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| Corporate Practice bd |
What-is-Libor? How-Libor-is-set? with Practical Examples
LIBOR, or the London Inter bank Offered Rate, is a benchmark interest rate at which major global banks lend to one another in the international inter bank market for short-term loans. It serves as a reference rate for various financial products, including loans, mortgages, derivatives, and bonds.
Here's how LIBOR is typically set:
Contributing Banks:
A panel of major banks (around 16 for USD LIBOR) located in London submits their estimated borrowing costs to the Intercontinental Exchange (ICE) Benchmark Administration, which oversees the LIBOR process. These banks represent different sectors of the financial market.
Submission:
Each contributing bank submits the interest rate at which it could borrow funds from other banks in the interbank market for various currencies and tenors (maturity periods), typically ranging from overnight to one year.
Trimming:
The highest and lowest submissions are removed, and the remaining rates are averaged to calculate the LIBOR fixing for each currency and tenor.
Publication:
The resulting LIBOR rates are published daily (excluding certain holidays) by ICE Benchmark Administration at around 11:55 a.m. London time for various currencies and tenors.
Example:
Let's consider an example of how USD LIBOR is set:
Contributing Banks: Major global banks such as JP Morgan Chase, Citibank, Barclays, Bank of America, and others submit their estimated borrowing costs for USD LIBOR to ICE Benchmark Administration.
Submission:
Each bank submits the interest rate at which it believes it could borrow funds from other banks in the interbank market in USD for different tenors, such as overnight, one week, one month, three months, six months, and one year.
Trimming:
ICE Benchmark Administration removes the highest and lowest submissions, then calculates the average of the remaining rates for each tenor.
Publication:
The resulting USD LIBOR rates for various tenors are published daily by ICE Benchmark Administration and used as a reference rate for a wide range of financial transactions worldwide.
It's worth noting that LIBOR is being phased out and replaced by alternative reference rates (such as SOFR in the United States and SONIA in the United Kingdom) due to concerns about its susceptibility to manipulation and the decline in inter bank lending activity.