how was libor calculated 
the iba had a designated panel of global banks for each currency and tenor pair for example 16 major banks including bank of america barclays citibank deutsche bank jpmorgan chase and ubs constituted the panel for u s dollar libor only those banks with a significant role in the london market were considered eligible for membership on the ice libor panel and the selection process was held annually 1in april 2018 the iba submitted a new proposal to strengthen the libor calculation methodology it suggested a standardized transaction based data driven layered method called the waterfall methodology for determining libor 3the iba calculated the libor using a trimmed mean approach applied to all the responses received trimmed mean is a method of averaging which eliminates a small specified percentage of the largest and smallest values before calculating the mean for libor figures in the highest and lowest quartile are thrown out and averaging is performed on the remaining numbers 4uses of liborlibor has been used worldwide in a wide variety of financial products they include the following libor is also used as a standard gauge of market expectations for interest rates finalized by central banks it accounts for the liquidity premiums for various instruments traded in the money markets as well as an indicator of the health of the overall banking system a lot of derivative products are created launched and traded in reference to libor libor is also used as a reference rate for other standard processes like clearing price discovery and product valuation a brief history of liborthe need for a uniform measure of interest rates across financial institutions became necessary as the market for interest rate based products began evolving during the 1980s the british bankers association bba which represented the banking and financial services industry set up bba interest settlement rates in 1984 5further streamlining led to the evolution of bba libor in 1986 which became the default standard interest rate for transacting in the interest rate and currency based financial dealings between financial institutions at the local and international levels 5since then libor underwent many changes the major one is when bba libor changed to ice libor in february 2014 after the intercontinental exchange took over the administration 6currencies involved in calculating libor have also changed while new currency rates have been added many have been removed or integrated following the introduction of the euro rates the 2007 2008 financial crisis saw a significant decline in the number of tenors for which libor was calculated 7alternatives to liborthough libor was once accepted globally there are several other interest rates that are popularly followed around the globe for instance europe has the european interbank offered rate euribor japan has the tokyo interbank offered rate tibor china has the shanghai interbank offered rate shibor and india has the mumbai interbank offered rate mibor libor rate rigging scandalwhile libor was a long established global benchmark standard for interest rates it was also the subject of a major scandal of rate rigging major banks allegedly colluded to manipulate the libors they took traders requests into account and submitted artificially low libors to keep them at their preferred levels the intention behind the alleged malpractice was to bump up the profits of traders who were holding positions in libor based financial securities 8following reporting by the wall street journal in 2008 major global banks which were on the panels and contributed to the libor determination process faced regulatory scrutiny including investigations by the u s department of justice similar investigations were launched in other parts of the globe including in the u k and europe 9major banks and financial institutions including barclays icap rabobank royal bank of scotland ubs and deutsche bank faced heavy fines punitive actions were also taken against their employees who were found to be involved in the malpractice the scandal was also one of the primary reasons why libor shifted from bba administration to ice 8libor was susceptible to rate rigging because banks could submit artificially high or low estimates of their lending rates the new metric sofr uses actual lending rates not the banks estimations benefits of watching liborsdespite the rate setting scandals libors provided a useful benchmark for the level of activity in the global economy a falling libor meant it was easier to borrow money possibly forecasting an increase in economic activity a rising libor meant that it was getting harder to borrow money and that business activity was likely to slow down these rates are particularly significant to a prospective borrower when you borrow money from a bank libors may account for part of your interest rate a high libor meant that you could have to pay a higher interest rate on your mortgage or personal loan while a low libor meant a more favorable rate libor phaseoutfollowing the rate rigging scandals regulators initiated reforms to revise the benchmark rates and ultimately replace libor as the interbank borrowing rate u k banks were no longer required to publish libors after 2021 1the new system was designed to replace the conjecture surrounding interest rates and instead use actual transaction rates the secured overnight financing rate sofr replaced libor in 2023 the sofr is also a benchmark interest rate used for dollar denominated loans and derivative contracts sofr is different from libor in that it s based on actual observed transactions in the u s treasury market while libor used estimations of borrowing rates however sofr is used in the united states and the u k while other countries have their own benchmark rates to replace libor examples of libor based products and transactionsthe most straightforward example of a libor based transaction is a floating rate bond which pays an annual interest based on libor say at libor 0 5 as the value of libor changes the interest payment will change libor also applies to interest rate swaps contractual agreements between two parties to exchange interest payments at a specified time assume paul owns a 1 million investment that pays him a variable libor based interest rate equal to libor 1 each quarter since his earnings are subject to libor values and are variable in nature he wants to switch to fixed rate interest payments then there is peter who has a similar 1 million investment which pays him a fixed interest of 1 5 per quarter he wishes to get a variable earning as it may occasionally give him higher payments both paul and peter can enter into a swap agreement exchanging their respective interest receipts paul will receive the fixed 1 5 interest over his 1 million investment from peter which equals 15 000 while peter receives libor 1 variable interest from paul if libor is 1 then peter will receive 2 or 20 000 from paul since this figure is higher than what he owes to paul in net terms peter will get 5 000 20 000 15 000 from paul by next quarter if libor comes down to 0 25 peter will be eligible to receive 1 25 or 12 500 from paul in net terms paul will get 2 500 15 000 12 500 from peter such swaps essentially fulfill the requirement of both the transacting parties who wanted to change the type of interest receipts fixed and floating was libor reliable while libor was once a trusted benchmark for global interest rates the 2012 rate rigging scandal raised many questions about its objectivity many financial institutions are phasing out libor in favor of other benchmarks such as sofr 