The Libor represents an interest rate in the context of interbank business. According to abbreviationfinder, the abbreviation stands for “London Interbank Offered Rate” and, as the name suggests, is formed in London as the reference interest rate for loans, among other things. The days of the Libor are numbered, however. The British supervisory authority Financial Conduct Authority (FCA) wants to replace the Libor with other, regional reference interest rates at the beginning of 2022. The background to this is that the Libor cannot map all loan variants, such as unsecured interbank loans.
- The Libor is a reference interest rate.
- The determination is carried out by 18 banks on bank working days in London.
- The Libor is calculated for five currencies and seven maturity dates.
- Due to the Libor scandal in 2012, this reference interest rate will be discontinued at the beginning of 2022 due to its susceptibility to manipulation.
Application of the Libor
The Libor is used as the reference interest rate for bonds , syndicated loans, swaps and derivatives, among other things . It is not margin-neutral as there is usually a premium on the Libor. The amount of the surcharge is based on the borrower’s creditworthiness . For example, a loan agreement can provide an interest rate of “Libor +0.5 percent”. If the Libor were 1.8%, the interest rate to be paid would be 2.3%. The Libor is also used to determine prices on the money market and is therefore one of the most important interest rates worldwide. The Libor is managed by Intercontinental Exchange Benchmark Administration Ltd. (ICE). This is monitored by the UK banking regulator.
Determining the Libor
Eighteen panel banks are involved in determining the Libor. On bank working days between 11:00 a.m. and 11:20 a.m. London time, they state their respective interest rates for unsecured loans that they would grant each other. Thomson Reuters then determines the official Libor on the basis of five decimal places by 11:45 a.m. A total of 18 major banks are involved in pricing. The four banks with the highest interest rates and the four banks with the lowest interest rates drop out of the pricing. The statistical mean is then calculated.
Not every bank reports their interest rates or an interest rate for every currency on a daily basis. The number of excluded banks decreases as the number of reporting banks decreases. If only eleven banks contribute to the pricing, the three highest and three lowest banks are excluded from the calculation.
The so-called ICE Libor applies to the following currencies:
- S. dollar
- Swiss franc
- British pound
The determination is limited to a few due dates:
- Overnight / Spot Next
- 1 week
- 1 month
- 2 months
- 3 months
- 6 months
- 1 year
The Libor manipulation 2012
In 2012 it became known that Barclays Bank had manipulated the Libor for many years through the interest rates it reported. Barclays wasn’t the only bank, however. Deutsche Bank, among others, was actively involved in the manipulation.
As a consequence, the supervision of the Libor was withdrawn from the London Stock Exchange. The successor was the New York Stock Exchange Euronext. The scandal was the trigger for the aforementioned replacement of the Libor. The reference interest rate is too susceptible to manipulation.
For the euro zone, the € STR, Euro Short Term Rate will apply from 2022. This reference interest rate is determined by the European Central Bank . The basis is the money market statistics in the euro system.
From this point on, loans in Swiss francs are based on the SARON, Swiss Average Rate Overnight. This is based on binding prices and transactions on the Swiss repo market.
Last but not least, the US dollar must also reorient itself. The SOFR, Secure Overnigth Financing Rate, will apply here from 2022. This is based on transactions on the US dollar repo market.