What is LIBOR? LIBOR is the abbreviation of London Interbank Offer Rate. It is an indicator of the average interest rates that UK banks charge other banks and financial institutions for short-term loans. Like people, banks also need to lend money to each other to satisfy their short-term needs. Currently, LIBOR is quoted for 5 main currencies, US dollar, Euro, Japanese Yen, British Pounds and Swiss Franc, and seven different maturity periods: overnight, one week, 1 month, 2 months, 3 months, 6 months and 1 year. In the combination of those currencies and maturities, the most commonly quoted rate is the 3-month US dollar LIBOR, which is usually referred to as the current LIBOR rate. Since its birth in 1986, LIBOR is mainly used as a global reference rate for different short-term interest rate financial products such as currency swaps, interest rate swaps, mortgages and so on. Many banks worldwide use Libor as a base rate for setting interest rates on consumer and corporate loans such as credit cards, auto, student, and home loans. Since LIBOR is an important reference for the interest rates for the financial products, it may dilute the effects of rate cuts from central banks. If the central bank cut rates but the LIBOR rates are staying at a high level, those high LIBOR rates will still prevent people from getting loans, making the rate cut less effective for the loan market. How is LIBOR calculated? LIBOR is administered by the Intercontinental Exchange, which will collect quotes from major banks about how much they will charge other banks for short-term loans. Then the Intercontinental Exchange will get rid of the highest and lowest 25 percent of submissions from the list and calculate the average from the remaining ones. The final calculated average rate will be announced and published each morning around 11 a.m. London time as the rate for that day. LIBOR Scandal And How It Was Manipulated Due to the fact that the data is based on the quotes from banks instead of the real rates, there is a chance that those major banks may allegedly colludeto manipulate the LIBOR rates in their own favour. The famous LIBOR scandal was reported in the Wall Street Journal in 2008 which indicated that some major banks deliberately submitted low LIBOR rates to tell LIBOR calculators that it can borrow money at relatively cheap rates which will make the bank appear less risky and thus can attract more business. Also, those major banks did also work with some swaps traders to provide LIBOR the rates which will benefit the traders instead of the real rates the bank would actually pay to borrow money. Those scandals are considered tohave eroded public trust in the marketplace. LIBOR Replacement SOFR Due to the LIBOR scandals which caused many dissatisfaction from the marketplace, there are many LIBOR alternatives emerging in recent years and the Secured Overnight Financing Rate, abbreviated as SOFR, is one of them. SOFR is a benchmark rate which is mainly for US dollar denominated financial products and loans. It will take rates from the US Treasury repo market which is much larger than the interbank loan market used by LIBOR. This will make the final calculation be more accurate than LIBOR. Moreover, unlike LIBOR, SOFR is based on data from observable transactions rather than on estimated borrowing rates. This make it to be a more accurate indicator to reflect the real borrowing costs.

• published: 26 Apr 2022
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