Why Ditching Libor Is Vexing the Financial World

For half a century the series of interest rates known collectively as the London interbank offered rate, or Libor, has helped determine the cost of all sorts of borrowing around the world. Now seen as outdated and discredited, the benchmark is being killed off from the end of this year. That’s sent the financial world scrambling to adjust the terms in contracts on hundreds of trillions of dollars’ worth of products — from mortgages and credit cards to interest-rate swaps. Life after Libor could be messy, and major global banks will spend more than $100 million each in 2021 in preparation for its demise.

Libor is a daily average of what banks say they would charge to lend to one another. It’s offered in five currencies and over various time periods, up to one year. Formalized by the British Bankers’ Association in 1986 to help set prices for derivatives and syndicated loans, Libor is used by pension and fund managers, insurance providers, big and small lenders and Wall Street banks that package loans into securities. Some $370 trillion worth of financial products are tied to the benchmark, including equipment leases, student and auto loans and bank deposits. The biggest component is derivatives such as interest-rate swaps — trades of a fixed interest rate for a floating one or vice versa — which are used by companies, banks and investors to hedge risk or speculate. Of the five Libor currency rates, the one tied to the U.S. dollar (“dollar Libor”) is most widespread, accounting for more $200 trillion worth of products.