LIBOR When comparing actual loan and deposit interest rates in the United States

LIBOR When comparing actual loan and deposit interest rates in the United States

with those in the Eurobank market, there is a problem of determining which interest rates to compare. In the Eurodollar market, loan interest rates are usually quoted as percentage points above LIBOR. LIBOR stands for London Interbank Offered Rate and is the interest rate at which a group of large London banks could borrow from each other each morning. The U.S. commercial paper rate is considered the most comparable domes- tic interest rate. The Eurodollar deposit rate is best compared to the large certificate of deposit (CD) rate in the United States.

The British Bankers’ Association (BBA) fixes a value for LIBOR each day at 11:00 A . M . London time for each major currency. LIBOR is the key rate for fixing interest rates around the world. For instance, a variable interest rate loan in some currency may be priced at 2 percentage points

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before 11:00 A . M . each business day, each bank reports the rate at which it could borrow funds of a reasonable market size by accepting interbank offers from banks other than the LIBOR panel of contributing banks. The contributed rates are ranked in order and only the middle two quartiles are averaged in determining LIBOR.

LIBOR is fixed daily for the following ten currencies: the British pound (GBP), Canadian dollar (CAD), Danish krone (DKK), euro (EUR), U.S. dollar (USD), Australian dollar (AUD), Japanese yen (JPY), New Zealand dollar (NZD), Swedish krona (SKR) and Swiss franc (CHF). There are 15 maturities for which LIBOR is set each day, from an overnight rate all the way up to 12 months. Thus, a total of 150 rates

are set each day. 1 These rates are used as reference for about $360 trillion dollars of financial contracts around the world.

FAQ: Why Is the LIBOR the Most Important Rate in the World?

As of the end of 2010, the NYSE market capitalization was slightly over $13 trillion dollars, yet we hear news every day of what happened to the stock market. The LIBOR affects financial assets worth at least 25 times more, but rarely receives any press. Loans of $10 trillion and Swaps worth about $350 trillion around the world are directly tied to the LIBOR, according to the British Bankers Association. For example, approximately half of the U.S. adjustable mortgages are tied to the LIBOR.

The process of collecting the LIBOR takes only two people. They collect information from 16 different respected banks, and eliminate the four highest and four lowest quotes. The borrowing costs for the remaining eight banks are averaged into the LIBOR rates. Due to the immense size of the financial instruments that rely on the LIBOR, safeguards have been taken to ensure that the rate is quoted without fail. The two employees collecting the LIBOR have dedicated phone lines in their homes, in case an emergency keeps

them from going to the London office. 2 A backup office also exists in a “small

town 150 miles from London” ( MacKenzie, 2008 , p. 237). All these safeguards are necessary to ensure that the most important rate in the world is continu- ously quoted.

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departures from the actual costs of borrowing by a number of banks. 3 The

potential misreporting can pay off greatly for banks. According to Snider and

Youle (2010) 4 a collusion among the banks to change the LIBOR by 0.25%

could earn a single bank as much as $3.37 billion in a single quarter. Thus, the incentive to quote incorrect rates or to collude exists.