London InterBank Offered Rate (LIBOR)

Overview

LIBOR (London InterBank Offered Rate) was the leading benchmark for short-term interbank lending rates worldwide. It represented the rates at which major banks said they could borrow unsecured funds from one another across several currencies and maturities. Due to manipulation scandals and methodological weaknesses, LIBOR was phased out—officially replaced in many markets by alternative, transaction-based rates such as the Secured Overnight Financing Rate (SOFR).

Key takeaways

• LIBOR was a panel-based benchmark quoting rates for five currencies and seven maturities (35 rates) and was widely used in loans, mortgages, derivatives, and other financial products.
• It was calculated from submissions by designated panel banks using a trimmed-mean approach; later reforms introduced a transaction-focused Waterfall Methodology.
• A major rate-rigging scandal exposed that some panel banks manipulated submissions, prompting heavy fines and regulatory reform.
• LIBOR was largely replaced by overnight, transaction-based rates (notably SOFR for USD) to improve transparency and reliability.

What LIBOR measured

LIBOR reflected the average interest rate at which major global banks would lend to each other unsecured for short periods. Commonly quoted rates included the three-month USD LIBOR, among others, spanning maturities from overnight to 12 months. Because many consumer and commercial interest rates referenced LIBOR, changes in LIBOR influenced mortgages, credit cards, corporate loans, and derivative valuations.

How LIBOR was calculated

Originally, LIBOR was produced by asking a panel of major banks each morning how much they would charge for short-term unsecured borrowing. The highest and lowest submissions were excluded and the mean of the remainder was published (a trimmed average).

In 2018 the ICE Benchmark Administration (IBA) proposed and implemented a strengthened, transaction-oriented Waterfall Methodology:
* Level 1 — Volume-weighted average price (VWAP) of eligible transactions (weighted toward transactions near the 11:00 a.m. London fix).
Level 2 — Transaction-derived submissions when a bank lacked sufficient Level 1 trades.
Level 3 — Expert judgement submissions referencing unsecured wholesale funding when no transaction data were available.

The final published LIBOR used a trimmed-mean process that discarded extreme submissions before averaging.

Uses

LIBOR underpinned a wide array of financial contracts and market functions:
* Derivatives: interest rate swaps, futures, options, swaptions.
Loans and deposits: floating-rate notes, syndicated loans, floating-rate CDs.
Consumer products: adjustable-rate mortgages and other variable-rate loans.
* Market benchmark: price discovery, clearing, valuation, and a gauge of short-term funding stress.

History and the rate-rigging scandal

LIBOR evolved from earlier interbank reference rates introduced in the 1980s and became a global standard. In the 2007–2012 period, investigations revealed that some traders and bank submitters colluded to influence LIBOR submissions for profit or to appear healthier during the financial crisis. Several banks faced large fines, and regulatory scrutiny led to reforms in administration (transfer to ICE) and methodology, and ultimately to the decision to replace LIBOR with more robust benchmarks.

Phaseout and replacements

Regulators moved to retire LIBOR because it relied partly on expert judgment and could be manipulated. Key points:
* Several LIBOR tenors (e.g., some USD short tenors) stopped publishing before full retirement.
Many jurisdictions set June 30, 2023, as the effective end date for most LIBOR settings; legacy contracts and specific tenors had earlier or staggered cutoffs.
SOFR (Secured Overnight Financing Rate) became the principal replacement for USD LIBOR. SOFR is based on actual overnight Treasury repo transactions (secured), making it transaction-based and harder to manipulate.
* Other regional replacements include EURIBOR, TIBOR, SHIBOR, MIBOR, and market-specific benchmarks like Ameribor. In the U.S., legislation and market conventions have promoted SOFR as the preferred replacement.

Because SOFR is secured and overnight (whereas LIBOR was unsecured and term-based), industry participants use spread adjustments and fallback conventions when converting legacy LIBOR contracts to SOFR or other benchmarks.

Example (floating-rate instrument and a swap)

A floating-rate bond might pay interest as LIBOR + 0.5%. If LIBOR rises, payments increase; if it falls, payments drop.

Interest-rate swaps let parties exchange fixed and floating payments. For example, one investor receiving LIBOR + 1% can swap with another receiving a fixed 1.5% so each achieves their preferred exposure. Net payments are settled between the parties depending on current LIBOR.

Practical implications for consumers and businesses

• Many adjustable-rate loans originally tied to LIBOR have been migrated to SOFR or other benchmark rates.
• The change aims for greater transparency and reliance on observable transactions, which should reduce manipulation risk.
• Borrowers may notice small differences in timing or volatility of rate resets because replacement rates have different characteristics (overnight vs. multi‑month unsecured).
• For legacy contracts, fallback provisions and conversion spreads are used to preserve economic intent when switching benchmarks.

Conclusion

LIBOR was once the dominant global reference rate for short-term borrowing but became vulnerable to manipulation and methodological weaknesses. Its retirement and replacement by transaction-based benchmarks such as SOFR mark a structural shift toward more transparent, reliable rate-setting for loans, derivatives, and other financial instruments.