How Is LIBOR Calculated? A Step-by-Step Breakdown

For decades, the London Interbank Offered Rate (LIBOR) was a key benchmark for interest rates worldwide, influencing everything from corporate loans to consumer mortgages. However, its calculation process was often misunderstood.

Panel Bank Submissions

LIBOR was based on daily estimates from selected panel banks with significant interbank market presence. Each bank provided the rate at which it could borrow unsecured funds from other banks for various maturities, from overnight to one year.

These submissions answered a standardized question: “At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11:00 a.m. London time?” This phrasing captured hypothetical borrowing costs rather than actual transactions, a point of controversy during the LIBOR manipulation scandal.

Banks submitted rates for multiple currencies, including the U.S. dollar, British pound, euro, Swiss franc, and Japanese yen. The number of panel banks varied by currency, with U.S. dollar LIBOR historically having the largest panel. These submissions were sent to the designated administrator, which in later years was the Intercontinental Exchange (ICE) Benchmark Administration, replacing the British Bankers’ Association (BBA) after regulatory reforms.

The Trimming Process

To prevent extreme values from distorting the final rate, the highest and lowest reported figures were removed.

The specific method depended on the number of banks submitting rates for a given currency. For example, when 18 banks submitted U.S. dollar LIBOR estimates, the top four and bottom four values were discarded, leaving the middle ten submissions to be averaged.

This step was especially relevant during financial instability when banks might have incentives to overstate or understate borrowing costs. By systematically removing outliers, the trimming process helped maintain a more stable benchmark.

The Average Calculation

With the trimmed set of submissions, a simple arithmetic mean was calculated. The remaining rates were summed and divided by the number of included submissions, producing a single figure representing the prevailing interbank borrowing cost for that currency and maturity.

Even small fluctuations could impact billions of dollars in interest payments across financial instruments tied to LIBOR, such as adjustable-rate mortgages, corporate bonds, and syndicated loans. A 0.10% change in the published rate could affect loan repayments for businesses and consumers alike.

Since the rate was based on estimates rather than actual transactions, it was susceptible to market conditions that might not fully reflect real borrowing activity. During liquidity stress, banks might have submitted conservative figures, affecting the final rate. This reliance on judgment rather than direct trade data was a longstanding concern that contributed to LIBOR’s eventual replacement.

Official Publication

Once the final rate was determined, it was published daily by ICE Benchmark Administration at approximately 11:55 a.m. London time. Financial institutions, corporations, and investors used this benchmark to price loans, derivatives, and other financial instruments.

Each publication included multiple tenors—ranging from overnight to 12 months—across different currencies, allowing users to reference the appropriate rate for their contracts. Given LIBOR’s widespread use in bond markets, syndicated loans, and interest rate swaps, its daily release played a key role in financial decision-making.