Headline interest rates are set by central banks. But the ones that we actually pay, as consumers or companies, are set by the banks themselves. And most of these are based on LIBOR – the London Inter-Bank Offer Rate – which is the main benchmark for $347 trillion of borrowing around the world. Now it seems the LIBOR rate is likely to rise by 30 May.
The background to this is slightly complex (details below), but the implications are enormous. Lending rates for 6 million US homeowners are likely to rise as a result, for example. Today the LIBOR system was discussed in the UK Parliament, and it seems a new system is likely to emerge by 30 May. Based on the evidence so far, this could increase actual lending rates quite significantly, by up to 0.30%.
The LIBOR system is based on reports from 16 elite banks of their loan rates for dollars, euros pounds and 8 other leading currencies. But in March, the Bank for International Settlements (the central bankers bank) said the ‘some lenders were manipulating the rates to prevent their own borrowing costs from rising’. It went to suggest that lack of transparency means that a ‘bank has an incentive to quote a lower interest rate publicly than it might be prepared to pay in a private transaction’.
As an example, the US Federal Reserve reported that secured loans were priced in the open market at 2.82% on 7 April. Yet unsecured LIBOR loans were supposedly available the same day at 2.72%. This has led the bigger, stronger, banks to claim the system is being manipulated – Barclays Capital calls current LIBOR rates ‘a lie’, whilst Citi said last month that LIBOR rates should be ‘0.3% higher than the current rate’.
Chemical companies and consumers have benefited via lower interest payments on their loans from this apparent mis-pricing. But a new LIBOR system will be introduced by 30 May, to overcome current problems. In turn, this will raise costs for most borrowers, as $62 trillion of debt is reset to the new basis.