London Inter-Bank Offered Rate is the global benchmark for interest rates

A multi-year, global investigation into the setting of interest rates has focussed on often complex trades in the financial centres of New York, London and Tokyo. But the accusations in the case have real-life consequences for consumers and businesses.

Banks around the world use financial benchmarks to set the interest rates on many of the loans they make. The most prominent of those benchmarks is the London Inter-Bank Offered Rate (LIBOR).

In setting the overall interest on loans, banks often ask borrowers to pay LIBOR — the three-month rate on Wednesday was 0.46 per cent-plus an added amount of interest. As LIBOR moves up, the borrower pays more, and vice versa. For instance, the top four U.S. mortgage lenders - Bank of America, JPMorgan Chase, Wells Fargo and U.S. Bancorp - all use LIBOR to establish interest payments on adjustable-rate mortgages.

Given its extensive reach, it would seem critical that LIBOR be calculated in an impartial and transparent manner. But the opposite seems to have been the case. In a settlement announced on Wednesday, regulators in the United States and Britain said that British bank Barclays had manipulated LIBOR to increase its traders' profits over several years. Barclays agreed to pay over $450 million to resolve the accusations; other large banks are expected to enter similar settlements.

“It's very important that we caught these guys,’’ said Bart Chilton, a commissioner at the Commodity Futures Trading Commission, one of the regulators. “LIBOR may sound like gobbledygook, but it's the world benchmark for interest rates consumers pay.’’ Conflicts arise from the fact that banks both set LIBOR and use it elsewhere in their businesses to make profits.

LIBOR is supposed to be a collective representation of the interest rates on short-term loans that banks make to each other. The LIBOR-setting banks each day tell a central entity how much interest they estimate they would have to pay on such loans.

That entity then eliminates some of the lowest and highest submissions and calculates an average from the remainder. Eighteen banks now supply data for setting dollar-denominated LIBOR. According to regulators, Barclays traders sought to skew LIBOR to benefit their bets. These trades were executed using financial contracts called derivatives that were linked to LIBOR. Regulators say they found dozens of communications from 2005 to 2009 in which derivatives traders pressed another group of Barclays employees to try to influence LIBOR. The British Bankers' Association, which oversees the standards for calculating LIBOR, does not allow banks to use interest rates-linked to derivatives to determine their LIBOR submissions.

While it might be hard for one bank among many to influence LIBOR, regulators felt Barclays’ was sometimes able to do so. In the findings for the Barclays settlement, the Justice Department said, “the manipulation of the submissions affected the fixed rates on some occasions.’’

Two big remaining questions are why banks still use LIBOR and why regulators do not appear to have pressed for it to be used less. There have been reports of its manipulation since 2008, yet the benchmark continues to be widely used.

There are alternatives to LIBOR. For instance, banks can set adjustable-rate mortgages using the yields of Treasuries. Bank of America, Wells Fargo, JPMorgan and U.S. Bancorp, the big mortgage lenders, did not comment when asked why they were still using LIBOR to set rates on mortgages, and whether they would stop after seeing the allegations against Barclays.

The British Bankers' Association is not regulated. It is conducting a review of how LIBOR is set but has not said when that will be completed. The group says regulators ‘are engaged’ with the review and ‘will be kept fully informed.’ Brian Capon, a spokesman, said in an email, “The review is industry-led, so the authorities are not direct participants.’’ — New York Times News Service

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