London Interbank Offered Rate (LIBOR)

Definition

The London Interbank Offered Rate (LIBOR) is a benchmark interest rate that serves as a reference point for a wide range of financial products and transactions worldwide. 

What is the London Interbank Offered Rate?

The London Interbank Offered Rate represents the average interest rate at which major banks based in London are willing to lend to one another on an unsecured basis in the interbank market.

LIBOR is calculated daily by polling a panel of major banks, asking them at what rate they could borrow funds from other banks in various currencies and for different durations. The rates provided by these banks are then averaged to determine the LIBOR rate for each currency and maturity.

While LIBOR is most commonly associated with the British Pound (GBP), it is also published for other major currencies, including the US Dollar (USD), Euro (EUR), Japanese Yen (JPY), and Swiss Franc (CHF), among others.

LIBOR serves as a benchmark for pricing various financial products and contracts, including interest rate swaps, floating-rate mortgages, corporate loans, and derivatives. It provides a reference point for determining the interest rates charged on these instruments, often by adding a margin to the relevant LIBOR rate.

Due to its widespread use in financial markets, LIBOR plays a crucial role in facilitating liquidity and efficiency in the global financial system. It is used by banks, corporations, investors, and central banks around the world to manage interest rate risk and price financial instruments.

Example of the London Interbank Offered Rate

Imagine a bank in London, Bank A, needs to borrow funds from another bank, Bank B, to meet its short-term liquidity needs. Bank A contacts Bank B and agrees to borrow £1 million for a period of one month. Bank B quotes an interest rate of 2.5% based on the current LIBOR rate for one-month loans. This means that Bank A will pay Bank B 2.5% interest on the £1 million loan for the one-month period.