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What is LIBOR rate and its significance?

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London Inter Bank Offered Rate or more commonly known as LIBOR is the average-weighted interest rate estimated by leading London-based banks for short term inter bank loans. Short-term inter bank loans are the unsecured loans tendered by one banking entity to the other in varying currencies for a time period as short as 1 day to a maximum of 1 year.

Simply put, LIBOR is nothing but an index signifying the cost of funds for global banks that operate in London Inter bank money markets. Globally, LIBOR is a benchmark for short term interest rate. In India, Libor rates assume significance, since FCNR (B) deposits are linked to LIBOR rates. Read more about FCNR (B) deposits here - FCNR(B) deposits

 

LIBOR is computed for 15 different maturities ranging from overnight to a year and for 10 currencies. British Bankers' Association (BBA) since the year 1985 has spearheaded the responsibility of announcing LIBOR rate on every working day at approximately 11:45 am (London time).

Method of Calculation:

The computation of LIBOR rates is not done basis the actual transactions and is arrived at by means of a survey conducted by BBA on a daily basis. The survey involves a panel of banks who are asked the question as at what interest rate do they expect to raise significant loans for the different maturity periods in the Inter-bank money market at the current moment. After, the survey is done, Thomson Reuters on behalf of the BBA discards the lowest and highest 25% values and computes the average of the remaining 50% values to arrive at the official LIBOR rate.

Importance of LIBOR rates :

Globally, LIBOR is considered to be the significant benchmark for short-term interest rates. Banks make use of the LIBOR rate when deciding the interest rate for savings, loans and mortgages. LIBOR rate is also taken as the base rate for several financial products, including swaps, futures and options. The rates are thus closely monitored by both the investor and borrower community who have taken business loans or include savings that are based on these indexes.

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