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Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

Greenwashing

Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

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+1,000 expert presented, on-demand video modules

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Build, scale and manage your organisation’s learning

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Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Introduction to LIBOR

Introduction to LIBOR

Peter Eisenhardt

30 years: Capital markets & investment banking

Peter provides an overview of floating rates and explains why LIBOR specifically is such an important tool.

Peter provides an overview of floating rates and explains why LIBOR specifically is such an important tool.

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Introduction to LIBOR

6 mins 36 secs

Overview

LIBOR was conceived in a world where the market’s current complexity was not anticipated and when monetary policy setters were not as independent or predictable as they are today. LIBOR had been an effective transmission mechanism for policy rates into the real economy, but during the global financial crisis of 2008 as banking went into a crisis, the bases underpinning LIBOR fell apart.

Key learning objectives:

  • Explain the origins of LIBOR and how it is calculated

  • Understand what happened to destabilise LIBOR during the global financial crisis

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Summary
How LIBOR originate and how it is calculated?
For decades, the key rate benchmark was the US dollar prime rate, defined “the rate at which a bank lends to favoured customers”. But this was ill-defined, inconsistent across banks, and not usable across multiple currencies. As Western economies grew in size and complexity and interest-rate derivatives markets evolved, a better interest-rate benchmark in a full range of currencies was badly needed. In the mid-1980s, the British Bankers Association (BBA) in conjunction with the major banks developed LIBOR – the London Interbank Offered Rate.
To calculate LIBOR, the BBA asked a panel of banks every day at 11am London time to submit the rates they could borrow in the interbank market in reasonable size in different maturities in a range of currencies. The highest and lowest 25% of rates submitted were discounted, and those left were averaged to arrive at LIBOR.
The interbank cash market was largely undifferentiated. Panel banks could broadly borrow at the same rates and the market largely ignored credit risk, especially in the short dates for which LIBOR was calculated. Market-derived benchmarks such as LIBOR tended to follow central bank base rates closely so were an effective transmission mechanism for policy rates into the real economy.
What happened to destabilise LIBOR during the global financial crisis?
But during the global financial crisis of 2008 as banking went into a crisis, trust between banks evaporated. Strong banks pulled back completely or only lent to other strong banks. Credit spreads for weaker banks ballooned and weaker banks worried about how it would look if they reported that their borrowing costs had spiked.
Further, the US dollar LIBOR panel was comprised mostly of non-US banks, which were finding it harder to borrow dollars in stressed market conditions. Floating rates should have been falling in line with the deteriorating economic conditions not rising because of stressed conditions in the interbank market.
Banks became unsure as to what rates to submit. Guidance from Central Banks and other regulators – on what “reasonable size” means, what banks should submit on days when the market is in chaos and trading comes to a halt – was far from clear and sometimes contradictory. It was unclear if regulators pressured banks to set their LIBOR rates artificially low to allay the crisis conditions, but it is understandable that regulators may have been tempted to suggest this given they are tasked with controlling systemic risk and defusing market panic.

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Peter Eisenhardt

Peter Eisenhardt

Peter has over 30 years experience working in banking. He has held several senior positions in international investment banks. Peter is now the Secretary General of the International Council of Securities Associations

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