LIBOR and You

One of the highlights in the news this week has been the LIBOR rigging scandal, for which the part nationalised RBS has been forced to pay a £390m fine.

Have you seen it on the 6 o clock news and, like the majority of the population who don’t work in financial markets, thought, “Hmmm, interesting. Let’s see if Eggheads has started on BBC2”?

The simple fact is, while these types of issues (of which there has been a continual stream since the meltdown 5 years ago) clearly affect the overall economy, most ordinary people feel too far detached from the core of the issue to be bothered thinking about the impact on their lives.  And who can blame us? We’ve got more important things to be doing.

So, what exactly is LIBOR and how does it affect you, your business and your personal finances? (Disclaimer – if you do happen to be an economist or a banker – stop reading here!)

Well, basically, it is an interest rate, specifically the “London Inter-Bank Offered Rate”. In the same way that we borrow money from the bank, the bank itself will borrow money from other banks so that they have enough cash to meet their customers’ needs. And, as with the money we borrow from the bank, there is an interest payment due on the borrowed cash. The bank who is lending the money is doing so to generate interest revenue from cash holdings which would otherwise be doing nothing. The LIBOR rate sets the standard for the amount of interest the banks can charge each other.

“Yawn” I can hear you thinking. “Interest rates, economics, whatever…nothing to do with me”

Well, if you have any bank borrowing or a credit card, the interest rates and fees you pay are likely to be based on the LIBOR rate. If the LIBOR rate goes up, it means that it is more expensive for banks and credit card companies to borrow money to lend to you, so the normal practice will be for the bank to very generously pass that extra cost onto you, the valued customer. They have a profit margin to protect after all!

Similarly, if the rate has been artificially low or high, then when it does come back in line, the cost of the correction is likely to also be passed on to the customer. In the case of this fine, RBS have thankfully assured us that the cost will be met by forfeited and clawed back bonuses.

So, why were these naughty bankers rigging the rate anyway? As with most of these scandals, it seems to be for personal gain of the corrupt few, for the purpose of securing various types of “Interest rate related” financial contracts with other banks, contracts on which profits would be linked to individual bonus payments.

Simple as that!