LIBOR Interest Rate

What is LIBOR?

In this post I would like to discuss a very important interest rate from UK, LIBOR, that banks in UK use as a Benchmark.

LIBOR - London Interbank Offering Rate

LIBOR is the most important interest rate that is used in LONDON. It is the borrowing rate that banks charge each other for lending various currencies. The rate is published by BBA where the top 16 banks release their rates for charging to other banks and BBA publishes one rate after using some formula behind it.  LIBOR is then used as a benchmark and all financial instruments that require interest rate as a part, would use LIBOR as a benchmark and add some spread based on the credibility. 

In a simple way, consumers will need to pay an interest rate higher than the LIBOR because no one can borrow at LIBOR except the banks themselves. 

These borrowing and lending can happen in any currency such as USD, Euro, Pound and so on. Hence, there is a corresponding LIBOR for USD, EURO, Pound or other currencies. Other than currency, the next important attribute of the LIBOR is the tenor, the duration for which banks want to lend another bank or so. 

Hence, there would be a LIBOR USD rate for 1M, 3M, 6M, 1Y and similarly LIBOR Sterling rate for the same tenor points.

Usage: 

These rates are used as a benchmark to offer various financial instruments to consumers such as Mortgage Rate, Auto Loan Rate, Student Loan and so on and so forth.

Process is very Simple: 

Scenario 01 

Let's say Bank A's can borrow at Libor from Bank B 

Bank A has a customer C1 who wants a short term loan for 1 Yr

Bank A sees the customer C1 to be of less risky and happy to give loan at 0.5% Margin

Finally, Bank will charge Customer C1 an interest rate of Libor + 0.5% + Whatever Processing Fee 

Scenario 02 

Let's say Bank A's can borrow at Libor from Bank B 

Bank A has a customer C2 who wants a short term loan for 1 Yr

Bank A sees the customer C2 to be of more riskier than C1 BUT happy to give loan at 2% Margin

Finally, Bank will charge Customer C1 an interest rate of Libor + 2% + Whatever Processing Fee 

Same process can go for a borrowing in any other currency such as Euro, Sterling and so on. 

Hope this helps,

Nitin