| Understanding the LIBOR Spread |
Looking at the LIBOR number itself is useful, but you shouldn't stop there. Check out what you can learn by digging into how the LIBOR is calculated.
by S. Wade Hansen Digging Into the LIBOR Number Each market day, the British Banker's Association (BBA) releases the a single London Interbank Offered Rate (LIBOR) that tells investors the average price banks are charging each other for U.S.-dollar denominated loans. While this number---which gives us a glimpse into the health of the global banking system---is extremely important, it doesn't tell you the whole story.  To get the whole story, you have to dig into how the LIBOR is calculated. To calculate the LIBOR each day, the BBA surveys 16 different banks to find out what rate each one is charging for its overnight loans made to other banks. [Learn more about LIBOR and how it is calculated.] Naturally, each bank is going to have a unique rate it is charging. For example, on May 27, 2009, the 16 banks the BBA surveys were charging the following interest rates:
As you can see in the list above, the Bank of Tokyo-Mitsubishi UFJ Ltd. and UBS AG are charging the highest rates---0.73 percent---while JP Morgan Chase is charging the lowest rate---0.62 percent. The difference between the highest rate---0.73 percent---and the lowest rate---0.62 percent---is the LIBOR spread, which in this case is 0.11 percent (0.73% - 0.62% = 0.11%). This is a relative large spread compared to how low the overall LIBOR rate is. When the LIBOR spread is high, it shows there is more concern in the banking sector that not all of the banks are on sound footing and there is a heightened default risk. When the LIBOR spread is low, it shows there is less concern in the banking sector that not all of the banks are on sound footing and there is a low default risk. The LIBOR spread is an often overlooked piece of information that gives us an idea of how healthy the banking system really is. Remember, banks may say they are doing well and they believe other banks are as well, but when the rubber hits the road, you can really tell how banks feel about other banks by looking at the interest rates they charge them when borrowing funds. NEXT: Learn about the LIBOR-OIS Spread. Keep up with us:
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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved." |
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