It makes sense for a large bank in London to lend at a floating rate linked to LIBOR since most of its borrowing would be from other banks in London, therefore matching the risk of the asset loans given with the risk of its liabilities i.
In reality, the major source of funds for a bank is the deposits it receives from its customers and not from borrowing from other banks. In simplistic terms, banks make money by accepting deposits at one rate and lending at a higher rate. If the cost of funding for the bank rises, say because of some change in government regulations, liquidity requirement, etc.
LIBOR was developed in the s to facilitate syndicated debt transactions. Growth in new financial instruments, also requiring standardized interest rate benchmarks, led to further development of LIBOR.
The determination of LIBOR is widely perceived to be a simple, objective, and transparent process which has helped it gain global acceptability and significance.
Continuing with the reasoning of protection from interest rate risk, LIBOR is viewed as a uniform and fair benchmark which creates a sense of certainty. However, with LIBOR manipulation cases reported in recent times, the certainty can be argued to be more a matter of perception than hard reality.
Due to recent scandals and questions around its validity as a benchmark rate, LIBOR is being phased out. According to the Federal Reserve and regulators in the U. It is also often used in building the expectations of future central bank rates as well as for gauging the health of the banking system in the world. Because of its global significance and reach, downward pressure on LIBOR during a financial crisis, as banks try to appear healthier, can potentially risk the entire global financial system.
The Intercontinental Exchange. Accessed January 11, Interest Rates. Advanced Forex Trading Concepts. Financial Futures Trading. The Bond Buyer 20 bond index is a barometer for yields on tax-free bonds issued by state governments and local municipalities.
The Fannie Mae year mortgage commitment for delivery within 60 days helps mortgage lenders determine what rates to charge on year fixed rate mortgages that are to be sold to Fannie Mae within the next 60 days.
The LIBOR rates, which stand for London Interbank Offered Rate, are benchmark interest rates for many adjustable rate mortgages, business loans, and financial instruments traded on global financial markets.
Even the savviest experts can only speculate. Some lenders offer protection against interest rate fluctuations, in the form of a cap. This is an upper limit above which the interest rate may not rise during the entire term of the mortgage. But this interest rate ceiling comes at a price. Usually, the charge for this type of agreement must be paid at the beginning of the mortgage term. Or you might have a credit card with an interest rate equal to the U. Prime Rate, plus 9 percent.
Your loan contract tells you whether your interest rate is fixed or adjustable. If you have questions about the impact of this transition on your loan or line of credit, you can call your lender or servicer for more information. Because lenders and servicers are currently planning for this transition, they might not have answers to all of your questions at this time.
More information will be available as the transition gets closer. As with any other financial decision, ask questions and consider your options before you agree to loan terms:. If you have other questions about adjustable-rate loans or lines of credit, you can find answers at Ask CFPB. Topics include:.
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