History of Libor:
Rooted from the early 1980s, LIBOR has an active part in the modern financial markets. In 1986, Libor was officially launched by the “British Bankers”, with top three currencies - dollar, yen and the pound sterling. Before the takeover by IBA (ICE Benchmark Administration) it was known as BBA libor until Feb 1, 2014.
SIGNIFICANCE OF LIBOR:
The libor rates have a vast spread significance and as it is not just limited to London or Europe. They have more than sixty nations as volunteered members possessing an international scope. This is primarily due to the lowest borrowing rates presented among all the other financial institutions.
The FOREX market is probably unthinkable without libor and its implications in global currency trade. Also familiar as ICE libor or benchmark rate offered by the London interbank, it is predominantly used in Forex markets to serve the purpose of calculating interest rates on various loans across the world.
WHAT IS LIBOR?
“LIBOR” or Intercontinental Exchange London Inter bank Offered Rate is a reference benchmark rate charged by the banks for short-term debt instruments which includes government and corporate bonds, derivatives such as currency and interest swaps etc.The rates offered are considered as the base price by banks to calculate interest rates. Libor is used as base price+marginal interest cost that help companies to hedge interest rates exposures.
HOW DOES LIBOR FUNCTION?
It is structured to work in a way where a group of major banks is asked to quote the rate at which they could borrow funds from other banks before 11:00 AM each morning (Greenwich Mean Time).
About 35 libor rates are posted each business day and the lowest interest rates are compiled for loans with 7 different maturities for 5 major currencies. Libor can range from overnight to twelve months, but the most quoted is the 3 month USD rate. Basically, libor is calculated on a method called “trimmed arithmetic mean” wherein the extreme values are included.This can be expressed as “LIBOR+X bps”, wherein bps stands for ‘basis point’ and ‘X’ is the premium charged over and above the libor rate by the lender to the borrower.
The publication of benchmark such as libor is beneficial for the bank customers to judge whether a loan rate is competitive in the market. Libor is not prefixed but is based on a questionnaire where selective banks estimate the borrowing rates.
LIBOR decides rates on five major currencies
4)JPY (Japanese Yen)
Most of the credit agencies, banks and other financial institutions all over the world look up to libor rates to set up their own interest rates. Presently, there are contracts worth more than trillions of dollars which are spread across different maturities to benchmark libor. Other rates are fixed on top of libor.
Though it has encountered a number of controversies, its daily borrowing rates continue to be at the top to calculate base for interest rates.