What is LIBOR and SOFR in the context of finance?
In: Economics
LIBOR = London Interbank Offered Rate
SOFR = Secured Overnight Financing Rate
Banks are required to keep a minimum amount of cash available for withdrawal for their customers to avoid a scenario where the bank runs out of cash. The required minimum fluctuates and is a function of the total deposits at the end of a business day. Lets say a bank has $1M in deposits and the regulations state that minimum reserve must be 10%. The the end of the day, the Bank checks to see if they have $100K in reserves. If they have that 100K or more, then no problem, but say that they have only 90K. They have to find that 10K somewhere to meet the requirement. The national bank (e.g. Federal Reserve bank, Bank of England, etc.) can step in and offer short-term loans to banks in order to meet this requirement – however, it is a loan and the bank has to pay interest.
This interest rate that is offered between financial institutions is important because its seen as the baseline of “what it costs to borrow money?”. LIBOR and SOFR are both examples of this rate.
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