The Inglorious Fall of LIBOR

[2021] 131 taxmann.com 19 (Article)

The 2008 Financial Crisis changed the world of Banking. Many malpractices by the Banks and various financial institutions came to light and the regulators started scrutinizing and penalizing them. The world’s most important number “LIBOR” came under the sword of the Regulators. In this article, we will explore the origins and the fall of the once-revered LIBOR rate.

I. Introduction

The LIBOR stands for London Interbank Offered Rate. It is the benchmark for various major global banks to lend short-term loans to one another. It is a globally accepted and revered benchmark rate that helps to determine the borrowing cost between banks. LIBOR is also the basis for various other securities like consumer loans, hence it also affects the general public as much as banks.

The rates, in the early days, were computed based on three currencies i.e. the dollar, the yen, and the pound. However, over time more currencies were added, until recently LIBOR rates were calculated on five major currencies, that is the Swiss Franc, Japanese Yen, US Dollar, British Pound, and the Euro.

LIBOR rates were derived based on situations like the rate on the inter banks offers for short-term loans prior to 11 am and then taking a reasonable market size of the same. Such a situation made the LIBOR vulnerable to manipulation and hence to tackle these concerns the British Banker’s Association (BBA)in 1986 took over the governing process of the LIBOR. Under the BBA, LIBOR became the default standard interest rate for transactions between banks. The BBA was administrating the LIBOR until 2014 when the Intercontinental Exchange (IE) took over the administration of the LIBOR.

There are many equivalents of the LIBOR around the world such as Mumbai Interbank Offer Rate (India), Shanghai Interbank Offer Rate (China), European Interbank Offer Rate (Europe), and Tokyo Interbank Offer Rate (TIBOR).

2. How is LIBOR determined?

LIBOR is determined with the Panelists consisting of contributing banks. 35 Rates are posted each day with interest rates compiled for the various currencies.

The Process of setting LIBOR starts with asking the panelists the rate at which they are going to lend the other banks. This is done prior early in the day even before the working hours begin. The rates are presented in the top-down manner of listing. The outlying quotes are eliminated once 25% of the lower and higher quoted rates are removed. Then the remaining rates are averaged and will be rounded to five decimal places. The process is carried out across the currencies for each maturity. 1

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