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LIBID vs. LIBOR: An Overview
LIBID and LIBOR were once key reference rates in the London interbank market, where banks exchanged funds directly or through electronic trading platforms. LIBOR (London Interbank Offered Rate) represented the rate at which banks lent funds to one another. LIBID (London Interbank Bid Rate) was the rate at which banks were willing to borrow funds.
Both rates were important in global finance, especially LIBOR. They served as benchmarks for many financial instruments, such as short-term interest futures contracts, forward rate agreements, interest rate swaps, and currency options.
LIBOR had a particularly pivotal role in the eurodollar market and served as the basis for pricing retail products, such as mortgages, student loans, and credit cards, playing a critical role in the financial markets for decades.
However, it was officially phased out on June 30, 2023. The move away from LIBOR was a result of concerns over its reliability, transparency, and vulnerability to manipulation. Similarly, LIBID was also phased out as it was also seen as unreliable. Its usage had been declining long before its official cessation.
Since LIBOR’s closure, financial institutions have transitioned to various other rates, such as the Secured Overnight Financing Rate (SOFR) in the U.S. and the Sterling Overnight Index Average (SONIA) in the U.K.
Key Takeaways
- LIBID and LIBOR were both interest rate benchmarks for short-term interest rates in the London interbank market, but have been discontinued.
- LIBID represented the rate at which banks were willing to borrow eurocurrency deposits, while LIBOR reflected the rate at which they lent.
- Both LIBID and LIBOR have been replaced with more transparent, transaction-based benchmarks, such as SOFR and SONIA.
LIBID
The London Interbank Bid Rate (LIBID) was the rate that banks were willing to pay for eurocurrency deposits and other bank funds in the London interbank market. Eurocurrency deposits are funds held in banks outside the country of the currency’s origin. For example, U.S. dollars held in a bank outside the U.S. would be considered eurodollars.
LIBID was generally set lower than LIBOR and represented the “bid” side of the interbank market. While some financial institutions used LIBID, it was not nearly as widely followed or governed as LIBOR.
Once LIBOR was being phased out, LIBID began to lose ground as well, primarily due to two reasons: (1) a decrease in the volume of interbank lending and borrowing, and (2) no formal methodology for its calculation.
LIBOR
The London Interbank Offered Rate (LIBOR) was the interest rate at which international banks were willing to lend unsecured funds to one another for different maturities and in multiple currencies. It was calculated daily for five currencies: the Swiss franc, the euro, the pound sterling, the U.S. dollar, and the Japanese yen, across seven maturities, from overnight to one year.
While LIBOR was widely used and important in financial markets, years of declining transaction volumes and manipulation scandals eventually led to its discontinuation.
Cessation of LIBOR and Transition to Alternative Rates
LIBOR was phased out due to concerns over its reliability and vulnerability. It was based on daily estimates submitted by banks rather than actual lending transactions, making it vulnerable to manipulation.
This became a global problem in 2012 during the LIBOR scandal, when it was revealed that several banks submitted false rates to benefit their trading positions, greatly reducing trust in the rate.
Furthermore, the underlying market that LIBOR was meant to reflect, unsecured interbank lending, had been shrinking since the 2008 financial crisis. With fewer actual transactions taking place, it became difficult for LIBOR to rely on actual rates and became more judgment-based.
Fast Fact
The U.S. dollar LIBOR stopped publication on June 30, 2023.
Once it became evident that LIBOR was no longer accurate or trustworthy, regulators decided to replace it with benchmarks that were based on observable data, reducing the chances of manipulation.
The U.S. adopted the Secured Overnight Financing Rate (SOFR), which is calculated from overnight Treasury-backed repurchase agreements. In the U.K., the Sterling Overnight Index Average (SONIA) replaced LIBOR.
These rates are considered to be more transparent, less prone to manipulation, and better reflections of the financial markets.
What Is SOFR?
SOFR, the Secured Overnight Financing Rate, is a benchmark interest rate used in the U.S. that reflects the cost of borrowing money overnight collateralized using U.S. Treasuries in the repo market. SOFR influences various short-term interest rates, such as loans and financial contracts. SOFR replaced LIBOR as the benchmark interest rate after the latter was revealed to have flaws, primarily vulnerability to manipulation, as it was based on estimated rates submitted by banks. SOFR, on the other hand, utilizes actual transactions, which makes it more transparent.
Why Was LIBOR Discontinued?
LIBOR, the London Interbank Offered Rate, was discontinued for several reasons. The rate was based upon estimates submitted by banks rather than actual transactions, leaving it open to manipulation. In 2012, it was revealed that some banks had submitted false rates to benefit themselves, rather than provide accurate information on borrowing costs. After the 2008 financial crisis, the volume of transactions in the London interbank market significantly decreased, making it harder to base the rate on real data, increasing the reliance on estimates, further contributing to the manipulation.
Who Decides Interest Rates?
In most nations, interest rates are determined by the country’s central bank. In the U.S., this is the Federal Reserve. The Federal Open Market Committee (FOMC) in the Fed meets regularly to determine if rates should increase, decrease, or remain the same. They do this to control inflation while at the same time maintaining employment and economic growth. Through this, the central bank sets the benchmark rate, which other institutions, such as banks, use to set the interest rates on their products, like loans.
The Bottom Line
LIBID and LIBOR were important benchmark interest rates in the global financial markets, each serving its own purpose. LIBOR was widely used and impacted many short-term rates, such as mortgages and credit cards.
After years of credibility issues, LIBOR was fully phased out in 2023, with LIBID also being discontinued before LIBOR. Both rates have since been replaced with more trustworthy alternatives, such as SOFR and SONIA.
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