The LIBO rate represents the rate at which banks and other borrowers can receive amounts of capital relative to the London interbank market. As a national measure of the best interest rates available, the LIBO rate also creates a convenient tool for assessing interest rates in other countries. As a variable value, the LIBO rate is maintained by the British Bankers Association, where prices are established on a frequent basis.
A national interbank market consists of loan transactions between major financial institutions in that country. Financial professionals talk about a prime lending rate, where they are often referring to the current interbank market rate. This prime lending rate sets a standard for other loan agreements and the interest rates that accompany them.
For a concrete example of how a prime lending rate affects a loan, a residential mortgage is most often tied to the prime lending rate. Initially, the rate for the mortgage will usually be a bit higher, but not extravagantly higher, than the current prime lending rate. If the mortgage is a fixed-rate mortgage, the interest rate will not change over the years that the borrower is paying it off, absent any unusual provisions in the loan agreement. If the mortgage is an adjustable mortgage, the interest rate may change based on changes to the prime lending rate.
In the arena of global finance, the LIBO rate has become more than a national measurement of interest rates. According to industry sources, the LIBO rate or LIBOR is now being used as a worldwide “benchmark” for short term deals and their interest rates. It’s worth considering why the London rate has been adopted by the financial world at large as a primary indicator.
For transactions that follow the LIBO rate, involved parties may talk about “LIBOR plus points,” which refers to interest rates over and above the London interbank market rate. In this use of the word “points,” a point represents 1% in an interest rate. This language can be confusing, as the word “points” can also refer to changes in stock prices or other elements of finance, in which case the term can have a different meaning, for example, a fixed value change in price.
Aside from the LIBO rate, which is the national interest rate set for the U.K., other countries have their own prime lending rates. These critical financial instruments, based on changing values, are necessary for arranging a wide variety of financial transactions, and most professionals will pay careful attention to the prime lending rate, whether they are in real estate, stock trading, or other sectors. The LIBOR is a common feature of financial news and a well known barometer of world trade.