What Was the London Interbank Offered Rate (LIBOR)?

What Was the London Interbank Offered Rate (LIBOR)?

Let me explain LIBOR to you directly: it was a benchmark interest rate for short-term loans between major global banks, mostly phased out in 2023 and completely in 2024. From 1986 through the 2000s, LIBOR stood as a globally accepted benchmark for the cost of borrowing between banks. The rate got calculated and published each day by the Intercontinental Exchange (ICE), but scandals and doubts about its validity led to its phaseout. According to the Federal Reserve and U.K. regulators, LIBOR ended on June 30, 2023, replaced by the Secured Overnight Financing Rate (SOFR). The one-week and two-month USD LIBORs stopped publishing as of December 31, 2021, as part of this transition.

How LIBOR Worked

LIBOR represented the average interest rate at which major global banks borrowed from one another. It covered five currencies—the U.S. dollar, euro, British pound, Japanese yen, and Swiss franc—and seven maturities: overnight/spot next, one week, and one, two, three, six, and 12 months. Interbank lending forms the basis for consumer loans worldwide, so it affects you as much as it does financial institutions. Interest rates on products like credit cards, car loans, and adjustable-rate mortgages fluctuate based on this interbank rate, determining how easy it is for banks and consumers to borrow.

Combining those currencies and maturities resulted in 35 different LIBOR rates calculated and reported each business day. The most quoted was the three-month U.S. dollar rate, often just called the current LIBOR. ICE figured this out by asking major global banks what they'd charge others for short-term loans, then trimming the highest and lowest figures to average the rest—this is the trimmed average method. They posted this daily rate each morning around 11:55 a.m. London time via the ICE Benchmark Administration.

How Was LIBOR Calculated?

The IBA maintained panels of global banks for each currency and tenor pair—for USD LIBOR, that included 16 major banks like Bank of America, Barclays, Citibank, Deutsche Bank, JPMorgan Chase, and UBS. Only banks with a big role in the London market qualified, with selections happening annually. In April 2018, the IBA proposed strengthening the methodology with the Waterfall Methodology, a standardized, transaction-based, data-driven, layered approach.

Here's how it broke down: The first level used a volume-weighted average price (VWAP) of eligible transactions, weighting those closer to 11 a.m. London time higher. If a bank lacked enough transactions for that, the second level pulled submissions from transaction-derived data. The third level relied on expert judgment, where the bank submitted the rate it could finance itself at 11 a.m., referencing the unsecured wholesale funding market. Finally, the IBA applied a trimmed mean to all responses, discarding the highest and lowest quartiles before averaging the rest.

Uses of LIBOR

LIBOR found use in financial products worldwide, from standard interbank items like forward rate agreements, interest rate swaps, futures, options, and swaptions to commercial products such as floating rate CDs, notes, variable rate mortgages, and syndicated loans. It also appeared in hybrid products like collateralized debt obligations, mortgage obligations, accrual notes, callable notes, and perpetual notes, plus consumer items like individual mortgages and student loans.

Beyond that, LIBOR gauged market expectations for central bank interest rates, factoring in liquidity premiums for money market instruments and indicating banking system health. Many derivative products were created and traded referencing LIBOR, and it served in processes like clearing, price discovery, and valuation.

A Brief History of LIBOR

The need for uniform interest rates grew in the 1980s as interest rate products evolved, leading the British Bankers’ Association (BBA) to set up interest-settlement rates in 1984. This evolved into BBA LIBOR in 1986, becoming the standard for interest rate and currency transactions between institutions locally and internationally. Changes followed: administration shifted to ICE LIBOR in February 2014. Currencies adjusted too, with some added, removed, or integrated after the euro's introduction, and the 2007–2008 crisis reduced the number of tenors calculated.

Alternatives to LIBOR

While LIBOR was global, other rates exist: Europe uses EURIBOR, Japan has TIBOR, China SHIBOR, and India MIBOR.

LIBOR Rate Rigging Scandal

LIBOR faced a major scandal over rate rigging, where major banks allegedly colluded to manipulate rates, incorporating traders’ requests to submit artificially low figures for profit on LIBOR-based securities. The Wall Street Journal's 2008 reporting triggered regulatory scrutiny, including U.S. Department of Justice investigations, and similar probes in the U.K. and Europe. Banks like Barclays, ICAP, Rabobank, Royal Bank of Scotland, UBS, and Deutsche Bank received heavy fines, with employees punished too. This scandal drove the shift from BBA to ICE administration.

Benefits of LIBOR Analysis

Despite scandals, LIBOR benchmarked global economic activity: a falling rate meant easier borrowing and potential economic upticks, while rising rates signaled slowdowns. For you as a borrower, high LIBOR could mean steeper interest on mortgages or loans, low LIBOR more favorable terms.

LIBOR Phaseout

Post-scandals, regulators reformed benchmarks, ending mandatory LIBOR publication after 2021 and replacing it with SOFR in 2023. SOFR uses actual U.S. Treasury market transactions, unlike LIBOR's estimates, for better transparency. It's used in the U.S. and U.K., with other countries adopting their own replacements.

Examples of LIBOR-Based Products and Transactions

A simple example is a floating rate bond paying annual interest at LIBOR + 0.5%, adjusting with LIBOR changes. It also applied to interest rate swaps: say Paul has a $1 million investment at LIBOR + 1% variable quarterly, wanting fixed; Peter has fixed 1.5% wanting variable. They swap: Paul gets Peter's fixed 1.5% ($15,000), Peter gets Paul's variable. If LIBOR is 1%, Peter gets $20,000, netting $5,000 from Paul; if 0.25%, Peter gets $12,500, netting Paul $2,500. This meets both needs for fixed or floating rates.

How Will I Use This in Real Life?

If you have a variable-rate loan or mortgage, it was likely tied to LIBOR and now to SOFR—the change won't drastically alter your payments, but it might cause slight shifts. The switch brings more transparency since SOFR uses actual transactions, making it reliable and harder to manipulate. You don't need to track SOFR daily unless in finance, but knowing it helps with decisions on loans, mortgages, or refinancing for better financial choices.

The Bottom Line

LIBOR was a benchmark for interbank short-term loan rates but fell under suspicion in 2012 due to manipulation for personal gain, leading to its full phaseout by 2023.