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International Internet Magazine. Baltic States news & analytics Thursday, 17.04.2014, 19:16

The Libor story: an instrument in the economic governance

Eugene Eteris, BC Scandinavian Office, 13.07.2012.Print version
Libor – short for London Interbank Offered Rate – is known as an average interest rate, estimated by leading banks in London that they would be charged if borrowing from other banks. It is becoming as popular as the primary benchmark (along with the Euribor), which is used for indicating short term interest rates around the world. The same system is used in the Baltic States, which serves businesses’ economic interests.

The abbreviation – Libor – stays for London Interbank Offered Rate, is known as an average interest rate, estimated by leading banks in London that they would be charged if borrowing from other banks. It is usually understood, at least officially, as the BBA Libor (for British Bankers' Association Libor) or the trademark bbalibor.

 

It is becoming as popular as the primary benchmark (along with the Euribor), which is used for indicating short term interest rates around the world.

 

Libor rates are calculated for ten different currencies and 15 borrowing periods ranging from overnight to one year and are published daily after 11 am (London time, generally, at 11:45 am) by Thomson Reuters. Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to it. At least $350 trillion in derivatives and other financial products are tied to the Libor.

 

Source: http://en.wikipedia.org/wiki/Libor.

 

Multiple criminal settlements recently revealed at Barclays Bank showed significant fraud and collusion by member banks connected to the rate submissions, leading to the Libor scandal and resignation of a couple of bank’s leaders.


Short Libor’s story

In mid-90s (precisely, in1984), 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. While recognizing that such instruments brought more business and greater depth to the London Interbank market, bankers worried that future growth could be inhibited unless a measure of uniformity was introduced.

 

Therefore in October 1984, the British Bankers' Association (BBA) along other partners, e.g. the Bank of England established various working parties, which eventually culminated in the production of the BBA standard for interest rate swaps, or "BBAIRS" terms. Part of this standard included the fixing of BBA interest-settlement rates, the predecessor of BBA Libor. From 2 September 1985, the BBAIRS terms became standard market practice.

 

BBA Libor fixings was officially introduce to the financial market on 1 January 1986; however, before that date some rates were fixed for a trial period as of December 1984.

 

In the Libor’s acknowledged procedures participated numerous international banks, with more than sixty nations represented among its 223 members and 37 associated professional firms (as of 2008), according to Wikipedia.


Libor as a regulatory tool

The LIBOR is widely used as a reference rate for many financial instruments, such as: forward rate agreements, short-term-interest-rate futures contracts, interest rate swaps and inflation swaps, floating rate notes, syndicated loans, variable rate mortgages and numerous currencies, especially the US dollar and euro.

 

These instruments therefore, provide the basis for some of the world's most liquid and active interest-rate markets. The same system was adopted in other European countries, including the Baltic States.

 

For the euro, however, the usual reference rates are the Euribor rates compiled by the European Banking Federation, from a larger bank panel. It exists, mainly for continuity purposes in swap contracts since about 1992-93 (so-called EMU – times).

 

Libor is specifically mentioned as a reference rate in the market standard International Swaps and Derivatives Association documentation, which are used by parties wishing to transact in over-the-counter interest rate derivatives.

 

For example, Libor is used by the Swiss National Bank as their reference rate for monetary policy. In the United States, around 60 percent of prime adjustable rate mortgages and nearly all subprime mortgages were indexed since 2008 to the Libor. In the UK, the three-month GBP Libor is used for some mortgages – especially for those with adverse credit history. The same structure is generally used in the Baltic States.

 

Libor, generally, specify the rates at which an individual "contributor bank" could borrow funds, i.e. by asking for and then accepting inter-bank offers in a reasonable market size.

 

Libor rates are fixed along the following financial instruments:

The rate at which each bank submits – in principle – loans and funds in the interbank market;

Contributions represent rates formed only in London’s headquarters;

Contributions must be for the currency specified (not the cost of producing one currency by borrowing in another currency and accessing the required currency via the foreign exchange markets);

The rates must be submitted by members of staff at a bank with primary responsibility for management of a bank’s cash;

The Libor uses the following definition of "funds": unsecured interbank cash or cash raised through primary issuance of interbank Certificates of Deposit.


Technical features

Libor is calculated and published by Thomson Reuters on behalf of the British Bankers' Association (BBA). It is a trimmed average of interbank deposit rates offered by designated contributor banks, for maturities ranging from overnight to one year.

 

Libor is calculated for 10 currencies. There are eight, twelve, sixteen or twenty contributor banks on each currency panel, and the reported interest is the mean of the 50% middle values (the so-called interquartile mean). The rates are a benchmark rather than a tradable rate; the actual rate at which banks will lend to one another continues to vary throughout the day.

 

The Libor is among the most common of benchmark interest rate indexes used to make adjustments to adjustable rate mortgages.

 

The following table shows the connections between the LIBOR and other interest rate indexes (as of July 10):

This week

Month ago

Year ago

Bond Buyer's 20 bond index

3.94

3.92

4.65

FNMA 30 yr Mtg Com del 60 days

3.02

3.18

4.25

1 Month LHYPERLINK "http://www.bankrate.com/rates/interest-rates/1-month-libor.aspx"iborHYPERLINK "http://www.bankrate.com/rates/interest-rates/1-month-libor.aspx" Rate

0.25

0.24

0.19

3 Month LHYPERLINK "http://www.bankrate.com/rates/interest-rates/3-month-libor.aspx"ibor HYPERLINK "http://www.bankrate.com/rates/interest-rates/3-month-libor.aspx"Rate

0.46

0.47

0.25

6 Month LHYPERLINK "http://www.bankrate.com/rates/interest-rates/6-month-libor.aspx"ibor HYPERLINK "http://www.bankrate.com/rates/interest-rates/6-month-libor.aspx"Rate

0.74

0.74

0.41

Call Money

2.00

2.00

2.00

1 Year LHYPERLINK "http://www.bankrate.com/rates/interest-rates/1-year-libor.aspx"ibor HYPERLINK "http://www.bankrate.com/rates/interest-rates/1-year-libor.aspx"Rate

1.07

1.07

0.74

 

These indexes are of interest to investors and borrowers alike, especially those who have mortgages or business loans tied to these indexes.


 

They include the Bond Buyer 20 bond index as a barometer for yields on tax-free bonds issued by state governments and local municipalities. The Fannie Mae 30-year mortgage commitment for delivery within 60 days helps mortgage lenders determine what rates to charge on 30-year fixed rate mortgages that are to be sold to Fannie Mae within the next 60 days. The Libor rates are benchmark interest rates for many adjustable rate mortgages, business loans, and financial instruments traded on global financial markets.






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