LIBOR

From MarketsWiki

The London Interbank Offered Rate (LIBOR) is the interest rate that banks charge each other to borrow short-term on the London interbank market. LIBOR is also the broader financial world's benchmark for setting short-term interest rates for products like variable-rate mortgages and corporate loans.

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Brief background

LIBOR was launched in 1986 by the British Bankers Association (BBA), which employs a reference panel of bankers to reset the LIBOR rate at 11:00 am GMT daily.^[1] LIBOR loans are priced in Eurodollars - U.S. dollars in foreign hands - and can mature in as little as 24 hours. It is used as a reference rate for key financial products like interest rate swaps, short-term interest rate futures, credit default swaps and forex rates.^[2]

Futures and options contracts on the LIBOR are a key component of the CME Group interest rate products suite, and are especially attractive to fixed interest money managers looking to hedge their short-term interest rate risk.^[3] The CME lists 12 consecutive one-month LIBOR futures contracts that trade most actively near the quarterly expiration months of CME Eurodollar futures. More than 1.5 million LIBOR futures contracts trade daily on the CME.

Recent Controversies

U.S. bankers and investors have complained in recent months that the LIBOR rate has remained higher than it should have, and have charged that the way it is calculated is somehow flawed.^[4] The rate spiked again in late April, 2008 on news that the BBA was investigating whether banks have, in fact, been deliberately under-reporting the interbank rates they've been paying.^[5]

Some observers point to the widening spread between LIBOR and the overnight indexed swap (OIS) rate - an indicator of expected central bank interest rates - as evidence that LIBOR is too high. Others say credit fears aren't the problem, since banks' credit-default swap (CDS) premiums have been falling. As a result, the Bank of England in April 2008 introduced a Special Liquidity Scheme allowing banks to swap asset-backed securities for 9-month treasury bills to raise liquidity in the LIBOR market.