London Interbank Offered Rate
Encyclopedia
The LIBOR rate is the average interest rate that leading banks in London charge when lending to other banks. It is an acronym for London Interbank Offered Rate (LIBOR, icon) Banks borrow money for one day, one month, two months, six months, one year etc. and they pay interest to their lenders based on certain rates. The LIBOR figure is an average of these rates. Many financial institutions, mortgage lenders and credit card agencies track the rate, which is produced daily at 11 a.m. to fix their own interest rates which are typically higher than the LIBOR rate. As such it is a benchmark for finance all around the world.

Introduction

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 swap
Interest rate swap
An interest rate swap is a popular and highly liquid financial derivative instrument in which two parties agree to exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate or from one floating rate to another...

s, foreign currency options
Foreign exchange option
In finance, a foreign-exchange option is a derivative financial instrument that gives the owner the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date.The FX options market is the deepest, largest and...

 and forward rate agreement
Forward rate agreement
In finance, a forward rate agreement is a forward contract, an over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used...

s. While recognizing that such instruments brought more business and greater depth to the London Interbank market, bankers worried that future growth could be inhibited unless a measure of uniformity was introduced. In October 1984 the British Bankers' Association
British Bankers' Association
The British Bankers’ Association is the trade association which represents the banks operating within the United Kingdom.-History:It was set up in 1919. In 1972 it accepted foreign banks...

 (BBA) – working with other parties, such as the Bank of England
Bank of England
The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694, it is the second oldest central bank in the world...

 – 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. 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 commencing in December 1984.

Member banks
British Bankers' Association
The British Bankers’ Association is the trade association which represents the banks operating within the United Kingdom.-History:It was set up in 1919. In 1972 it accepted foreign banks...

 are international in scope, with more than sixty nations represented among its 223 members and 37 associated professional firms (as of 2008).

Scope

The LIBOR is widely used as a reference rate for financial instruments such as
  • forward rate agreement
    Forward rate agreement
    In finance, a forward rate agreement is a forward contract, an over-the-counter contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used...

    s
  • short-term-interest-rate futures contract
    Futures contract
    In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...

    s
  • interest rate swap
    Interest rate swap
    An interest rate swap is a popular and highly liquid financial derivative instrument in which two parties agree to exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate or from one floating rate to another...

    s
  • inflation swaps
  • floating rate note
    Floating rate note
    Floating rate notes are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e. they pay out interest every three months, though counter...

    s
  • syndicated loan
    Syndicated loan
    A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial banks or investment banks known as arrangers....

    s
  • variable rate mortgages
  • currencies
    Currency
    In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...

    , especially the US dollar (see also Eurodollar
    Eurodollar
    Eurodollars are time deposits denominated in U.S. dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve. Consequently, such deposits are subject to much less regulation than similar deposits within the U.S., allowing for higher margins. The term...

    ).


They thus provide the basis for some of the world's most liquid and active interest-rate markets.

For the euro
Euro
The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...

, however, the usual reference rates are the Euribor
Euribor
The Euro Interbank Offered Rate is a daily reference rate based on the averaged interest rates at which Eurozone banks offer to lend unsecured funds to other banks in the euro wholesale money market .-Scope:...

 rates compiled by the European Banking Federation
European Banking Federation
The European Banking Federation is an organization of the European banking sector, representing interest of over 5000 European banks in 31 countries with combined assets of over 30,000 billion Euro and around 2.4 million employees...

, from a larger bank panel. A euro LIBOR does exist, but mainly for continuity purposes in swap contracts dating back to pre-EMU
Economic and Monetary Union of the European Union
The Economic and Monetary Union is an umbrella term for the group of policies aimed at converging the economies of members of the European Union in three stages so as to allow them to adopt a single currency, the euro. As such, it is largely synonymous with the eurozone.All member states of the...

 times.
LIBOR is an estimate and not interred in the legally binding contracts of an LLC. It is, however, specifically mentioned as a reference rate in the market standard International Swaps and Derivatives Association
International Swaps and Derivatives Association
The International Swaps and Derivatives Association is a trade organization of participants in the market for over-the-counter derivatives....

 documentation, which are used by parties wishing to transact in over-the-counter interest rate derivative
Interest rate derivative
An interest rate derivative is a derivative where the underlying asset is the right to pay or receive a notional amount of money at a given interest rate...

s.

LIBOR is used by the Swiss National Bank
Swiss National Bank
The Swiss National Bank is the central bank of Switzerland. It is responsible for Swiss monetary policy and for issuing Swiss franc banknotes.The names of the institution in the four official languages of the country are: ; ; ; ....

 as their reference rate for monetary policy.

Definition of LIBOR

LIBOR is defined as:

"The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 London time."

This definition is amplified as follows:-
  • The rate at which each bank submits must be formed from that bank’s perception of its cost of funds in the interbank market.
  • Contributions must represent rates formed in London and not elsewhere.
  • Contributions must be for the currency concerned, not the cost of producing one currency by borrowing in another currency and accessing the required currency via the foreign exchange markets.
  • The rates must be submitted by members of staff at a bank with primary responsibility for management of a bank’s cash, rather than a bank’s derivative book.
  • The definition of “funds” is: unsecured interbank cash or cash raised through primary issuance of interbank Certificates of Deposit.


For other details of BBA LIBOR, see the BBA guide: BBA LIBOR explained.

Technical features

LIBOR is calculated and published by Thomson Reuters
Thomson Reuters
Thomson Reuters Corporation is a provider of information for the world's businesses and professionals and is created by the Thomson Corporation's purchase of Reuters Group on 17 April 2008. Thomson Reuters is headquartered at 3 Times Square, New York City, USA...

 on behalf of the British Bankers' Association
British Bankers' Association
The British Bankers’ Association is the trade association which represents the banks operating within the United Kingdom.-History:It was set up in 1919. In 1972 it accepted foreign banks...

 (BBA) after 11:00 AM (and generally around 11:45 AM) each day (London time). It is a trimmed average of interbank deposit rates offered by designated contributor banks, for maturities ranging from overnight to one year. LIBOR is calculated for 10 currencies. There are eight, twelve, sixteen or twenty contributor banks on each currency panel, and the reported interest is the mean of the 50% middle values (the interquartile mean
Interquartile mean
The interquartile mean is a statistical measure of central tendency, much like the mean , the median, and the mode....

). The rates are a benchmark rather than a tradable rate; the actual rate at which banks will lend to one another continues to vary throughout the day.

LIBOR is often used as a rate of reference for pound sterling
Pound sterling
The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...

 and other currencies, including US dollar, euro
Euro
The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...

, Japanese yen, Swiss franc
Swiss franc
The franc is the currency and legal tender of Switzerland and Liechtenstein; it is also legal tender in the Italian exclave Campione d'Italia. Although not formally legal tender in the German exclave Büsingen , it is in wide daily use there...

, Canadian dollar
Canadian dollar
The Canadian dollar is the currency of Canada. As of 2007, the Canadian dollar is the 7th most traded currency in the world. It is abbreviated with the dollar sign $, or C$ to distinguish it from other dollar-denominated currencies...

, Australian dollar
Australian dollar
The Australian dollar is the currency of the Commonwealth of Australia, including Christmas Island, Cocos Islands, and Norfolk Island, as well as the independent Pacific Island states of Kiribati, Nauru and Tuvalu...

, Swedish krona
Swedish krona
The krona has been the currency of Sweden since 1873. Both the ISO code "SEK" and currency sign "kr" are in common use; the former precedes or follows the value, the latter usually follows it, but especially in the past, it sometimes preceded the value...

, Danish krone
Danish krone
The krone is the official currency of the Kingdom of Denmark consisting of Denmark, the Faroe Islands and Greenland. It is subdivided into 100 øre...

 and New Zealand dollar
New Zealand dollar
The New Zealand dollar is the currency of New Zealand. It also circulates in the Cook Islands , Niue, Tokelau, and the Pitcairn Islands. It is divided into 100 cents....

.

In the 1990s, the yen LIBOR was influenced by credit problems affecting some of the contributor banks.

Six-month USD LIBOR is used as an index for some US mortgages. In the UK, the three-month GBP LIBOR is used for some mortgages—especially for those with adverse credit history.

Eurodollar contracts

The Chicago Mercantile Exchange
Chicago Mercantile Exchange
The Chicago Mercantile Exchange is an American financial and commodity derivative exchange based in Chicago. The CME was founded in 1898 as the Chicago Butter and Egg Board. Originally, the exchange was a non-profit organization...

's Eurodollar
Eurodollar
Eurodollars are time deposits denominated in U.S. dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve. Consequently, such deposits are subject to much less regulation than similar deposits within the U.S., allowing for higher margins. The term...

 contracts are based on three-month US dollar LIBOR rates. They are the world's most heavily traded short term interest rate futures contracts and extend up to ten years. Shorter maturities trade on the Singapore Exchange
Singapore Exchange
Singapore Exchange Limited is an investment holding company located in Singapore and providing different services related to securities and derivatives trading and others. SGX is a member of the World Federation of Exchanges and the Asian and Oceanian Stock Exchanges FederationSingapore Exchange...

 in Asian time.

Interest rate swaps

Interest rate swaps based on short LIBOR rates currently trade on the interbank market
Interbank market
The interbank market is the top-level foreign exchange market where banks exchange different currencies. The banks can either deal with one another directly, or through electronic brokering platforms. The Electronic Broking Services and Thomson Reuters Dealing 3000 Xtra are the two competitors in...

 for maturities up to 50 years. In the swap market a "five year LIBOR" rate refers to the 5 year swap rate where the floating leg of the swap references 3 or 6 month LIBOR (this can be expressed more precisely as for example "5 year rate vs 6 month LIBOR"). "LIBOR + x basis point
Basis point
A basis point is a unit equal to 1/100 of a percentage point or one part per ten thousand...

s", when talking about a bond, means that the bond's cash flows have to be discounted on the swaps' zero-coupon yield curve
Yield curve
In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...

 shifted by x basis points in order to equal the bond's actual market price. The day count convention
Day count convention
In finance, a day count convention determines how interest accrues over time for a variety of investments, including bonds, notes, loans, mortgages, medium-term notes, swaps, and forward rate agreements . This determines the amount transferred on interest payment dates, and also the calculation of...

 for LIBOR rates in interest rate swaps is Actual/360, except for the GBP currency for which it is Actual/365 (fixed).

Reliability

On Thursday, 29 May 2008, The Wall Street Journal
The Wall Street Journal
The Wall Street Journal is an American English-language international daily newspaper. It is published in New York City by Dow Jones & Company, a division of News Corporation, along with the Asian and European editions of the Journal....

(WSJ) released a controversial study suggesting that banks may have understated borrowing costs they reported for LIBOR during the 2008 credit crunch. Such underreporting could have created an impression that banks could borrow from other banks more cheaply than they could in reality. It could also have made the banking system or specific contributing bank appear healthier than it was during the 2008 credit crunch.

For example, the study found that rates at which one major bank "said it could borrow dollars for three months were about 0.87 percentage point lower than the rate calculated using default-insurance data."

To further bring this case to light, The Wall Street Journal released another article dealing with this matter titled "U.S. Probe Presents Dilemma over Libor" on Friday, March 18, 2011. The article stated that regulators are focusing on Bank of America Corp., Citi-group Inc. and UBS AG. Making a case would be very difficult because determining the LIBOR rate does not occur on an open exchange. According to people familiar with the situation, subpoenas have been issued to the three banks.

In response to the study released by the WSJ, the British Bankers' Association announced that LIBOR continues to be reliable even in times of financial crisis. According to the British Bankers' Association, other proxies for financial health, such as the default-credit-insurance market, are not necessarily more sound than LIBOR at times of financial crisis, though they are more widely used in Latin America, especially the Ecuadorian and Bolivian markets.

Additionally, other authorities have contradicted the Wall Street Journal article. In its March 2008 Quarterly Review, The Bank for International Settlements
Bank for International Settlements
The Bank for International Settlements is an intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government...

 has stated that "available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings."
Further, in October 2008 the International Monetary Fund
International Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...

 published its regular Global Financial Stability Review which also found that "Although the integrity of the U.S. dollar LIBOR-fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar LIBOR remains an accurate measure of a typical creditworthy bank’s marginal cost of unsecured U.S. dollar term funding."

See also

  • Euribor
    Euribor
    The Euro Interbank Offered Rate is a daily reference rate based on the averaged interest rates at which Eurozone banks offer to lend unsecured funds to other banks in the euro wholesale money market .-Scope:...

  • TIBOR
    TIBOR
    TIBOR stands for the Tokyo Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the Japan wholesale money market...

  • Prime rate
    Prime rate
    Prime rate or prime lending rate is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case...

  • Ted spread
    TED spread
    The TED spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt . TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract....

  • Libor-OIS spread
    LIBOR-OIS spread
    The LIBOR–OIS is the difference between LIBOR and the overnight indexed swap rates. The spread between the two rates is considered to be a measure of health of the banking system.-Risk barometer:...

  • LIBID
    LIBID
    The London Interbank Bid Rate is a bid rate; the rate bid by banks on Eurocurrency deposits . It is "the opposite" of the LIBOR...

  • MIBOR
    MIBOR
    MIBOR may refer to:*MIBOR *MIBOR *MIBOR...

  • JIBAR
  • SONIA
    SONIA
    SONIA is the acronym for Sterling OverNight Index Average, the reference rate for overnight unsecured transactions in the Sterling market...

  • Interbank lending market
    Interbank lending market
    The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate...


Further reading

  • Carrick Mollenkamp and Mark Whitehouse, "Study Casts Doubt on Key Rate: WSJ Analysis Suggests Banks May Have Reported Flawed Interest Data for Libor", The Wall Street Journal
    The Wall Street Journal
    The Wall Street Journal is an American English-language international daily newspaper. It is published in New York City by Dow Jones & Company, a division of News Corporation, along with the Asian and European editions of the Journal....

    , Thursday, May 29, 2008, p. 1.

  • Donald MacKenzie, "What's in a Number?", London Review of Books
    London Review of Books
    The London Review of Books is a fortnightly British magazine of literary and intellectual essays.-History:The LRB was founded in 1979, during the year-long lock-out at The Times, by publisher A...

    , September 25, 2008, p. 11-12.

External links

  • BBALIBOR.COM, including historical worldwide rates, on the British Bankers' Association website

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