LIBOR - London InterBank Offered Rate

LIBOR, stands for the London InterBank Offered Rate, provides a measure of how much large banks would have to pay to borrow money from other large banks on an unsecured basis. Banks rely on this money to lend to customers and businesses and so it is a vital indicator of confidence in the banking system.

It is the most common reference base for pricing interest rate sensitive instruments (e.g. it is the key rate in the interest rate swap market, whilst corporate loans and even some adjustable rate residential mortgages are pegged to LIBOR).

LIBOR has hit the headlines recently following the £290m fine imposed on Barclays by the Financial Services Authority along with US regulators, after an investigation found they had been attempting to manipulate the level of LIBOR.

Here, we take a look at how LIBOR is calculated, how it could have been manipulated and the potential impact on investors as a result.

 

What rates are submitted and by whom?

• LIBOR is calculated every day (at around 11am) in 10 different currencies, with 15 loan maturities quoted for each currency (ranging from overnight to one year). Therefore, 150 rates are calculated in total every day.

• For each currency, there are a panel of banks chosen as a reflection of the largest and most active banks in that currency.

• Each day, every one of those banks is asked to provide a submission of the rate at which they could borrow funds in that currency over the relevant maturity.

• Just as customers with bad credit records have to pay higher interest rates, large banks which are deemed in poorer financial health are charged more to borrow.

How is the LIBOR rate then calculated?

• For each maturity, the submissions from the panel of banks are ranked from the highest to lowest.

• The highest 25% and the lowest 25% of submissions are dropped and the remaining rates are averaged.

• This average is reported as the LIBOR rate for that maturity on that day.

• Whilst extreme quotes are cut out during the calculation of LIBOR, all rates are subsequently made public as part of the monitoring of the system.

How can LIBOR be manipulated?

• The fact that the panel of banks who help set the rate are also invested in financial instruments which are tied to LIBOR, means that they potentially have an incentive to misquote.

• Such behavior can be limited to a certain extent by the removal of the extreme quotes as part of the calculation methodology noted above.

• However, even the average rate could theoretically be manipulated if enough banks collude or if a sufficient number change their behavior.

Supplier's Credit - Overview

Supplier's Credit: 

 

I would like to restrict this topic considering Importer in India. Overall concept remains same. However local regulation shall be applied as per importer’s country.

First of all, we need to check how Reserve Bank of India (RBI – India’s central bank) has defined a trade credit. “Trade Credits (TC) refer to credits extended for imports directly by the overseas supplier, bank and financial institution for maturity of less than three years. Depending on the source of finance, such trade credits include suppliers’ credit or buyers’ credit. Suppliers’ credit relates to credit for imports into India extended by the overseas supplier, while buyers’ credit refers to loans for payment of imports into India arranged by the importer from a bank or financial institution outside India for maturity of less than three years. It may be noted that buyers’ credit and suppliers’ credit for three years and above come under the category of External Commercial Borrowings (ECB) which are governed by ECB guidelines”     

Overall concept remains same. Suppliers Credit is a financing arrangement under which supplier (seller) extends credit to a foreign importer (Buyer).

Through Supplier’s credit importers can avail cheaper loan pegged to LIBOR rates and agreed margin. This margin should be within range as prescribed by central bank of importer. In India as on date (26/03/2014) ceiling is 6M Libor + 350 bppa. Present market rate being offered may be much lower than the ceiling rate mentioned. 

Investopedia defines LIBOR as “An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.”

Amount and Maturity:

Authorised Dealers/ banks are permitted to approve trade credits for imports into India up to USD 20 million per import transaction for imports permissible under the current Foreign Trade Policy of the DGFT with a maturity period up to one year (from the date of shipment). For import of capital goods as classified by DGFT, AD banks may approve trade credits up to USD 20 million per import transaction with a maturity period of more than one year and less than three years (from the date of shipment). No roll-over/extension will be permitted beyond the permissible period.

The companies in the infrastructure sector, where “infrastructure” is as defined under the extant guidelines on External Commercial Borrowings (ECB) by RBI have been allowed to avail of trade credit up to a maximum period of five years for import of capital goods as classified by DGFT subject to conditions that the trade credit must be abinitio contracted for a period not less than fifteen months and should not be in the nature of short-term roll overs. However, the condition of 'abinitio' buyers'credit would be for 6 (six) months only for trade credits availed of on or before December 14, 2012.

AD banks shall not approve trade credit exceeding USD 20 million per import transaction.

The period of trade credit should be linked to the operating cycle and trade transaction

Why Suppliers Credit:

Cheaper Loan

Extended Credit Period

Various cost associated with Suppliers Credit:

There ain't no such thing as a free lunch. Let’s see various costs associated.

A. Financing Cost

• LIBOR : Libor rate of the agreed date. 
• Spread over LIBOR : Interest charged over and above the LIBOR. Care: Ensure this spread is within limit approved by central bank.

B. Operational Costs

• LC Opening Charges: As agreed with importer’s bank
• Hedging Charges: When the importer wants to restrict the liability of the Supplier Credit in local currency, he can do so by booking a forward contract / option on the same and the forward premium / option cost to be added to the total cost of availing Suppliers Credit
• Funding Bank LC Confirmation Cost
• Acceptance Charges
• LC Advising and/or amendment cost
• Negotiation Cost
• Postage and Swift Charges
• Reimbursement Charges

 

 

Reference: RBI Master Circular on External Commercial Borrowings and Trade Credits