The LIBOR rigging scandal. What was it and why was it so significant?
In: 7
Any loan which charges interest has a few different factors which contribute to that interest rate: cover running costs, profit, and **risk**.
You might be used to the idea that a bank will calculate whether you *personally* are a high or low risk for a loan. Good credit history => low risk.
But what about applying for a loan during a booming economy compared to applying for the same loan during a global recession? Now we have a background level of risk which is nothing to do with you personally. That background risk changes constantly, and every lender needs to factor it into their rates for any kind of loan.
So how would you get a handle on what that risk is, so you could set the rates for your loans? To answer that you need to strip away all the risk attached to the individual borrower so you’re left with only the background risk. You’d ask the question “*If I had the most trustworthy borrower in the world, borrowing money in the market today, what interest rate would I charge them?*”
And where would you find the most trustworthy borrower in the world? Well, a group of banks in London made a pact. They were already borrowing and lending amongst themselves because banks are most profitable when they stay exactly in their sweet spot for money held vs money lent. And like any loan, they charge each other interest. And they basically said “The most trustworthy borrower in the world is one of my fellow London banks, so the interest rate that I charge them is about as pure a measurement of background risk as I will find”.
So once you know what the London Inter-Bank Offer Rate is, you van add on your running costs, profit margin and individual risk calculation and figure out how much interest to charge your customer.
Latest Answers