Despite the constant monitoring of financial experts and business people on the current LIBOR rate, some individuals are not aware of how this number is so important when transacting with banking institutions, both local and abroad. People who simply send and receive money from loved ones don’t seem to see the importance of such rates. Well, this is because the London Interbank Offered Rate (LIBOR) is more relevant to institutional perspective, and if you work in a bank or similar sector, this is something you should be aware of.
LIBOR Defined
The LIBOR acts as a global standard interest rate that presents borrowing fees between financial institutions like banks. The number is computed and regularly shown daily by a global exchange service provider or the Intercontinental Exchange (ICE). But in light of the recent issues related to its validity as the standard rate, it’s been removed and no longer in use. According to the UK’s regulators and Federal Reserve, LIBOR will be phased out by 2023 and utilize the Secured Overnight Financing Rate (SOFR) as a replacement.
The Process
LIBOR is the median interest rate used when global financial institutions owe each other. It is based on the five currencies–Euro, Pound, US Dollar, Yen, and Franc. The loan consists of several maturities such as one day or on the spot, a week, 30 day libor, two, six, and 12 months.
The integration of the currencies and maturities results in 35 various LIBOR rates computed and shown every day. The most prevalent rate is the three-month American dollar rate or also known as the current LIBOR rate.
The ICE requests from major international banks, what is their rate for the short-term loan offered to other banks. The organization gets the top and bottom numbers, then computes the median from the leftover in-between numbers. This process is the trimmed average method. This is the number published every day as the daily rate. Hence, the figure varies. As soon as the numbers for every currency and maturity are computed, they will be presented daily, five minutes before noontime. The timing is based on London time.
LIBOR is also used as the benchmark for consumer loans worldwide. Thus, it significantly affects ordinary people just as banks do. The rates on different products like auto loans, credit cards, and mortgages are unstable and constantly changing based on the interbank rate. The variations in rate identifies the streamlined borrowing process between consumers and financial institutions.
The fluctuation of LIBOR rate
The Downside
Whether consumers or banks choose a 30 day libor rate or longer, there is a disadvantage to it. The cheaper borrowing costs look encouraging, it can have an impact on the returns on some securities. There are mutual funds connected with LIBOR, so the results may go down as the LIBOR changes.
The Purpose
LIBOR serves as the standard measurement of market forecast on interest rates established by central financial institutions. It consists of premiums of different traded elements in money markets and the indicator of the entire banking system’s condition. Furthermore, it is a reference rate for regular procedures such as price discovery, clearing, and product valuation.
