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London Interbank Offered Rate (Libor) Controversy

London Interbank Offered Rate (Libor) Controversy (June 2008)

Presently, there are two issues regarding the London Interbank Offered Rate (LIBOR). First, dollar Libor quotes are considered too high compared to the federal funds rate. Second, elevated Libor quotes are considered too low compared to other market-based interest rates.

British Bankers’ Association (BBA) Reaction (bba.org.uk)

The British Bankers’ Association (BBA) reviewed the situation and decided to alter the process for setting Libor. Possibly by fall 2008, the British Bankers’ Association will increase the number of banks that contribute the rates that comprise the London interbank rates. Using more contributor banks would give a more accurate average rate. Also, the British Bankers’ Association plans to increase the scrutiny of the contributed rates to ensure their validity. Changing Libor bank rates in any way is a challenge, legally and financially. Hundreds of trillions of dollars in financial contracts around the world depend on the Libor benchmark.

Libor Federal Funds Spread

Regarding the first issue, the federal funds rate is currently at 2% and the short-term dollar Libor rate is significantly higher. Actual Libor bank rates fluctuate and differ by maturity, but the overnight dollar Libor rate was recently at 2.48%. US banks can raise dollar funds from the US Federal Reserve. European banks cannot. This implies that US banks can raise dollar funds more cheaply than European banks. Dollar Libor is calculated using rates contributed by 3 US banks and 13 European banks. Because there are more European contributor banks than US contributor banks, the dollar Libor rates are skewed to the higher European rates. The BBA is considering publishing a separate index to represent dollar Libor quotes for European banks.

Validity of Libor

Recent rises in Libor lagged behind rises in other market-based interest rates. This raised suspicion regarding the validity of Libor. Some suspect contributor panel banks were underreporting their borrowing costs to avoid looking desperate for cash.

Contributor panel banks submit borrowing rates to the BBA each weekday. Some analysts suspect that contributor banks are submitting rates lower than the true borrowing rates. Banks may be reluctant to reveal that they are paying higher borrowing rates, which might indicate less creditworthiness. Lower than expected Libor rates could be evidence that some banks are submitting lower than actual borrowing rates. The financial markets expect the US Federal Reserve to raise its key interest rate later this year. This is influencing rises in short-term treasury yields and money market borrowing rates. In this environment, Libor rates have not gone up as much as expected.

Today’s Libor Index

For the dollar Libor rate today and other Libor current rates, go to: bankrate.com.

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london interbank offered rate (libor)

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london interbank offered rate (libor)

See Also:
LIBOR
Libor versus Prime Rate
Annual Percentage Rate
Required Rate of Return
What are the ‘Twin Deficits’?

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Libor versus Prime Rate

See Also:
LIBOR
Prime Lending Rate
Interest Expense
Interest Rate Swaps
Federal Funds Rate

Libor versus Prime Rate

The London Interbank Offered Rate (Libor) and the US Prime Rate are both benchmark interest rates. Both rates are used as reference rates for various lending and borrowing transactions. (For current and historical rates, see the links below.) To see comparisons of Libor versus prime rate, keep reading.

Libor History – Prime Rate History

Libor originated in London, England, and was established between 1984 and 1985. The US Prime Rate, also called the WSJ Prime Rate, originated in the United States. Historical prime rate data go back as far as 1929. When we study the age of Libor versus prime rate, prime rate is much older than Libor.

Setting Libor and Prime Rate

Libor is an average derived from the rates at which major banks lend to each other in London’s money markets. Whereas, US Prime Rate is typically set at three percentage points above the federal funds rate. Setting Libor is more complicated than setting US Prime Rate.

Fixed Rate, Floating Rate

Libor is a floating rate as it fluctuates continually. US Prime Rate is a fixed rate, which means it typically remains unchanged for extended periods of time. Prime Rate versus Libor: Prime rate is a fixed rate, whereas Libor is a floating rate.

Primary Users of Libor and Prime Rate

Libor is used by banks – it is the interest rate at which banks lend to each other in certain London money markets. (Borrowers, lenders, and investors may use Libor as a reference rate.) Comparatively, US Prime Rate is used by consumers – it is the rate at which banks lend to their best customers. (Borrowers, lenders, and investors may use prime rate as a reference rate.) Libor is used primarily by banks (in theory). Prime is used primarily by consumers.

Libor Benchmark – Benchmark Prime Lending Rate

Libor is a benchmark interest rate used as a reference in lending and borrowing transactions around the globe. (Keep in mind, Libor bank rates are also used as reference rates in various financial derivatives.) Comparatively, US Prime Rate is a benchmark interest rate used as a reference in lending and borrowing transactions in the United States and elsewhere. When we look at Libor versus Prime Rate, we find both rates are benchmark interest rates with wide global usage.

Publication of Libor and Prime Rate

Libor bank rates are published daily at 11:30am GMT by the British Bankers’ Association (bba.org.uk). The US Prime Interest Rate, also called the Wall Street Journal Prime Rate, is published in the Wall Street Journal. Prime Rate versus Libor: Prime interest rate is published by the WSJ whereas Libor is published by the BBA.

Variations of Libor and Prime Rate

Libor is published for 10 currencies and 15 maturities. It also ranges from overnight to one year. In comparison, prime lending rates may vary slightly among individual commercial banks. Libor vs Prime Rate: there are many more official versions of Libor than there are official versions of US Prime Rate.

Wall Street Journal Prime Rate (WSJ Prime Rate)

To see historic US Prime Rates, from 1947 to the present, go to: wsjprimerate.us

If you want to learn prime rate historical data from 1929 to present, then go to: research.stlouisfed.org

To read about current and recent US Prime Rates, as well as other rates, go to: bloomberg.com

Libor Historical Rates and Current Rates

For Libor rates, go to: bba.org.uk, bankrate.com and bloomberg.com.

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Libor versus prime rate

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Libor versus prime rate

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LIBOR (London Interbank Offered Rate)

See Also:
Interest Rate Swaps
Prime Lending Rate
Libor versus Prime Rate
Federal Funds Rate

LIBOR Definition

The LIBOR definition is a benchmark interest rate derived from the rates at which banks are able to borrow funds from one another in the London inter-bank market, is the foundation of all lending rates. Furthermore, this term is a common reference rate for short-term lending transactions around the world. The British Bankers‘ Association publishes this rate daily at approximately 11:30am GMT.

LIBOR Explanation

LIBOR, explained below, is one of the most pivotal lending rates for the entire world. LIBOR rates are based on a filtered average of the market rates at which banks are willing to offer deposits to other banks for certain currencies, maturities, and fixing dates. In addition, LIBOR publishes rates for Australian Dollars, Euros, Japanese Yen, Sterling, US Dollars, and other currencies. Maturities can range from overnight to one year. LIBOR commonly quotes the rates for 1 month, 3 months, 6 months, and 1 year. The fixing date is the date on which the rate is relevant. While actual market rates fluctuate throughout the day, LIBOR remains fixed for 24 hours.

LIBOR as a Reference Rate

LIBOR is used as a reference interest rate for loans to borrowers with good credit as well as loans to borrowers with poor credit.

Example

For example, a borrower with good credit might secure a loan at LIBOR, the reference rate, plus a narrow quoted margin, or the percentage point spread above the reference rate. Meanwhile, a borrower with poor credit might secure a loan at LIBOR plus a wider quoted margin. LIBOR swap rates are also used as a reference rate for currencies, mortgages, interest rate swaps and other financial instruments.

LIBOR Quotes

Overnight LIBOR-Rate

1-month LIBOR-Rate

3-month LIBOR-Rate

6-month LIBOR-Rate

1-year LIBOR-Rate

LIBOR Calculation

LIBOR, calculated daily by the British Bankers’ Association (BBA), is based on a filtered average of inter-bank deposit offer quotes submitted from certain contributor banks.

The BBA selects a panel of at least 8 Contributor Banks for each relevant currency. For example, the Australian Dollar panel consists of 8 banks. The Canadian Dollar panel consists of 12 banks. And the Japanese Yen panel consists of 16 banks. The Contributor Panel selections are based on the banks’ credit standing, reputation, participation in the London inter-bank market, and other relevant factors. The compositions of the Contributor Bank Panels are reviewed annually.

Each day, between 11:00am GMT and 11:10am GMT, each Contributor Bank submits to the BBA the actual rate at which it could borrow funds just before 11:00am GMT on that day in the London inter-bank market for particular currencies, maturities, and fixing dates.

Then the submitted rates are ranked. Then they calculate the mean using only the two middle quartiles of the ranking. For example, if 16 rates are submitted, then calculate the mean using the middle 8 rates. Whereas if 12 rates are submitted, then use the middle 6 rates. And if 8 rates are submitted, then use the middle 4. The calculated mean becomes the London Inter-bank Offered Rate for that particular currency, maturity, and fixing date. The BBA then publishes this rate at approximately 11:30am GMT.

History of LIBOR

LIBOR was established between 1984 and 1985. It provides a standardized rate to facilitate the increasing usage of new financial instruments, such as interest rate swaps, foreign currency options, and forward rate agreements.

LIBOR Historical Rates and Current Rates

For LIBOR rates, see:

bba.org.uk

bankrate.com

bloomberg.com

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LIBOR Definition

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LIBOR Definition

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Basis Points

See Also:
Accounts Payable
Margin vs Markup
Collateralized Debt Obligations
Are You Collecting Business Data?
Benchmarking

A basis point is one hundredth of a percentage point. A single basis point would look like this: 0.01%. Fifty basis points is a half a percentage point: 0.50%. 100 basis points equal one percentage point: 1.00%.

When To Use Basis Points

In finance, changes in the values of financial instruments or interest rates may be denoted in basis point. They are used to describe quantities less than one percent. When the Federal Reserve lowers its fed funds rate by a half a percent, the media may report that the fed funds rate was lowered by 50 basis points.

Similarly, the interest rate on a loan or debt instrument that is based on a reference rate, such as LIBOR or the Prime Rate, may have a spread quoted using the term basis point. The rate may be described as Prime Rate plus 50 basis point. If Prime Rate is 5%, then the rate on that loan or debt instrument would be 5.5%.

basis points

 

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Libor vs Prime Rate

Interesting article in the April 23rd Wall Street Journal on page C1 highlighting the divergence of Libor from U.S. Prime Rate. Let’s dive into what the difference between Libor vs Prime Rate is.

What’s the Difference Between Libor vs Prime Rate?

Libor has been increasing while the Prime Rate has been dropping.

You need to check your loan agreement to see what is the index for setting your loan rate. Now is also a good time to see if there is a floor on your interest rate. I have had clients in the past who woke up to find that the prime rate had fallen significantly but their interest rate had a floor on it. You can often negotiate that floor away.

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Libor vs Prime Rate

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Libor vs Prime Rate

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