DEFINITION of LIBOR
LIBOR or the London Interbank Offered Rate is a benchmark that dictates daily interest rates on loans and financial instruments around the world. Which some of the world’s leading banks charge each other for short-term loans.
WHAT IT IS IN ESSENCE
To calculate LIBOR, the Intercontinental Exchange (ICE) asks banks around the world to provide the rates at which they would offer a short-term loan to each other. It then averages each response to give the daily London Interbank Offered Rate rate.
Its rates are calculating for five currencies and seven borrowing periods ranging from overnight to one year. And are publishing each business day by Thomson Reuters.
Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to it.
At least $350 trillion in derivatives and other financial products are in connection to Libor.
In 1984, it became apparent that an increasing number of banks were trading actively in a variety of relatively new market instruments. Notably interest rate swaps, foreign currency options, and forward rate agreements.
Such instruments brought more business and greater depth to the London Interbank market. Hence, bankers worried that future growth could be inhibited unless a measure of uniformity was introduced.
In October 1984, the British Bankers’ Association (BBA) established various working parties. Which eventually culminated in the production of the BBA standard for interest rate swaps, or “BBAIRS” terms.
Part of this standard included the fixing of BBA interest-settlement rates, the predecessor of BBA Libor.
HOW TO USE
From 2 September 1985, the BBAIRS terms became standard market practice. BBA Libor fixings did not commence officially before 1 January 1986. Before that date, however, some rates were fixed for a trial period beginning in December 1984.
Member banks are international in scope. With more than sixty nations among its 223 members and 37 professional firms as of 2008 in the association. Seventeen banks for example currently contribute to the fixing of US Dollar Libor.
Financial companies around the world use the LIBOR rate to calculate their own interest rates on loans, mortgages, credit cards, and financial derivative prices.