LIBOR stands for London Inter-Bank Offer Rate. It is the accepted benchmark interest rate for global banks which give unsecured loans to other international banks for the short term. It indicates the borrowing cost in the world's interbank market. Swaps involving interest and currency rates along with mortgages are priced through it. The financial health of banks and the possible direction of the central banks' imminent policy rate changes are determined by it.
ICE or Intercontinental Exchange administers LIBOR. Before deciding the rate, ICE enquires from prominent international banks about the chargeable interest at which they can offer loans to other banks for a short duration. When an entity applies for a loan with interest decided by the interbank offer, the financial institution would note the LIBOR rate and then levy an extra percentage for issuing the loan after factoring in the applicant's income, credit rating, and loan duration.
Importance of LIBOR
LIBOR interest rates are not just restricted to banks operative in London or the European Union. The member nations that have volunteered to use this benchmark rate exceeds 60. This leverages the international significance of LIBOR rates, which are the lowest for borrowing compared to other financial agencies.
In the global currency market, LIBOR facilitates the trading of Forex by offering a premise for the interest rate calculation of different loans across the globe. The rates are reasonably more accurate than similar other benchmark interest rates that are linked to unsecured funding by banks.
Interesting Facts about LIBOR
You can learn about the important facts related to LIBOR below -
- The interest rate computation is done for five currencies: US dollar, Pound Sterling, Euro, Japan's Yen, and Swiss Franc.
- The short-term maturity period falls under seven categories that range from one day to one year.
- Contribution for individual currencies is made by 11-18 banks administered by ICE.
- ICE arranges the rates sent by banks in a descending order; outliers are then removed by excluding the bottom and top quartiles.
- After eliminating the outliers, the final rate is arrived at by calculating the arithmetic mean of the remaining rates.
- The above process is iterated for five currencies individually for seven maturity terms; consequently, 35 rates of reference are generated.
- The reference rate most frequently used for borrowing is that of 3 months.
- The standard, transaction-driven, data underpinned, and layered Waterfall Methodology is used for calculating the LIBOR rate.
- The calculated rates are published every day by ICE.
- Earlier, BBA (British Bankers Association) set the interbank offer rate.
- The rate is also used for pricing mortgages on an adjustable basis, securities backed by assets, credit default swapping, loans to private students, corporate debts, and municipal bonds.
- As of now, more than $1.5 trillion in value of the customer and residential mortgage loans have been appraised with this benchmark interest rate.
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Addressing LIBOR Manipulation Concerns
During 2008's financial crisis, LIBOR was rigged and manipulated extensively by the BBA. Hence, BBA was replaced in February 2014 with a new administrator, ‘ICE,' by the Hogg Tendering Advisory Committee based on the recommendation of the Wheatley Review.
However, crises and scandals have been hounding the interbank offer rate administrators for quite some time now. Hence, the UK's Federal Reserve and regulating agency have decided to phase out the rate by 30th June 2023. SOFR (Secured Overnight Financing Rate) will replace the existing rate mechanism. Publishing the weekly and bi-monthly USD rates has been discontinued from 31st December 2021.
FAQs on LIBOR
Q.1. LIBOR is the acronym of which financial term?
LIBOR is the acronym for the London Interbank Offer Rate.
Q.2. What does LIBOR signify?
LIBOR signifies the benchmark interest rate in the global interbank market at which major banks offer short-term unsecured loans, corporate debt, and mortgages to other banks.
Q.3. Which agency is the present administrator of LIBOR?
The Intercontinental Exchange (ICE) is the present administrator of LIBOR.
Q.4. When will LIBOR be discontinued?
LIBOR will have to phase out completely by 30th June 2023. It will be replaced by SOFR (Secured Overnight Financing Rate).
Q.5. How many currencies are considered for deciding LIBOR?
Five currencies, namely the US dollar, Pound Sterling, Euro, Japan's Yen, and Swiss Franc, are the currencies considered for deciding LIBOR.