LIBOR is an acronym for London InterBank Offered Rate. This rate is that which is charged by London banks, and is then published and used as the benchmark for bank rates all over the world. LIBOR is compiled by the British Bankers Association (BBA).
This market allows banks with liquidity requirements to borrow quickly from other banks with surpluses, enabling banks to avoid holding excessively large amounts of
their asset base as liquid assets. The LIBOR is officially fixed once a day by a small group of
large London banks, but the rate changes throughout the day.
LIBOR was established as a standardized benchmark for
the pricing of floating-rate corporate loans. However, its
introduction coincided with the growth of new interest rate–
based financial instruments—such as forward rate agreements and interest rate swaps—that also require standardized
and transparent interest rate benchmarks.
LIBOR is supposed to reflect reality—an average of what
banks believe they would have to pay to borrow a “reasonable” amount of currency for a specified short period. That
is, it represents the cost of funds—although a bank may not
actually have a need for the funds on any given day.
But LIBOR has long been dogged by perceptions that the
method for setting the rates is flawed and prone to distorted
results during periods of market stress when banks stop lending to each other across the full maturity spectrum, from
overnight to one year.
A more direct challen