London Inter Bank Offering Rates (LIBOR) Explained:

In 1958 it became apparent that there were an increasing number of banks trading frequently in a variety of relatively new market s with brand new products, most known for interest rate swaps, foreign currency options, and most noteworthy; forward rate agreements.

While recognizing that these particular instruments brought in more business (depositors) and shaping the depth of the London Interbank market, it was starting to become apparent that future growth (in banks) could be inhibited. Simply put, there needed to be a measure of uniformity between financial institutions.

In October of 1984, British Bankers' Association working with various parties such as the Bank of England to establish working parties, which soon culminated in developing BBAIRS terms. (The BBA standard for interest rate swaps) This standard includes fixing the BBA interest settlement rates. (The predecessor of BBA LIBOR) Moving forward from September of 1985, the terms of BBAIRS became standard in the market place.

How is the London Interbank Offering Rate (LIBOR) calculated?

LIBOR is calculated by Thomson Reuters and published by the British Bankers' Association (BBA) after 11:00 each day of market hours in London Time. It’s a trimmed average of interbank deposit rates offered by designated contributor banks. The LIBOR is calculated in 10 currencies. The rates should be viewed as a benchmark rather than a tradable rate. The actual rate at which banks will lend to one another should continue to vary throughout the trading day.

What should I know about the LIBOR when shopping for a mortgage today?

In May of 2008 The Wall Street Journal released a highly controversial study suggesting that banks may have understated borrowing costs reported for LIBOR during 2008’s “credit crunch”. Underreporting may have created a false impression that banks can borrow from other bank for a lower rate than they can in reality in current market conditions. It may have created the banking system to appear much healthier than it appeared for the year of 2008.

In response to the Wall Street Journal’s article, The British Bankers' Association made claims that the LIBOR should continue to remain reliable, even in times of financial crisis and panic. Other authorities have also contradicted the Wall Street Journal article.