The London Interbank Offered Rate, or LIBOR ,is a benchmark interest applied to funds borrowed between financial instutions in the London interbank lending market.
Is LIBOR Similar To The Federal Funds Rate?
Yes, but only a little. In the American financial system, the Federal Funds Rate is used as a guideline for the unsecured lending that occurs on the U.S. interbank market. LIBOR does perform this same function for banks in the United Kingdom, acting as the benchmark interest rate between English banks, but LIBOR differs because of the method used to calculate it, the number of financial instruments to which it serves as a guide, and the body that manages it.
How Is LIBOR Calculated?
LIBOR is officially 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."
The rate is calculated based on a survey of banks operating in London's financial sector (the number or banks surveyed depends on the product in question) conducted on behalf of the British Bankers' Association. The highest four and lowest four responses are discarded and then an average is taken of the remaining ten. This rate is calculated every day, just prior to 11a.m London time, and reported thirty minutes later. Because LIBOR is used as a guide for different types of instruments, loan types, etc, a LIBOR rate is reported for each of these.
Maturities Available For LIBOR:
- 1 through12 months
- 2 weeks
- 1 week
- 24 hours
To What Financial instruments Does LIBOR Apply?
There are three classes of financial instrument that LIBOR is used for: Standard Interbank Products, Commercial Field Products, and Hybrid Products.
Standard Interbank Products:
- Forward Rate Agreements
- Interest Rate Futures
- Interest Rate Swaps
- 'Swaptions'
- Overnight Indexed Swaps
- Different types of Interest Rate Options Contracts
Commercial Field Products:
- Floating Rate Notes
- Floating Rate Certificates of Deposit
- Syndicated Loans
- Variable Rate Mortgages
- Term Loans
Hybrid Products:
- Range Accrual Notes
- Step Up Callable Notes
- Target Redemption Notes
- Hybrid Perpetual Notes
- Collateralized Mortgage Obligations (CMO's)
- Collaterilized Debt Obligations (CDO's)
LIBOR is also used to fix exchage rates for the world's major currencies
- Australian Dollar
- Canadian Dollar
- Swiss Francs
- Danish Krone
- Euros
- British Pound Sterling
- Japanese Yen
- New Zealand Dollar
- Swedish Krona
- U.S. Dollars
What Body Administers LIBOR?
Article comments
1 - jamminsue
LIBOR probably controls your credit card rate and your boss' lease COLA. It controls rates on financial documents from pensions to Savings & Loan interest. This is a really big deal. No one seems to care. From what I read, this could be what crashed Greece. It is past time people are apathetic about white-collar crime, this matters. Just as the hedge funds and mortgage fraud destroyed this country, things like LIOBR scandal are responsible for slowing recovery, and creating additional uncertainty. Because of how interrelated financial institutions are, we can no longer allow bankers to act like bobber barons of times past. We should not have to learn this lesson over again. We learned it in 1857, the first time.
2 - Alexander J Smith III
LIBOR has a lot of implications that most consumers aren't aware of simply because they don't really know what it is. That's one of the main reasons I do this series, so that folks can start to understand that these complex terms and instruments really do apply to their everyday wallets. You make a great point about the LIBOR scandal, and other investment/banking/accounting frauds leading to increased uncertainty in global markets, and that's something that legitimate regulatory policy can help to quell.
3 - Igor
Alexander,
Good article. Very useful.
What are the fees associated with LIBOR transactions?
I suspect that the fees are very low. Low fees and high-speed response times together determine the instability in our western economic systems.
I believe that one of the reasons for Greeces economic problems is that Goldman-Sachs, acting as financial advisors to the Greek Finance Ministry, sold Greece on the kind of constant re-finance plan that has become popular, thus hitching Greeces fortunes to the LIBOR.
4 - Alexander J Smith III
Igor,
That is an excellent question, and honestly don't know but ill definitely look into it and try and find out for you.
If you want more insight into Greece, I would check out, "The Euro In Crisis" Parts 3 and 4, though you're right Goldman Sachs and other U.S. financial institutions did play a role in the increase of its national debt. How that connects to the LIBOR I would also like to look into.