What is the LIBOR?

Until the summer of last year the London Interbank Offered Rate (LIBOR) was largely unknown to the general public. This is despite it playing a significant financial role in many lives. It can be described as “the rate at which international banks lend to one another in London”, as defined in Brealey, Myers, Allen, 2011. Although technically correct this explanation is too simple as it fails to take into account the wider economic implications of the rate. The LIBOR affects a broad range of interest rates as it acts as a benchmark for many borrowings such as mortgages, student loans etc. Thus the LIBOR affects each and every one of us throughout our lives.

 

 

In the 1980s new financial instruments were introduced into the markets, during this period London became a hub for loan syndication. Banks sought to trade the new instruments but were concerned by the fact that the underlying rates were to be agreed upon prior to trade. This resulted in an appeal to the British Bankers’ Association (BBA) to determine a benchmark interest rate. The LIBOR was subsequently introduced in January 1986, at this time it was solely calculated for three currencies.

 

 

The LIBOR is, these days, calculated at 11am each day by Thomas Reuters. It is estimated for ten different currencies and fifteen various time horizons; these vary from a 24 hour rate to a one year rate. Sixteen major banks, including Barclays and Royal Bank of Scotland, are asked the question “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?” The LIBOR is then estimated as the lowest of these rates for each currency and time horizon. This very fact that it is banks, rather than market forces, which determine the rate is what it enables it to be, so easily manipulated.

With this blog I seek to explore the rate's fixing and crucially whether a new system is needed.