LIBOR stands for London Interbank Offered Rate and serves as a globally accepted key benchmark for short-term interest rate indicating borrowing costs between banks. It is produced for five currencies (CHF, EUR, GBP, JPY and USD) and seven tenors (Overnight/Spot Next, 1 Week, 1 Month, 2 Months, 3 Months, 6 Months and 12 Months) based on submissions from a reference panel of between 11 and 16 banks for each currency, making in total 35 rates every London business day.
The rate is calculated and published each day at around 11:55 am London time by the Intercontinental Exchange (ICE). The most commonly quoted rate is the 3 Months US dollar rate, usually referred to as the current LIBOR rate.
LIBOR also serves in determining interest rates for consumer loans, so it impacts consumers just as much as it does financial institutions. The interest rates on various credit products fluctuate based on the interbank rate.
Interest rate-based products began evolving during the 1980s thus the need for a uniform measure of interest rates across financial institutions. The British Bankers’ Association (BBA) set up BBA interest-settlement rates in 1984. Evolving to BBA LIBOR in 1986, it became the default standard interest rate for the interest rate and currency-based financial transactions between financial institutions at the local and international levels.
LIBOR rate was calculated using trimmed mean approach applied on all the responses received. Trimmed mean is a method of averaging which eliminates a small specified percentage of the largest and smallest values before calculating the mean.
As of April 2019, banks are using a standardized, transaction-based, data-driven, layered method called the Waterfall Methodology for making LIBOR submissions. The Waterfall Methodology requires LIBOR panel banks to base their submissions in eligible wholesale, unsecured funding transactions to the extent available
Other similar regional interest rates are followed globally. Europe has the European Interbank Offered Rate (EURIBOR), Japan has the Tokyo Interbank Offered Rate (TIBOR), China has Shanghai Interbank Offered Rate (SHIBOR), and India has the Mumbai Interbank Offered Rate (MIBOR).
Some of major banks allegedly manipulated the LIBOR rates. They submitted artificially low LIBOR rates to keep them at trader’s preferred levels. They included Barclays, ICAP, Rabobank, Royal Bank of Scotland, UBS, and Deutsche Bank which faced heavy fines. Nowadays, Fed is urging US financial industry to move away from LIBOR. Libor will be phased out entirely by 2022.