LIBOR is an acronym for the London Interbank Offered Rate, being the measure of the rate at which banks are prepared to offer funds in the London Interbank market. There is also LIBID, the London Interbank Bid Rate, the rate at which banks are prepared to bid for funds, as well as LIMEAN which is the average between the two.
LIBOR is more properly known as BBA LIBOR, which is a registered trade mark of the British Bankers' Association (there is even a 'bbalibor' logo complete with TM symbol). There is however no BBA LIBID rate, as although the Bank of England establishes LIBID rates for the purposes of calculating data on LIBOR-LIBID spreads, there is no equivalent authoritative statement of what LIBID is at any point in time. Therefore although LIBID is often used as a benchmark for deposit rates, it generally defined as being LIBOR minus an 1/8th, 0.125%, or 12.5 basis points. (There are good reasons why banks do not like to publicise the rates that they are prepared to pay for funds for fear of appearing a l
ittle too desperate for money.)
According to the British Bankers' Association (BBA) it was during the early 1980s that it "became apparent that an increasing number of banks were trading actively in a variety of relatively new market instruments, notably Interest Rate Swaps, Foreign Currency Options and Forward Rate Agreements". It was also apparent that the trade in such instruments would be facilitated if there was some widely accepted measure of what interest rates actually pertained to these instruments. Therefore in October 1984 the BBA began working with other parties such as the Bank of England and eventually formulated the BBA standard for Interest Swap rates otherwise known as BBAIRS, and then from the 1st January 1986 began publishing details of daily BBA LIBOR fixings.
BBA LIBOR is calculated for a range of ten currencies, being Sterling (GBP), US Dollar (USD), Japanese Yen (JPY), Swiss Franc (CHF), Canadian Dollar (CAD), Australian Dollar (AUD), Euro (EUR), Danish Kroner (DKK), Swedish Krona (SEK) and the New Zealand Dollar (NZD), on a range of maturities ranging from overnight up to twelve months. It is compiled by the British Bankers' Association in conjunction with Reuters and released to the market shortly after 11.00 am London time each day.
As far as each currency is concerned there is a Contributor Panel comprising of between eight and sixteen banks. According to the BBA, "Contributor Panels will broadly reflect the balance of activity in the inter-bank deposit market. Individual Contributor Banks are selected by the BBA's Foreign Exchange and Money Markets Advisory Panel after private nomination and discussions with the Steering Group, on the basis of reputation, scale of activity in the London market and perceived expertise in the currency concerned, and giving due consideration to credit standing." Each of these Contributor Banks supplies details of the interest rates it is offering to pay across the range of maturities in the respective currency, and the BBA LIBOR Fixing consists of calculating the interquartile mean of the contributed rates for each particular currency, maturity and fixing date.
The importance of BBA LIBOR is that it the "primary benchmark for short term interest rates globally". According to the BBA it is "used as the basis for settlement of interest rate contracts on many of the world's major futures and options exchanges (including LIFFE, Deutsche Term Börse, Euronext, SIMEX and TIFFE) as well as most Over the Counter (OTC) and lending transactions". It is also widely used in the United States as an interest rate benchmark and many Adjustable Rate Mortgage products are priced against LIBOR. The reason being that although the Federal Reserve does set a target rate and there is what is known as an Effective Federal Funds Rate, which is the interest rate at which depository institutions lend excess balances deposited at the Federal Reserve to each other, this only relates to the overnight market, and due to the nature of the American banking system there is no comparable interbank market in the United States. In its Key Rates Bloombergs therefore quotes the rates for both 1-Month Libor and 3-Month Libor alongside the Federal Reserve Target Rate and the Prime Rate.
SOURCES
- Key facts about BBA LIBOR
http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=145&a=10202&artpage=all
- BBA LIBOR Panels
http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=145&a=13777&artpage=all
- Corporate Finance Manual: Glossary
http://www.hmrc.gov.uk/manuals/cfmmanual/glossary/cfm800.htm
- Bloomberg Key Rates
http://www.bloomberg.com/markets/rates/keyrates.html