What Is LIBOR?

• Author: John Kiff
• Position: a Senior Financial Sector Expert in the IMF’s Monetary and Capital Markets Department.

Back to Basics

Every weekday at about 11 a.m., 18 large banks, under the auspices of the British Bankers’ Association, report the rate at which they believe they can borrow a “reasonable” amount of dollars from each other in the so-called London interbank market. They report rates for 15 borrowing terms that range from overnight to one year. The financial news agency Thomson Reuters gathers the reported rates on behalf of the bankers’ group, throws out the four highest and four lowest, and averages the rest. It then announces that average rate at which banks say they can borrow dollars for each of the 15 maturities.

The process is carried out for nine other currencies as well. The average—often referred to in the singular even though there are 150 rates—is called the London interbank offered rate (LIBOR). It is one of the best known and most important interest rates in the world.

But it is not important because banks actually transact business with each other at the announced rate—although that can happen. Rather, LIBOR’s importance derives from its widespread use as a benchmark for many other interest rates at which business is actually carried out. According to a recent U.K. Treasury report, $300 trillion in financial contracts are tied to LIBOR—and that doesn’t include rates on uncounted tens of billions of dollars of adjustable rate home mortgages and other consumer loans around the globe in which LIBOR, in one way or another, is referenced.

Because the U.S. dollar is the most important of the world’s currencies, U.S. dollar LIBOR rates are probably the most widely used and cited. Other panels—ranging in size from 6 banks to 16—report daily what it would cost them to borrow Australian dollars, British pounds sterling, Canadian dollars, Danish kroner, euros, Japanese yen, New Zealand dollars, Swedish kronor, and Swiss francs short term in the London interbank market.

Much is likely to change, though, as a result of controversy over how some banks report the rates at which they “believe” they can borrow and because of some underlying problems with the LIBOR concept. In late September the U.K. government announced proposals to bring the setting and maintenance of this important benchmark under government purview, base it on actual transactions, and eliminate most of the 150 separate rates.

A recent innovation

Although banks in London have been lending to one another for centuries, LIBOR is a relatively new idea. It has its roots in the...