What is the Interbank Rate?

LIBOR is one of the most widely used benchmarks for short-term interest rates and is unlike the prime rate in the United States, which is somewhat arbitrarily based on certain banks' lending costs plus a profit margin. Borrowers thus generally support the use of LIBOR in interest-rate calculations because it represents a true market rate. In general, LIBOR also tends to be below U.S. prime rates.

Frequently the interest rate on variable-rate corporate debt is based on LIBOR plus a spread. LIBOR is also commonly used as the underlying interest rate for derivative contracts.

How Does the Interbank Rate Work?

Interbank rates are interest rates on short-term loans between banks. Banks that have extra cash on hand can make a little money by lending to another bank. The interest rate that the lending bank charges is called the interbank rate.

LIBOR rates are compiled by the British Bankers' Association (BBA) at 11 a.m. London time each business day, although the rates change throughout the day. To calculate LIBOR rates, the BBA consults member banks, averages their rates and publishes the results. There are 15 different LIBOR rates, each corresponding to varying maturities up to one year. The BBA also calculates LIBOR in nine currencies.

Why Does the Interbank Rate Matter?

Also called the London Interbank Offered Rate (LIBOR), the interbank rate is the base lending rate banks charge each other in the London Eurocurrency market. LIBOR is an actual market rate determined by the supply and demand of Eurodollars in London's capital markets.

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