London Interbank Offer Rate

Introduction

• The London Interbank Offered Rate (LIBOR) is a globally accepted key benchmark interest rate which indicates the borrowing costs between banks globally.
• It is the rate at which major global banks lend to one another in the international interbank market for short-term loans.
• The rate is calculated and will continue to be published each day by the Intercontinental Exchange (ICE), but due to recent scandals and questions around its validity as a benchmark rate, it is being phased out.

Features of LIBOR

• LIBOR is based on five currencies including the U.S. dollar, the euro, the British pound, the Japanese yen, and the Swiss franc, and serves seven different maturities. 
• LIBOR is also the basis for consumer loans in countries around the world, so it impacts consumers just as much as it does financial institutions. 
• The interest rates on various credit products such as credit cards, car loans, and adjustable-rate mortgages fluctuate based on the interbank rate. This change in rate helps determine the ease of borrowing between banks and consumers.
• LIBOR is also used as a standard gauge of market expectation 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. 

Note

• According to the Federal Reserve and regulators in the UK, LIBOR will be phased out by June 30, 2023, and will be replaced by the Secured Overnight Financing Rate (SOFR). 
• SOFR represents the borrowing costs of cash collateralized by Treasury securities based on transactions in the “repo” market.
• The repo market is where short-term borrowing and lending transactions occur, in which agreements are collateralized by highly liquid securities, namely government bonds.