Page 31 - Bank Case Studies

Libor its Function and Calculation

LIBOR Libor measures how much banks have to pay to borrow from each
other.

Libor is calculated on a daily basis by the British Bankers'
Association from estimates submitted by the major banks of the
cost of their own interbank lending.

The rate each bank has to pay is a reflection of their rivals'
perception of its financial strength, effectively how much it is
trusted.

The higher the interest a bank has to pay to borrow funds, the less
confidence the lending bank has in it.

In turn, this means that the Libor rate indicates the health of the
wider banking sector. Libor has a European equivalent called
Euribor, which plays the same role.

It has been claimed that Libor rates manipulation had been common
since at least 1991 with these rates being set by a self-selected, self-

policing committee of the world’s largest banks that measured how
much it cost them to borrow from each other (see Table 1). The

Economist (1) reported that as of June 2011, the over-the-counter

(OTC) derivatives market amounted to approximately $700 trillion.
Since mortgages, student loans, and other financial derivatives often

rely on Libor as a reference rate, the manipulation of submissions

used to calculate these rates could have significant negative effects
on consumers and financial markets globally.