Fingers in the Cookie jar !

Many people are mystified by the banking upheaval in London.  Veteran British bank Barclays has been levied fines for allegedly tampering with the LIBOR rate, and it's CEO has fallen on his sword as a result.

Here in Australia we keep our eye on the Reserve bank because it seems to regulate interest rates, but this LIBOR mechanism applies to the behind the scenes pressure on what our investments earn and whether we will have enough superannuation to one day comfortably retire - so it might be helpful to understand LIBOR.

The acronym  stands for London Interbank  Offer Rate.   It is a mechanism by which the world's leading banks calculate the interest that will apply to the money they will borrow to fund their operations.  At regular intervals banks such as Bank of America,  Bank of Tokyo, Deutsche Bank, Citi Group, UBS, JP Morgan and others report on what interest they expect to be charged for their borrowings.

An " averaging " mechanism then swings into place.   The highest and the lowest contributions are .discarded and the remainder pooled to produce a mean average - and that becomes the rate that these banks will charge one another when they borrow money from one another on the international market.

This LIBOR rate then has an effect on a host of other interest rates that apply across the world of commerce, including things like derivatives, interest on superannuation investments, even the world price of commodities like grain and sugar.   The whole world of commerce is closely related to the highs and lows of the LIBOR mechanism.

Like many such institutions in merry olde England, the setting of LIBOR rates comes from the world of gentleman's clubs and deals settled by a shaking of hands.   There are no hard and fast control mechanisms to keep wayward fingers from straying into the cookie jar - and it seems that LIBOR rates may have been adjusted to suit the needs of the banking fraternity on a " nod and wink " basis.

The commercial world was certainly thrown into turmoil by the GFC, but there are suggestions that such a mighty institution as the Bank of England may have quietly condoned a degree of LIBOR manipulation to artificially improve trading conditions and relieve pressure on the money supply.

This world seems equally divided into opposing interests when money is concerned.  On one side are the people who need to borrow money to finance world trade, and on the other are those who need to get a return from the money they have to finance every day living.    When interest rates rise, one side is advantaged, but the other side disadvantaged, and when rates fall the reverse applies.

The London enquiry is probing whether vested interests between and within the banks conspired to artificially control LIBOR rates and whether this was condoned from the highest echelon of member governments.    No doubt there will be accusations, but arriving at a conclusion will be difficult.

What does seem certain is that there is a need for an independent umpire to oversee the entire LIBOR question.    The tricky part will be constructing a mechanism that is entirely free of sticky little fingers straying where they are not supposed to go !