London Inter Bank Offered Rate

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The London Inter Bank Offered Rate, known fondly as “LIBOR” is — or until now has been — the basic rate of interest used in lending between banks on the London interbank market and also used as a reference for setting the interest rate on other loans.

Each day, the administrator would ask major global banks at what rate could they borrow from other banks for short-term loans, take out the highest and lowest figures and calculate a “trimmed average” from the remainder. Once the rates for each maturity and currency are calculated and finalized, they are announced/published once a day at around 11:55 am London time by the British Bankers’ Association who, it is fair to say, didn’t have a terribly good handle on what LIBOR was used for and how serious it might be if someone abused the privilege of helping to set it.

LIBOR was dull. It used to be so snoresville that no one paid it any attention — not even the BBA who notionally calculated it — which meant it was ideal fodder for pernicious types who lurk in the undergarments of the financial services industry ripping everyone else off for their own personal gain. The LIBOR rates submitted by the banks weren’t firm prices, there was no real method to their calculation. This appeared to surprise people, during the global financial crisis.

Firstly, it turned out that banks were systematically “lowballing” the rates at which they could borrow in the market — perhaps at the direction of the Bank of England itself — to prevent further widespread panic in the market at the prospect of bank failures indicated by sharply increasing LIBOR submissions.

This is an interesting dynamic, and illustrates real-world acknowledgment that it perception is as important as reality in determining financial outcomes: if punters think their bank is on the point of failure — even if it isn’t — they would be queueing outside branches to withdraw their savings, which might catastrophically erode capital and precipitate its failure. This is a bank run.

But the converse is also true: if punters do not think their bank is on the point of failure — even if it is — they will not collectively pull out their savings, and it might not fail.

This second outcome is plainly better for the wider economy, even if it involved misleading or even fraudulent behaviour.

It turned out that this second scenario was happening across the market. Suddenly, LIBOR became big news, Barclays lost much of its senior management, and the the world was turned on its head.

Once you have looked under a rock, you keep looking. Rock inspectors found a second thing, quite unrelated to the financial crisis. Those who were submitting LIBOR rates in ordinary markets were, it was thought, gaming the rates they were submitting to the LIBOR committee to suit the bank’s trading book. This they could do because there is no unitary single rate that a bank is offered to borrow money during the day: different lenders will offer different rates to different businesses. In a nutshell, there are a range of rates at which different parts of a bank could borrow funds on any day. Banks were choosing, out of those rates, the one that most suited the position in its trading books.

This was deemed also to be fraudulent behaviour. Traders were tried, convicted, sent to jail and then, in America of all places, acquitted.

Convicted British Libor submitters such as Tom Hayes appealed. That process is not yet complete, but Hayes and Palombo v R [2024] EWCA Crim 304sheds great insight on the practical workings of the financial markets — and legal systems.

See also

• Hayes and Palombo v R [2024] EWCA Crim 304
• British Bankers’ Association
• Interest