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Sean Hinton

Tom Shohfi

The graph to the left is for the 3 month LIBOR.

LIBOR, or the London Interbank Offered Rate, is the average interest rate between banks in the London interbank market. LIBOR is a widely used short-term interest rate benchmark since it is designed to reflect the cost of borrowing between some of the world's largest, most reputable banks.

What is LIBOR?

There isn't just one LIBOR; there are numerous rates determined by two variables:

• Currency - there are ten currencies for which LIBOR is computed:^[1]
  • Australian Dollar (AUD)
  • Canadian Dollar (CAD)
  • Swiss Franc (CHF)
  • Danish Krone (DKK)
  • Euro (EUR)
  • British Pound (GBP)
  • Japanese Yen (JPY)
  • New Zealand Dollar (NZD)
  • Swedish Krona (SEK)
  • U.S. Dollar (USD)
• Maturity (or the length of time between when the rate is quoted and when the hypothetical loan would have to be repaid) - the LIBOR is a short-term interest rate, only calculated up to a maturity of 12 months.^[2]
  • Overnight - the shortest maturity for the euro, U.S. dollar, British pound, and Canadian dollar.
  • Spot/next - the shortest maturity for all other currencies, spot/next rates mature in three days.
  • 1 week
  • 2 week
  • Monthly - 1 to 11 months from the date of publication. The three-month dollar LIBOR is a benchmark used to calculate the TED Spread, for example.
  • Yearly - 12 months from the date of publication.

Every business day at just after 11:00 am London time, the British Bankers' Association, in conjunction with Reuters, releases new rates for each combination of these.^[3] For example, there's a new 3-month LIBOR for the yen, overnight LIBOR for the euro, and 2-week LIBOR for the pound released daily. These rates indicate both the health of the currencies (and their respective economies) relative to one another and expectations about future economic conditions.

There are ten LIBOR panels, one for each of the ten currencies for which the rate is determined. Each panel is composed of at least eight contributor banks, chosen for their reputations and their perceived expertise in a given currency. The BBA takes the daily deposit rates reported by its designated contributor banks and calculates the mean of the middle 50%; the resulting number is the LIBOR for the currency in question.^[4] The average rates at which these banks say they would lend to one another is taken as an indication of the health of the banking systems of the ten LIBOR currencies. A list of the panels and their members as of May 30, 2008, can be found here on the British Bankers' Association's website.

Why is LIBOR important?

Not only does LIBOR provide information about the cost of borrowing in different currencies, it actually influences it. LIBOR is used as the basis for other interest rates across the globe. IE, variable interest rate loans such as mortgages and car loans will often be quotes at LIBOR + a percentage. For example, a loan that was LIBOR + 5% would charge 10% interest when the LIBOR is 5%, and 7% when the LIBOR is 2%.

Estimates for the total value of financial products with rates tied to LIBOR vary widely, from as low as $150 trillion,^[5] to $360 trillion, ^[6]to as high as $500 trillion.^[7]

LIBOR impacts financial instruments and products including:

• Corporate loans
• Mortgage loans (including adjustable-rate mortgages)
• Student loans
• Short-term interest rate futures contracts
• Interest rate swaps
• the Eurodollar
• Floating-rate notes
• Forward rate agreements

Additionally, the difference between the libor rate and the interest rate on treasury bills is a key marker of the financial health of banks. For more information, see TED Spread.

Criticism

On May 29, 2008, the Wall Street Journal reported that certain banks had been reporting lower rates to the BBA than what WSJ analysis suggested they should have been.^[8] Given the trillions of dollars tied to the LIBOR, even a small inaccuracy in either direction can cost lenders, borrowers, companies, or even whole economies billions of dollars. The WSJ study estimated that, if true, the artificially low U.S. dollar LIBOR saved U.S. borrowers about $45 billion over the first four months of 2008.^[9] The banks, however, denied this claim and stuck by the rates they'd reported to the BBA and Reuters.

Charts

References

1. ↑ British Bankers' Association - BBA LIBOR Panels
2. ↑ BBA - Historic LIBOR Rates
3. ↑ BBA LIBOR Frequently Asked Questions, British Bankers' Association.
4. ↑ London Interbank Offered Rate - Wikipedia
5. ↑ Yanked from Obscurity: Why Finance Experts Are Rethinking LIBOR - Knowledge@Wharton
6. ↑ We are the World: We are LIBOR - LIBORATED.com
7. ↑ Bankers Cast Doubt On Key Rate Amid Crisis - WSJ.com
8. ↑ Study Casts Doubt on Key Rate - WSJ.com
9. ↑ Study Casts Doubt on Key Rate - WSJ.com