London Interbank Offered Rate (LIBOR): Definition, History & Future

What Is the London Interbank Offered Rate?

The London Interbank Offered Rate, commonly known as LIBOR, is the average interest rate that leading global banks charge each other for short-term loans on the London interbank market. This benchmark interest rate is calculated for five currencies and seven borrowing periods, ranging from overnight to 12 months. Financial institutions worldwide use LIBOR as a reference rate to price loans, mortgages, credit cards, and complex derivatives worth trillions of dollars.

How Is LIBOR Calculated?

Every business day, a panel of prominent banks submits the rates at which they believe they can borrow unsecured funds from other banks. The Intercontinental Exchange (ICE) Benchmark Administration trims the highest and lowest 25 % of submissions and averages the rest, producing the official LIBOR fix for each currency and tenor. Because it reflects real-time funding costs, investors and lenders rely on LIBOR to gauge market liquidity and credit risk.

Why LIBOR Matters to Consumers and Businesses

When a variable-rate mortgage, student loan, or corporate credit line references “LIBOR + 2 %,” the borrower pays two percentage points above the quoted LIBOR rate. As LIBOR moves up or down, interest payments adjust accordingly. A rising LIBOR can therefore increase monthly mortgage bills, while a falling rate can lower corporate borrowing costs and stimulate investment.

The Transition Away From LIBOR

After manipulation scandals and declining transaction volumes, global regulators decided to phase out the London Interbank Offered Rate. Most tenors will cease publication in June 2023, with the remaining U.S. dollar settings ending in June 2023. Alternative reference rates such as the Secured Overnight Financing Rate (SOFR) in the United States, SONIA in the United Kingdom, and €STR in the eurozone are replacing LIBOR. Market participants must amend contracts, update valuation models, and educate clients to ensure a smooth transition.

Key Takeaways

LIBOR has long been the world’s premier benchmark interest rate, influencing everything from adjustable-rate mortgages to complex derivatives. Understanding how it is calculated, why it impacts borrowing costs, and how its replacement will unfold is essential for lenders, investors, and everyday consumers navigating today’s evolving financial landscape.