You might not have ever heard of Libor. Which means you most likely don’t know that it can affect your financial life. Here’s a breakdown of what it is, why it matters, and the possible impact it can have on your personal finances, including loans you’ve taken out.
A Little Bit About Libor
Libor, which stands for the London Interbank Offered Rate, is a benchmark interest rate that (although it’s on the way out) has a significant impact on global commercial and consumer lending. It’s used to set interest rates for more than $350 trillion in loans worldwide, possibly including a loan you’ve taken out. Libor is determined each day in London by more than 15 major international banks, including Deutsche Bank, HSBC,
J.P. Morgan, Bank of America, and Barclays.
How It Works
Every morning, the international banks submit offers to the Intercontinental Exchange Benchmark Administration for rates they would pay to borrow from the others. The highest and lowest offers are eliminated, and an average rate is calculated from the rest.
Libor rates reflect the level of confidence in both banking institutions and economies. When Libor trends higher, it’s a reflection of banks’ concern about the health of their fellow institutions.
But a low Libor can’t always be construed as a positive sign: Some of the chaos surrounding the 2008 financial crisis had roots in an intentional skewing of the rate. In the past, banks have paid billions in fines and penalties for manipulating Libor. Because of these past manipulations, regulators are phasing out Libor; plans are in the works to replace it with a new benchmark rate by 2021.
Libor’s impact on everyday living — and possibly your loans
In the U.S., Libor affects the interest rates on adjustable-rate mortgages and student loans. The interest rate is a clear example of how global financial markets can impact everyday living costs in nearly every corner of the globe.
It appears that the days when local banking dominated financial dealings are long gone. At one time, a bank in your area would invest its assets by lending to consumers and businesses within the bank’s community. Unfortunately, bankers eventually realized that maintaining all assets and liabilities in-house carried a significant risk. Consequently, Wall Street encouraged banks to sell off loans to institutional investors, the earliest of whom were familiar with Libor and decided to use it as an index for pricing secondary market loans. All of which may trickle down to a loan that you’ve taken out on your home or to pay for your education.