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Category — Rates
By Konstantin Vasilev Member of the Board of Directors of Cbonds, Ph.D. in Economics
Updated September 11, 2023

What does LIBOR mean?

LIBOR, or the London Interbank Offered Rate, was a crucial benchmark interest rate utilized in the international interbank market for short-term loans. This rate indicated the cost at which major global banks lent funds to one another.

Functioning as a widely accepted standard, LIBOR represented the prevailing borrowing expenses among banks. Its computation and daily release were overseen by the Intercontinental Exchange (ICE). However, due to controversies and doubts about its reliability as a benchmark, the decision was made to discontinue its use.

On June 30, 2023, as per directives from the U.S. Federal Reserve and U.K. regulators, LIBOR was officially phased out. Its replacement was the Secured Overnight Financing Rate (SOFR). As part of the gradual discontinuation process, the publication of certain LIBOR rates, such as the one-week and two-month USD LIBOR rates, ceased as of December 31, 2021. The shift impacts various financial products including adjustable-rate loan products, such as many adjustable-rate mortgages, and also home equity lines of credit, reverse mortgages (including Home Equity Conversion Mortgages), private student loans, and credit cards that presently rely on LIBOR for determining their interest rates. In the case of credit cards and home equity lines of credit, numerous lenders are opting for the prime rate as the substitute benchmark index.

How did the LIBOR work?

LIBOR, or the London Interbank Offered Rate, operated as an average interest rate at which major global banks engaged in short-term borrowing from one another. This rate was established across five different currencies—U.S. dollar, euro, British pound, Japanese yen, and Swiss franc—and covered seven distinct maturity periods, ranging from overnight to one, two, three, six, and twelve months.

The intricate combination of these currencies and maturities yielded a total of 35 unique LIBOR rates, computed and disclosed on each business day. Among these rates, the most commonly referenced one was the three-month U.S. dollar rate, commonly termed as the current LIBOR rate.

The process involved major global banks providing their estimates of what they would charge other banks for short-term loans to ICE (Intercontinental Exchange). ICE then eliminated the highest and lowest figures, calculating an average from the remaining values, which was referred to as the trimmed average. This dynamic rate was published daily and not a static value. The finalized rates for each currency and maturity were announced and released once a day, usually around 11:55 a.m. London time, by the ICE Benchmark Administration (IBA).

Importantly, LIBOR extended its influence to impact consumer loans globally. The rates on diverse credit products, such as credit cards, car loans, and adjustable-rate mortgages, were linked to LIBOR. Consequently, fluctuations in the interbank rate affected both financial institutions and consumers, shaping the ease of borrowing between these entities.

However, there were drawbacks associated with relying on the LIBOR rate. While lower borrowing costs were appealing to consumers, they also affected the returns on specific securities. Certain mutual funds were tied to LIBOR, causing their yields to decrease in tandem with LIBOR’s fluctuations.

Uses of LIBOR

Lenders, encompassing banks and various financial institutions, historically employed LIBOR as the pivotal benchmark for ascertaining interest rates across diverse debt instruments. This encompassed its utilization as a benchmark rate for mortgages, corporate loans, government bonds, credit cards, and student loans across multiple countries. Additionally, LIBOR extended its influence to encompass financial products like derivatives—ranging from interest rate swaps to currency swaps.

For instance, consider a corporate bond denominated in U.S. dollars, featuring quarterly coupon payments. The interest rate structure could be formulated as LIBOR plus a specified margin (such as thirty basis points) for variability. Consequently, the interest rate would equate to the three-month U.S. Dollar LIBOR plus the predetermined thirty basis points (if the three-month U.S. Dollar LIBOR stood at 4% at the period’s outset, the quarter’s end would entail an interest rate of 4.30% - 4% plus 30 basis points). This rate would be recalibrated every quarter to align with the prevailing LIBOR at that point, in conjunction with the fixed margin. The margin is generally factored in the issuing bank or institution’s creditworthiness.

However, as part of regulatory transformations, initiatives emerged to reform benchmark rates and ultimately replace LIBOR as the primary interbank borrowing rate. The shift away from LIBOR gained momentum in recent years. UK regulators indicated that banks would no longer be obligated to publish LIBOR rates after 2021. Adjustable-rate loans, encompassing adjustable-rate mortgages, home equity lines of credit, and private student loans, are directly influenced by replacing LIBOR. These loans relied on LIBOR as a basis for determining their interest rates.

How is LIBOR calculated?

The process of calculating LIBOR involved the aggregation of a total of 35 distinct rates, updated daily. These rates covered loans with seven varying maturities for each of the five major currencies: Swiss franc, euro, pound sterling, Japanese yen, and U.S. dollar.

Every day, shortly before 11 a.m. Greenwich Mean Time, the ICE Benchmark Administration (IBA) engaged a panel of contributor banks, typically numbering 11 to 16 significant international banks. These banks were presented with a specific query: "Considering a reasonable market size, and just prior to 11 a.m. London time, at what rate could you secure funds through interbank borrowing?"

Responding to this inquiry, contributor banks provided their individual estimates of the interest rates they would likely attain from interbank borrowing, adhering to the aforementioned conditions. These estimates were based on their assessments of potential borrowing costs under the specified circumstances.

After collecting the responses, the IBA excluded the highest and lowest figures from the dataset, eliminating any potential outliers that might distort the average. Subsequently, the IBA computed the average rate from the remaining contributor estimates, creating what was known as the trimmed average.

This trimmed average rate was then disclosed as the LIBOR rate for the respective currency and maturity. This procedure was executed daily and played a pivotal role in communicating prevailing interbank borrowing rates to financial markets, significantly influencing a wide range of financial transactions and products. However, it’s important to note that LIBOR has since been replaced, following reforms and considerations of its reliability.

What is the difference between LIBOR and SOFR?

  1. Calculation Methodology:

    • LIBOR is an estimate-based benchmark rate. It is determined by asking a panel of major banks what interest rate they would expect to pay when borrowing funds from other banks.

    • SOFR, on the other hand, is a transaction-based benchmark rate. It is calculated based on actual transactions in the U.S. Treasury repurchase (repo) market, where banks and financial institutions borrow and lend money overnight using U.S. Treasuries as collateral.

  2. Underlying Transactions:

    • LIBOR was based on interbank lending rates, reflecting the estimated cost of borrowing funds between banks in the unsecured market.

    • SOFR is based on secured transactions in the repo market, where banks offer U.S. Treasuries as collateral for short-term borrowing. This makes SOFR more representative of actual market transactions.

  3. Currencies and Maturities:

    • LIBOR covered multiple currencies (e.g., USD, EUR, GBP) and various maturities, resulting in different rates for different combinations.

    • SOFR specifically focuses on the U.S. dollar market and primarily encompasses overnight transactions.

  4. Reliability and Manipulation Concerns:

    • LIBOR faced controversies and concerns about potential manipulation, as it was based on estimated rates reported by banks.

    • SOFR’s transaction-based nature makes it less susceptible to manipulation and provides a more transparent and objective measure of borrowing costs.


  • Why LIBOR is discontinued?

  • Where can I find LIBOR rates?

  • Is LIBOR the same as interest rate?

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