What is an interest rate benchmark, and why is important?

Question

Accepted Answer

A “benchmark” is a pre-determined standard against which the performance of financial investments and lending costs are measured.

A benchmark can be used to measure the performance of an index, a security or even an investment manager. For example, mutual fund performance is often compared to changes in the “benchmark” Standard & Poor's 500 Stock Index. A benchmark can also be used to define the asset allocation of a portfolio or for computing the performance fees.

A benchmark can be used as a useful basis for cash products (corporate loans, family loans, mortgages overdrafts) and non-cash products (other more complex financial transactions such as derivatives).

Banks use benchmarks for interest rates when they calculate interest on loans, notes and deposits. For example, banks might lend money at an agreed interest rate that is indexed to a particular benchmark rate plus a spread. If the spread is set at 1%, then the interest paid will be 1% more than the current benchmark rate. So, the cost of the loan goes up if the benchmark rate goes up and vice versa. In this case, the benchmark can be a reliable, independent, and relatively simple reference for all the involved parties.

Interest Rate Benchmarks are crucial to financial stability and therefore play a central role in financial markets because they are widely used by individuals and organizations throughout the economic system. The most common interest rate benchmarks are the EURIBOR and the London Interbank Offered Rate (LIBOR). They form a basis for lending and borrowing prices for the global financial system.

Benchmarks Reform

Activate now Mobile Banking

Activate now
Mobile Banking