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What does London interbank offered rate mean?

Libor definition

The London interbank offered rate, or Libor, stands for a benchmark interest rate in the international interbank market. It means that Libor is used by major international banks to lend to one another. Every bank estimates at what rate it would be charged in case it borrows from another bank, the resulting rate is abbreviated as Libor. 

Libor is a globally accepted interest rate, which defines the cost of borrowing between banks. Every day, the Libor rate is published and calculated by the Intercontinental Exchange (ICE).

The Libor rate is based on five currencies, including the British pound, the euro, the US dollar, Swiss franc and the Japanese yen. It has seven borrowing periods, or seven maturities, namely: overnight, one week, one-, two-, three-, six- and twelve months. 

The combination of seven maturities and five currencies results in thirty five different Libor rates, which are reported and published every business day by Thomson Reuters. When we talk about the current Libor rate we usually mean the US dollar three-month rate, which is one of the most commonly quoted rates. 

Various financial institutions, credit card agencies and mortgage lenders determine their own rates according to Libor. Around $350tn in derivatives and other financial products are tied to Libor rate. They include:

  • Standard interbank products, including FRA (forward rate agreements), interest rate options and futures
  • Commercial products, including syndicated loans and variable rate mortgages
  • Hybrid products, including CDO (collateralised debt obligations) and CMO (collateralised mortgage obligations)

How is Libor calculated?

Every day, the Intercontinental Exchange (ICE) asks major international banks how much they would charge other banks for providing short-term loans. 

Libor calculation presupposes taking out the lowest and the highest number, provided by the banks, and calculating the average figure from the remaining numbers, which is known as the trimmed average. The Libor rate is updated each day at around 11.55 am GMT .

Only banks with a significant presence in the London market participate in the ICE Libor panel. The list of banks is determined annually. For example, the US dollar Libor rate includes the Bank of America, JPMorgan Chase and Citibank.

However, Libor is applied not only between financial institutions, but also for providing consumer loans in different parts of the world. The interest rates on different credit services and products including car loans, student loans, credit cards, individual mortgages fluctuate according to the interbank rate. 

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