What does 1 month LIBOR mean?

LIBOR interest rate

We now know what the acronym LIBOR stands for. But what is the definition of the LIBOR interest rate? LIBOR is the average interest rate at which internationally renowned banks (panel banks) on the London Stock Exchange are willing to borrow money from other banks at short notice. The LIBOR interest rate is therefore a reference interest rate and stands for the interest rate at which the different banks grant each other loans with a wide variety of terms.

There are different types of LIBOR for every currency traded. The respective LIBOR can also be given different terms, between one and twelve months. The two parties involved report the relevant interest rates to the Thomson Reuters agency by 11.00 a.m. GMT every working day.

Historical background

In the 1980s, London's financial institutions wanted to generate a standard for loan interest rates. This interest rate index was introduced primarily for calculating the prices of financial products and was intended to make it easier. In 1984, under the direction of the British Bankers' Association (BBA), various measures were taken which, in 1986, resulted in the publication of the first LIBOR interest rate.

Why does LIBOR exist?

Since the LIBOR is used on the financial market as the base rate for a large number of different products, such as swaps or futures, it is referred to as the most important interest rate index for short-term interest rates, and therefore also lending, worldwide. Banks, too, often use LIBOR as an index to determine their interest rates. Products such as mortgages, savings accounts or loans for private individuals are calculated using the LIBOR interest rate.

Because: LIBOR is so well known as the base rate that its development is being watched by experts in the financial sector and by private individuals.

LIBOR content values

The LIBOR is calculated for the following currencies:

USD - US dollarsCAD - Canadian dollar
GBP - British poundAUD - Australian dollar
EUR - EuroNZD - New Zealand Dollar
JPY - Japanese yenDKK - Danish krone
CHF - Swiss FrancsSEK - Swedish Crowns

The main currencies for calculating LIBOR are only five, namely the euro (EUR), US dollar (USD), Swiss franc (CHF), Japanese yen (JPY) and British pound sterling (GBP).

LIBOR maturities

There are seven different maturities at which the LIBOR is calculated. Conversely, this means that there are also seven different LIBOR interest rates per currency.

  • Overnight (1 day)
  • 1 week
  • 1 month
  • 2 months
  • 3 months
  • 6 months
  • 12 months

Example: The overnight (1 day) LIBOR interest rate is the average interest rate at which bank A is willing to lend another bank B a loan in euros with a term of one day.

Types of LIBOR

Alongside the key rate, the LIBOR was the only reference rate in the world for a long time. From 1985 to 1999 there was also the FIBOR in addition to the LIBOR. FIBOR stands for Frankfurt Interbank Offered Rate and was an interest rate that was calculated on working days on the Frankfurt Stock Exchange for the Deutsche Mark (DM). It was only later that further reference or base interest rates were established.

After the announcement that the euro would be introduced, the FIBOR was replaced by the EURIBOR on January 1st, 1999. EURIBOR stands for Euro Interbank Offered Rate. This reference interest rate is now recognized in the EMU (European Economic and Monetary Union) and is also used internationally for monetary transactions in euros.

There are no real differences when it comes to determining and publishing the two interest rates - LIBOR and EURIBOR. In addition to these two, there is another interest rate that was also established in January 1990: the EONIA. The ACI (The Financial Markets Association) had planned EURIBOR and EONIA as an alternative to LIBOR as the euro reference rate.

The EONIA differs significantly from LIBOR and EURIBOR: it is not calculated on the basis of hypothetical interest payments, but is based on the calculation of existing money transactions and is therefore regarded as the weighted average interest rate.

Differences: EURIBOR and LIBOR

The abbreviation EURIBOR stands for Euro Interbank Offered Rate. The EURIBOR stands for the average interest rate that European banks use to issue loans to one another in euros.

The difference to LIBOR is that EURIBOR is only about trading between European banks in the EURO currency and not, like LIBOR, about international banks that trade in different currencies.

Other non-EU countries followed and developed their own reference interest rates, which are identical to LIBOR in terms of the calculation.

In the Asian financial market it was:

  • SHIBOR (Shanghai)
  • TIBOR (Tokyo)
  • HIBOR (Hong Kong)

And on the European financial market it was CHF-LIBOR (Switzerland).

LIBOR rates & calculation

LIBOR interest rates are used as the basis for many transactions on the financial market. For transactions such as loans, interest-bearing paper or mortgages, the banks set a rate independently of the central banks at which they would lend money to other banks.

As already described, the LIBOR interest rate is a hypothetical expected interest rate at which a transaction could or would take place if the parties agree, but need not. This is a big difference to the key interest rate set for months by a national bank. This independence makes LIBOR an important standard worldwide.

Responsibility for the administration of the LIBOR interest rate

Until June 2012, the London Stock Exchange was responsible for calculating the LIBOR. In mid-2012 it became known that Barclays Bank had manipulated LIBOR for years and the so-called LIBOR scandal was triggered. In the course of this scandal, in which the Deutsche Bank and other major banks were also involved, the responsibility for calculating the LIBOR interest rate was withdrawn from the London Stock Exchange and this responsibility was temporarily transferred to the New York stock exchange NYSE Euronext.

The British government, in the form of an independent committee, then decided in July 2013 to use the ICE Benchmark Administration (IBA) to manage LIBOR. For this administration alone, the IBA decided to use a London subsidiary, the Intercontinental Exchange Benchmark Administration Ltd. (ICE) to establish. ICE has since been monitored by the UK banking regulator, the Financial Conduct Authority (FCA). The administration mandate was transferred to ICE on January 31, 2014 from the previously lead BBA (British Bankers' Association).

Determination of the LIBOR

To calculate the LIBOR interest rate, it is necessary to determine the average interest rate of all participating panel banks.

What are panel banks?

A panel is a constant circle of, in this case, banks. These banks announce the interest rates at which they would be willing to lend money to other banks.

As already mentioned, the LIBOR interest rates are not based on real transactions. The reason for this is that not every lender (bank) lends amounts every day for all terms and therefore no real transactions can be considered.

The banks therefore report their hypothetical interest rates for the respective term to the Thomson Reuters agency every working day by 11.00 a.m. (GMT). The Thomson Reuters agency collects and evaluates all the interest rates quoted by the various panel banks.

  • A banking panel consists of either 8, 12 or 16 members.
  • All members disclose their interest rates.
  • The lowest 25 percent and the highest 25 percent are excluded from the calculation.
  • The average of the remaining 50 percent values ​​is calculated to determine the official LIBOR.

Between 11:20 a.m. and 11:45 a.m., the interest rates reported by the panel banks are calculated by the Thomson Reuters news agency with four decimal places. If there are 8 contributing banks, the banks with the two highest and two lowest interest rates are eliminated and the arithmetic mean of the remaining four banks is determined. This method is intended to prevent extreme downward or upward swings. Around 11:45 a.m., the interest rates determined are published by the Thomson Reuters agency. The respective partners of the ICE then publish the results. The interest calculation method used is generally actual / 360.

Interest calculation method

As mentioned, the so-called Euro interest method actual / 360 is normally used when calculating the LIBOR interest rate.

That means:

  • The interest days are determined exactly to the calendar. The interest year therefore has 365 or 366 days.
  • The base year is set at 360 days - regardless of the actual remaining days.
  • The first day of investment earns interest - the last day of investment does not earn interest.

The LIBOR scandal

In 2011 there was a scandal in connection with the LIBOR interest rate. Because the LIBOR interest rate has a high influence on a large number of financial market transactions, various banks in the interbank business have manipulated the interest rate on a large scale and thus gained advantages over their competitors.

The interest rate risk

Interest rate risks arise when credit institutions in the fixed-income area carry out maturity transformation and then a change in the market interest rate occurs.

As with insider trading, the reference interest rates could be exploited through speculative transactions, since the interest rates were controlled by the banks themselves.

Insider trading is a criminal offense in Germany and the EU

Anyone who engages in insider trading uses information that no one else has to deal with stock market transactions. Trading in this inside information is a criminal offense in Germany as well as in the EU.

Since banks normally used the LIBOR interest rates at the beginning of the month for personal loans, the temporary increase in the LIBOR interest rate at the beginning of the month gave borrowers excessive interest rates.

Method for manipulating the LIBOR interest rate

How did the banks handle the manipulation? This method was actually relatively simple. The traders of the individual products on the financial market have agreed with each other. Shortly before 11 a.m. they contacted employees in other banks and agreed on who would manipulate the interest rate up or down.

Since the LIBOR interest calculation, as already explained, omits the 50 percent of the extreme cases, but there were only extreme cases when reporting the interest because the banks reported incorrect numbers, the average interest rate was artificially high or low. Depending on how it made the most sense for the banks that day.

The impact of this manipulation has hit many investors hard. In some investment products, investors get money if the LIBOR interest rate is above a certain threshold at a certain point in time. The investor loses money if the LIBOR interest rate is below this threshold. Because of this, many investors have lost their money.

Companies also base their investment decisions on the LIBOR interest rate. Depending on how high or low it is, companies weigh up whether an investment is worthwhile based on the resulting return or not. The investment market was very distorted by the manipulation of the LIBOR.

Responses from the supervisory authorities

In the wake of the announcement of the scandal, fines were imposed on banks by the regulatory authorities. Some banks reached settlements with the British, American and other countries' authorities.

  • The British Barclay Bank had to pay around 360 million euros.
  • The Royal Bank of Scotland paid about 455 million euros.
  • The Swiss UBS had to pay around 1.2 billion euros in fine.
  • The Dutch Rabobank agreed on a fine of around 774 million euros.

The EU Commission and the EU antitrust authorities also investigated various banks and imposed fines on some banks.

  • Deutsche Bank had to pay a fine of around 725 million euros.
  • The French Société Générale around 446 million euros.
  • The Royal Bank of Scotland again with around 391 million euros.
  • The US bank Citigroup approx. 80 million euros.
  • JPMorgan Chase, also from the USA, costs around 70 million euros.
  • RP Martin with a fine of around 250,000 euros.

However, Deutsche Bank had to pay even more of the fine: it agreed with the British and US authorities on a payment of $ 2.5 billion. The responsible employees were also fired.

Why was Deutsche Bank's fine so high?

Deutsche Bank was accused of trying to deceive the tax authorities in clearing up the scandal.