LIBOR is designed to reflect the short term funding costs of major banks active in London, one of the world’s most important wholesale financial markets.
Banks don’t just lend money to one another whenever they like. Every day a group of leading banks submit the interest rates at which they are willing to lend to other finance houses. They suggest rates in five currencies covering seven maturities quoted for each currency, ranging from overnight to 12 months, producing 35 rates each business day. All LIBOR rates are quoted as an annualized interest rate. The rates submitted are what the banks estimate they would pay other banks to borrow dollars for different terms if they borrowed money on the day the rate is being set. From there, an average is calculated.