What is the London Interbank Offered Rate (LIBOR)?

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Overview:

The Reserve Bank of India (RBI) recently told banks and other regulated entities to ensure a complete transition away from the London Interbank Offered Rate (LIBOR).

About London Interbank Offered Rate (LIBOR):

  • It is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans.
  • It acts as a benchmark for short-term interest rates.
  • It is an indicator of the health of the financial system and provides an idea of the trajectory of impending policy rates of central banks.
  • LIBOR is also the basis for consumer loans in countries around the world, so it impacts consumers just as much as it does financial institutions.
  • How is LIBOR calculated?
    • The rate is calculated and will continue to be published each day by the Intercontinental Exchange (ICE).
    • It is computed for five currencies with seven different maturities ranging from overnight to a year. 
    • The five currencies for which LIBOR is computed are the Swiss franc, euro, pound sterling, Japanese yen and US dollar. 
    • Each day, ICE asks major global banks how much they would charge other banks for short-term loans. 
    • ICE benchmark administration consists of 11 to 18 banks that contribute for each currency. Only those banks that have a significant role in the London market are considered eligible for membership on the ICE LIBOR panel, and the selection process is held annually.
    • The rates received from the banks are arranged in descending order, and the top and bottom quartiles are excluded to remove outliers.
    • The arithmetic mean of the remaining data is then computed to get the LIBOR rate. 
    • The process is repeated for each of the 5 currencies and 7 maturities, thereby producing 35 reference rates. 
    • The most commonly quoted rate is the three-month U.S. dollar rate, usually referred to as the current LIBOR rate.

 


Q1) What does Intercontinental Exchange do?

It operates futures and OTC marketplaces for trading and clearing energy and agricultural commodities, credit default swaps, data services, equity indexes, and currency contracts. ICE also offers risk management services including trade execution, pre-and post-trade processing, market data and clearing services.

Source: RBI asks banks to ensure complete move away from LIBOR by July