate reflecting the rate which banks
have most recently borrowed from other banks.
It is used to price a number of financial instruments, both long term and
short term. It’s the world’s most widely used short-term
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3. Other facts
It is governed by the British Banker’s Association (BBA) and calculated by
Thomson Reuters on their behalf.
The calculation is based on 16 submissions from the large banking
institutions. The highest and lowest values are removed before the
average is determined.
The submissions of all the participant banks are published, along with
each day’s LIBOR fix.
The value of the loans upon which the rates are calculated is
denominated in Eurodollars.
Its produced for 10 currencies.
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4. The key driver
Bank liquidity – Sometimes a bank could have an increase in its deposits
in the short term, hence increased liquidity. The main outcomes of this
is:
– They are less likely to have a need to borrow from another bank to finance
capital engagements (e.g. loans)
– They could consider ‘investing’ the surplus cash with other less liquid banks in
the interbank market (i.e. lend to banks in the opposite position)
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5. Why is it important?
Because it provides the reference point for the cost of borrowings of all
kinds – Mortgages, Credit cards, Term Leases etc. – as they are all usually
set at a few basis points above the LIBOR.
It is also used to drive pricing in thousands of derivative products.
Because the way it is calculated and published helps mitigate
uncontrolled influence of the market by big banks (an element of game
theory comes to play).
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6. Where it get interesting
There are two aspects to the Barclays LIBOR scandal.
The signalling effect – Banks are not happy to show weakness by stating
it will cost more than their peers to borrow as this might cause lenders
to pause and cause a financial freeze. Certain fast-moving
deals/transactions will struggle.
– There are some disagreements on the interpretation of the conversation
between the Bank of England and Bob Diamond. Either way, that conversation
was all about the signalling effect and the market’s perspective of Barclays
based on their submissions.
Influencing the LIBOR rate is a form of intra-bank collusion with the
intent to positively influence subsequent transactions in the trading day.
– As the story broke, there were a number of emails from traders to the LIBOR
reporting team which indicate collusion where Chinese walls should have been
in place.
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7. Contact us
London Johannesburg Cape Town
David Reinhardt Laura Greaves Laura Greaves
Regional Delivery Manager Business Development Business Development
+44 7841 947 198 +27 11 215 6666 +27 11 215 6666
david.reinhardt@bsguk.co.uk busdev@bsg.co.za busdev@bsg.co.za
230 City Road 33 Fricker Road Metropolitan Centre
London Illovo Boulevard, Sandton 7 Coen Steytler Avenue
EC1V 2TT 2196 8001
www.bsgdelivers.com
www.bsg.co.za www.bsg.co.za
@bsguk
@bsgafrica @bsgafrica
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