LIBOR rigging: Difference between revisions

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 ====LIBOR and the business of banking====
-{{drop|T|he basic model}} of a bank is to borrow short-term, at a low rate, and lend long-term to businesses and homeowners at a high rate. Thus, overnight deposits pay interest at a [[Floating rate|floating]] rate. Most term loans pay interest at a [[Fixed rate|fixed]] rate. Not all; but most.
+{{drop|T|he basic model}} of a bank is to borrow, short-term, at a low rate, and lend, long-term, at a high rate. ''Generally'' banks calculate interest on overnight deposits, by which they borrow, at a [[Floating rate|floating]] rate. And they charge interest on the term loans, which they lend, at [[Fixed rate|fixed]] rates.
-As a general proposition, therefore, banks ''borrow'' in floating and ''lend'' in fixed. They have “structural interest rate risk”. They want floating rates on their deposits to be low.  In that case, all other things being equal, they make money.
+''Generally'', therefore, banks ''borrow'' in floating and ''lend'' in fixed. They have “structural interest rate risk”. They want floating rates to be low.  In that case, all other things being equal, they make money. (All other things are not always equal, though, as we know (but, apparently, Silicon Valley Bank did not).)
-All other things are not always equal, though, as we know (but, apparently, Silicon Valley Bank did not).
-How to determine what that floating rate should be day to day?
+So, a foundational question: How to determine what that floating rate should be, day to day?
-Enter the [[British Bankers’ Association]]. This was just the sleepy, city-grandees-in-a-smoke-filled-gentlemen’s-club-in-Threadneedle-Street of your imagination. Inasmuch as it ever did anything useful, the BBA compiled LIBOR, sleepily, by inviting about 18 banks, literally, to phone in the rate at which they could borrow in various currencies and maturities in the market each day,
+Enter the [[British Bankers’ Association]]. This was just the sleepy, city-grandees-in-a-smoke-filled-gentlemen’s-club-in-Threadneedle-Street of your imagination. Inasmuch as it ever did anything useful, the BBA compiled LIBOR, sleepily, by inviting about 18 banks, literally, to ''phone in'' the rate at which they could borrow in various currencies and maturities in the market each day,
-They would “trim” the top and bottom four entries and average the remainder to produce the LIBOR rate for each currency and maturity for that day, then toddle off for a liquid lunch before their regular three o’clock tee time.
-The banks could then set their rates — for deposits and loans — based on the day’s relevant LIBOR rate.
+The BBA would then  “trim” the top and bottom four submissions and average the remainder to produce a daily LIBOR rate for each currency and maturity, then toddle off for a liquid lunch before their regular three o’clock tee time.
+The banks could then set their rates — for deposits and loans — based on the day’s published LIBOR rate. Happy, dull stuff.
 Notwithstanding that this process played an important part in the world’s financial plumbing, LIBOR submitting was yet a dull, unexotic backwater. All the cool kids were out shorting structured credit.
-As per the basic model, to manage their structural interest rate risk, Banks generally would want LIBOR low — but overnight deposits are not the only show in town. Investment banks had exposure to the interest rate market in other ways: principally through swaps.
+As per the basic model, to manage their structural interest rate risk, banks ''generally'' would want LIBOR low — but deposits are not the only show in town. Some banks — principally those that were  swap dealers — had exposure to the interest rate market through swaps.
-Here, the bank “swaps” interest rates with its customers: one customer might agree to pay over a fixed rate in return for a floating rate; another might swap floating for fixed. Some LIBOR banks are also [[Swap dealer|swap dealers]].
+Here, the bank “swaps” interest rates with its customers: one customer might pay a fixed rate and receive a floating rate; another might swap floating for fixed.
-If a bank swaps a fixed rate for a floating rate, and then LIBOR goes up, by definition the replacement value of its incoming floating rate will increase — a stream of 3.25% cashflows is numerically worth more than a stream of 3.00% cashflows, all else being equal — while the replacement cost of the outgoing fixed rate stays the same. The bank’s net position in that swap —its “[[mark-to-market]] exposure” — has moved [[in-the-money]].
+If a dealer swaps a fixed rate for a floating rate, and then LIBOR goes up, by definition the replacement value of its incoming floating rate will increase — a stream of 3.25% cashflows is numerically worth more than a stream of 3.00% cashflows, all else being equal — while the replacement cost of the outgoing fixed rate stays the same. The bank’s net position in that swap —its “[[mark-to-market]] exposure” — has moved [[in-the-money]].
 While dealers try to balance their customer swaps to offset each other as far as possible, they may also wish to manage that structural interest rate risk that arises from their normal banking activities.