LIBOR History

From LoveToKnow Mortgage

The LIBOR history extends from a solution to implement new investment products in the 1980s through the needs to adapt to a new financial currency and to the definition of the word "prime."

The LIBOR index is the basis of many loan rates

New Financial Products Require Pricing Help

In the 1980s many London banks were trading in new market instruments such as interest rate swaps, foreign currency options and forward rate agreements. To price and analyze these new types of investments, a new measure of interest rate uniformity was needed.

By 1984 the British Bankers' Associations (BBA), the trade association for British banks, had successfully worked with several British banks including the Bank of England to create a standard index for interest swap rates called the "BBAIRS terms." The BBAIRS terms became the standard for interest swap rates starting in September 1985.

By January 1986 the LIBOR history unfolded into a new interest rate index when the BBA introduced the LIBOR index for use by its member banks. The BBA has always been a major force in the international banking world and currently includes over 200 member banks from over sixty nations.

The LIBOR index was initially provided in only three currencies:

Pounds Sterling
United States Dollar
Japanese Yen

LIBOR History: Changes

There have only been two significant changes in LIBOR history since the LIBOR rate index was introduced:

First, in 1998 there was a change in one of the questions asked of the participating banks. The BBA was concerned that there was no longer a universal definition of a prime bank. The change was made to delete the words "prime bank" from the question.
- The prior question was: At what rate do you think interbank term deposits will be offered by one prime bank to another prime bank for a reasonable market size today at 11am?
- The question was changed to: At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11am?
Second, the Euro was introduced as a LIBOR currency in January 1999.

Current LIBOR Facts

Today the LIBOR rates are currently used as an index to set the rates for a wide variety of interest rate-based financial instruments including:

Currency valuations
Variable rate mortgages
Floating rate notes
Short-term interest rate futures contracts
Forward rate agreements
Syndicated loans
Interest rate swaps
Inflation swaps

The LIBOR is:

Calculated daily by Thomson Reuters, an international financial information company
Published by the BBA shortly before Noon London time
Calculated in ten currencies:
- Pound Sterling
- Euro
- United States Dollar
- Canadian Dollar
- Australian Dollar
- New Zealand Dollar
- Swedish Krona
- Danish Krone
- Japanese Yen
- Swiss Franc
Available in fifteen maturities from overnight to one year
Used as an index for many adjustable rate mortgages in the United States. Typically the LIBOR six-month United States Dollar rates are used as the rate setting index.

Reliability Controversy

The Wall Street Journal published a study in May 2008 suggesting that the use of the LIBOR interest rates may have understated the cost of funds for banks to borrow from other banks. The study suggested that this understatement could have misled the banking industry, causing the banks to set interest rates that were too low and making the banks feel that they were financially healthier than they actually were.

The BBA quickly responded to the Wall Street Journal controversy by saying that the LIBOR rates have always been a reliable indicator of the wholesale interest rates.