Hedging Video Series: “What Is LIBOR?” [Chapter 1] — By Jillian Mariutti
This is the first episode in a series of eight videos on Hedging.
Chapter 1: What Is LIBOR?
LIBOR stands for London Interbank Offered Rate and it’s the world’s most widely used benchmark for short term interest rates. It is the benchmark that underpins approximately $350 trillion of financial contracts. How is it determined? Each morning, just before 11 a.m. Greenwich Mean Time, a group of major banks are asked the rate at which they could borrow funds from other banks on an unsecured basis. Thus LIBOR reflects the health of the financial system because if the banks being polled feel confident, they report a low number and if the member banks lack confidence in the financial system, they report a higher interest rate number. Back during the crisis, there was collusion and LIBOR manipulation. Banks were falsely inflating or deflating their rates so as to profit from trades or to give the impression that they were more creditworthy than they were. Therefore, something had to change.
In November 2014, the Federal Reserve convened the Alternative Reference Rates Committee (“ARRC”) to explore alternatives for replacing LIBOR as a benchmark rate in the US. This past June 2017, ARRC voted and determined its preferred alternative rate.