The London Connection: London Average Interest Rate (LIBOR)

With the assistance of the Bank of England and large international banks, the British Bankers Association (BBA) designed a process to calculate an interest rate that would be acceptable worldwide. The newly designed system began operation in 1986. In designing that process, BBA got almost all giant international banks involved. In principle, the envisioned system was simple and straightforward as summarized in the following five steps:BBA designated ten major currencies — e.g., the US dollar, the euro, the Australian dollar, the Yen, and the British Pound.BBA negotiated with large international banks to be members of, what amounted to be like, “voting” panels, one panel for each currency. These are the bank panels of submitters. For the US dollar, for example, the panel of submitters in 2009 consisted of three US banks, nine European banks, two banks from Japan, a Canadian bank, and a bank from Hong Kong.By 11:10 a.m. London time every day, each bank submits interest rates in response to the following question:At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11:00 a.m.?Each bank submitted rates for each of 15 short-term loans varying from one day to one year.BBA retained an agency that was later sold to Thomson Reuters to calculate the average rate for each loan term using a specific procedure.At 11:30 a.m. London time, BBA announces the obtained averages as the rates at which big banks could borrow short-term loans from one another…