“Let There Be LIBOR”
A History of the London Interbank Offered Rate—the LIBOR index

March 10, 2009

The BBC has wondered aloud if LIBOR is “the world’s most important number” as over $360 trillion in financial instruments are tied to this index. We all may wonder aloud how we ever survived without this most important number (with none wondering more loudly than the folks who bring you LIBORATED.com). LIBOR is barely more than 20 years old, but its precursors go back decades further, a period marked by the growth of the global economy and the emerging need for financial benchmarks comprising diverse inputs that could guide diverse and complex transactions.

LIBOR’s roots extend to the late 1950s with the advent of the London Interbank Market, a trading forum for Eurodollars, U.S. currency held in the European market. Eurodollars evolved after World War II as the Marshall Plan and expanding U.S. exports increased dollar holdings in overseas banks. Ironically, it was the enemy of the United States and capitalism itself, the Soviet Union, which spurred the Eurodollar. Concerned that its dollar deposits in U.S. banks might be frozen due to Cold War intrigues, the Soviets transferred greenbacks to Moscow Narodny Bank, Soviet-owned but with a British charter, creating the first “Eurodollars.” (Moscow Narodny subsequently redeposited the dollars in the U.S., making the money immune from freezing since a bank under an ally’s flag, not the Kremlin, was technically controlling the funds.)

In the 1960s, the British Bankers’ Association (BBA) began polling a group of its banks for rates on dollar-denominated deposits. The London location of this dollar tracking became increasingly important when President Lyndon Johnson tried to limit the movement of dollars out of the United States. The circulation of U.S. dollars outside of the United States gained momentum in the 1970s with the steep jump in oil prices and resultant rise in dollar transactions for commodities beyond America’s borders. During this decade, the BBA began soliciting rates from a group of four banks for the U.S. dollar to set interest rates for floating rate notes and syndicated loans. Calculating and publishing this predecessor to today’s LIBOR created a benchmark to guide forward rate agreements, interest rate swaps, and foreign currency options.

During the 1980s, increasing numbers of banks were trading in the aforementioned instruments of forward rate agreements, interest rate swaps, and foreign currency options. Realizing that these complex financial dealings represented new business opportunities for the London Interbank market, the BBA knew that standardization was essential to such transactions. In Q4 1984, the BBA collaborated with the Bank of England and other entities to devise BBAIRS terms, the standard for interest swap rates. Fixed BBA interest settlement rates were integral to this standard, with these figures becoming the prototype for BBA LIBOR.

LIBOR as it is known today launched on New Year’s Day, 1986, although certain rates had been compiled throughout 1985 in a trial. Augmenting its original U.S. dollar focus, LIBOR tracks interbank lending rates in 10 major currencies. 8 to 16 contributor banks are surveyed for rates pertaining to each currency. The BBA conducted major reviews of the methods it uses to collect and compute LIBOR data in 1998 and 2008.

From its informal genesis, LIBOR has become the world’s financial beacon illuminating availability of capital, cost of funds and market mood. Let there be LIBOR!

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