LIBOR, or the London Interbank Offered Rate, is a benchmark that dictates daily interest rates on loans and financial instruments around the world.
It is the reference interest rate that’s calculated daily at which global banks lend to one another.
LIBOR is also used as a standard gauge of market expectations for interest rates finalized by central banks.
It accounts for the liquidity premiums for various instruments traded in the money markets, as well as an indicator of the health of the overall banking system.
To calculate LIBOR each day, 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.
ICE takes out the highest and lowest figures, then calculates the average from the remaining numbers.
The result is the daily LIBOR figure.
LIBOR is calculated in five different currencies:
- U.S. dollar
- Euro
- British pound
- Japanese yen
- Swiss franc
Each with seven different lengths of loan:
- Overnight/spot next
- One week
- One month
- Two months
- Three months
- Six months
- Twelve months
The combination of five currencies and seven maturities leads to a total of 35 different LIBOR rates calculated and reported each business day.
The most commonly quoted rate is the three-month U.S. dollar rate, usually referred to as the current LIBOR rate.
Financial companies around the world use the LIBOR as the basis to calculate their own interest rates on loans, mortgages, credit cards, and financial derivative prices.
This means that LIBOR impacts consumers also, and not just financial institutions.
While LIBOR is accepted globally, other domestic and regional financial centers construct their own interbank offered rates for domestic loans and financial instruments.
For example, Europe has the European Interbank Offered Rate (EURIBOR), Japan has the Tokyo Interbank Offered Rate (TIBOR), China has Shanghai Interbank Offered Rate (SHIBOR), and India has the Mumbai Interbank Offered Rate (MIBOR).
LIBOR plays a crucial role in global financial markets as it helps to determine the borrowing costs for various financial products and transactions.
However, in recent years, LIBOR has been subject to several controversies, including a rate-rigging scandal, which has led to calls for the replacement of LIBOR with alternative benchmark rates.
As a result, several jurisdictions have introduced new reference rates to replace LIBOR.
For example, the United States has introduced the Secured Overnight Financing Rate (SOFR) as an alternative benchmark, while the United Kingdom has introduced the Sterling Overnight Index Average (SONIA).