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Libor: “The report of my death was an exaggeration”

November 1, 2018 | Commentary

  • The London Interbank Offer Rate (LIBOR) has been the standard reference rate for floating rate loans, mortgages and interest rate swaps for over 20 years. According to the Bank for International Settlements (BIS) there are more than $300 trillion in interest rate swaps outstanding, almost all of which are LIBOR-based.
  • LIBOR, in theory, measures the rate of interest that prime banks charge each other to borrow. It is calculated from a daily survey of those banks, which provide what they believe their borrowing costs would be if they sought unsecured funds from another bank. The process is subjective and has been shown to be open to collusion among responders and manipulation. Guilty banks have been fined billions of dollars and some bankers have been sentenced to jail.
  • The highly publicized troubles with LIBOR have caused regulators around the world to look for replacement benchmarks. In the United States the leading candidate is the Secured Overnight Funding Rate (SOFR), which began reporting in April of this year. Despite the official endorsement of the Federal Reserve and other banking regulators, SOFR poses its own challenges. It may not be easy to manipulate, but the market it reflects moves with considerable volatility.
  • Despite the widely publicized shenanigans around LIBOR, it remains the reference rate of choice for almost all floating-rate borrowing and swaps activity. If the market thought LIBOR was fatally broken, people long ago would have stopped using it. Like Mark Twain’s first assumed passing, the reports of LIBOR’s death may be exaggerated.

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