Libor Rate: Understanding the Benchmark Interest Rate

What is the Libor Rate?

The London Interbank Offered Rate (Libor) was a widely used benchmark interest rate. It represented the average interest rate that several of the world’s leading banks estimated they would be charged if they borrowed short-term funds from one another in the interbank market.

Key Concepts of Libor

Libor was calculated for different currencies and maturities, typically overnight, 1 week, 1 month, 3 months, 6 months, and 12 months. It served as a reference rate for a vast array of financial products.

Deep Dive into Libor Calculation

Each day, a panel of banks submitted their estimated borrowing rates. The lowest and highest submissions were trimmed, and the remaining rates were averaged to produce the Libor rate for each currency and tenor. This process aimed to provide a representative rate.

Applications of Libor

Libor was a foundational element in the global financial system. It was used to price:

• Floating-rate loans
• Mortgages
• Student loans
• Credit card rates
• Derivatives, such as interest rate swaps and futures

Its influence extended to trillions of dollars in financial contracts globally.

Challenges and Misconceptions

Libor faced significant scrutiny and eventual discontinuation due to manipulation scandals. Banks were found to be submitting false rates to benefit their trading positions. This undermined its credibility and led to a global transition away from Libor.

FAQs about Libor

What replaced Libor?

Many jurisdictions have adopted alternative reference rates (ARRs), such as the Secured Overnight Financing Rate (SOFR) in the US and the Sterling Overnight Index Average (SONIA) in the UK.

Why was Libor discontinued?

Concerns about its susceptibility to manipulation and a lack of underlying transactions led to its phasing out.