An Overview Of The LIBOR Rate
The LIBOR rate stands for the London InterBank Offered Rate, and is essentially a measure of the interest rates that banks are willing to lend money to each other. The LIBOR rate today has many application in terms of foreign currency exchange, mortgage, the futures markets and a range of financial instruments. This article will explain what the relevance is of the current LIBOR rate, the LIBOR rate history, and its relevance to financial transactions today.
The LIBOR rate history
Libor Rate History
From a simple standpoint, banks and financial institutions have always lent money for a profit – and thus earning interest and a profit on each transaction. As time has passed, there has been steadily more and more complex methods of packaging debt and reselling the package to make money. Each package or financial instrument would offer different interest rates and different rates of risk. This came about as banks sought further ways to make money – and investors looked for different ways to invest their earnings.
In the early 1980s, the British Bankers Association decided that they needed some form of uniformity across these new financial instruments and came up with a set interest rate that people could use as a frame of reference. This interest rate eventually became known as the LIBOR, and is a worldwide recognized benchmark.
LIBOR rate history & how is the current LIBOR rate calculated
The LIBOR rate is calculated everyday by calculating the average interest rate for borrowing at exactly 11am GMT from 16 of the biggest multinational banks. These massive banks are who the high street banks borrow money off, and form the upper levels of the borrowing pyramid. The rate is calculated for ‘loans’ from overnight to 10 years, and also calculated for all the different currencies at the same time. Most banks keep a close eye on this rate and fix their interest rates higher than the announced value, so they are lending money at a higher rate than they are borrowing. The LIBOR will therefore be the lowest value you could possibly get an unsecured loan at that time with that currency. If you are looking to borrow money in a certain currency you will have to look at the correct LIBOR as there are separate rates for the US dollar (which is the most often quoted), pound sterling, and Japanese Yen among others.
Where can I find the current LIBOR rate?
The LIBOR rate is published by Thomson Reuters each day at 11am with the exception of bank holidays.
What do changes in the LIBOR mean?
Simply speaking, if the rate of the 1 year LIBOR increases, that means that the major banks are less willing to lend money at that time, and want to be more fully compensated. Conversely, a reduction in the 6 month LIBOR will mean that the major banks are happier to lend out money, because they feel that they are more likely to get a return. In times of recession or poor economy, you are likely to find higher rates, where as in times of booming economy you are looking at lower rates. Your bank makes money by borrowing off these larger banks at the LIBOR and lending to you at a profit.
Relevance of LIBOR to national interest rates
LIBOR is particularly relevant to the national interest rate set by the main bank of that country. The shorter term 6 month LIBOR typically is around 0.2-0.4% higher than the predicted interest rate announcement. If it is higher, then again, it means that the main banks are unwilling to lend at a lower rate, and that there is still a lot of people willing to borrow at that price. It is worth noting that like any other financial instrument, the LIBORs are traded.
Relevance of LIBOR rate to mortgages
Typical mortgage rates are based upon the 6 month and 1 year LIBOR rates. There are some higher risk mortgages that are determined by the 3 month rate. The mortgage lender will once again be aiming to borrow money from the massive banks at LIBOR and lend to the consumer at a higher interest rates. If the LIBOR rates are increasing, then it is likely that the mortgage provider will have to boost the mortgage rate to compensate, as they will not want to take a loss.