You’ve been LIBORed

I was fascinated to pick up on an article in The Financial Times last week about LIBOR, the London Interbank Offered Rate. It got a bad vibe because the world discovered bankers were rigging the system but, ever since, we have been looking for a replacement. What is it?

LIBOR is about a number. A single number that, for decades, sat quietly in the background of the financial system and yet influenced almost every aspect of global banking. Most people outside finance have never heard of LIBOR, yet it affected them every day. If you had a mortgage, a student loan, a corporate borrowing facility, a floating-rate bond or a derivative contract, there was a good chance that LIBOR was embedded somewhere within the agreement.

At its peak, it was referenced by hundreds of trillions of dollars of financial contracts around the world.

It was, quite literally, the benchmark upon which modern finance was built.

The remarkable thing about LIBOR is that it was never really a market price. It was an estimate. The highest and lowest submissions would be discarded and an average calculated. The resulting figure became the benchmark rate for global finance.

Think about it like this.

Imagine if every morning all the banks got together and asked how much interest they would charge  you if they lent money to you. The average became LIBOR.

For many years, nobody questioned the process because the market trusted the institutions involved and the system appeared to work.

The problem with any benchmark, based upon opinion rather than actual transactions, is that it ultimately depends upon trust. As long as everyone believes the participants are acting honestly, the system functions smoothly. The moment that trust is questioned, however, the entire structure begins to look fragile. That is exactly what happened during the financial crisis in 2008.

When regulators began investigating LIBOR submissions during the late 2000s, they discovered that traders at several major banks had attempted to influence the benchmark for their own benefit. In some cases, small changes in LIBOR could generate significant profits for trading positions linked to the rate.

What that basically means is that I quote you 5% in the early morning LIBOR call and then lend at 4.75%. I win, you lose. I lied to you. That is the reason why LIBOR failed.

The scandal that followed became one of the defining moments of post-crisis banking. Institutions paid billions in fines, traders were prosecuted and regulators launched extensive reforms. Unusually, some bankers were even jailed. Yet the manipulation scandal was only part of the story. In many ways, the more significant issue was that the market LIBOR was designed to measure was gradually disappearing.

LIBOR was intended to reflect the cost of unsecured lending between banks. However, after the financial crisis, banks changed the way they funded themselves. Regulatory requirements increased, liquidity rules became stricter and wholesale funding markets evolved. The volume of unsecured interbank lending declined significantly.

As a result, LIBOR increasingly relied on expert judgement rather than actual market activity. The benchmark was becoming detached from the reality it was supposed to represent.

This is why regulators eventually concluded that LIBOR could not be repaired.

The issue was not simply misconduct. The issue was that the underlying market had become too small to support a benchmark of such global importance. In effect, finance had built an enormous tower on foundations that were slowly disappearing.

The response was one of the largest infrastructure projects the financial industry has ever undertaken. Regulators across the world coordinated a transition away from LIBOR towards alternative reference rates based on real transactions.

In the United States, the replacement became SOFR, the Secured Overnight Financing Rate. In the United Kingdom, the benchmark became SONIA, the Sterling Overnight Index Average. Similar changes occurred across Europe, Asia and other major financial markets.

The thing is that, as The Financial Times recently highlighted an intriguing development. Even though LIBOR has disappeared, some market participants are beginning to miss certain characteristics that made it useful. The reason is that LIBOR captured something that many of the replacement rates do not: bank credit risk.

LIBOR reflected the reality that lending money to a bank carries risk. During periods of financial stress, LIBOR would typically rise as concerns about the banking sector increased. The benchmark therefore contained valuable information about market conditions and the health of financial institutions. By contrast, rates such as SOFR and SONIA are effectively risk-free benchmarks. They are based upon secured or highly liquid transactions and therefore do not reflect the same degree of credit sensitivity.

Think of it like this: I guess if I lend to you, you can pay it back versus I guess if I lend to you, I have no idea if you can pay it back.

For some borrowers and lenders, this creates a challenge.

Loan markets are always looking for reference rates that better capture the economic reality of credit risk, and it is this search that has led to the development of various credit-sensitive benchmarks that attempt to bridge the gap between the old world of LIBOR and the new world of transaction-based rates.

The debate now emerging is whether the industry is in danger of recreating some of the same challenges that led to LIBOR's demise.

No one is suggesting a return to the manipulation scandals of the past. Governance standards are far stronger, oversight is significantly more rigorous and regulators remain highly vigilant. Nevertheless, the tension remains. Markets often want benchmarks that capture credit conditions and economic realities, while regulators prefer benchmarks rooted in observable transactions and objective data.

This tension highlights a broader truth about financial infrastructure.

There is no such thing as a perfect benchmark.

Every benchmark represents a compromise between simplicity, transparency, relevance and resilience.

A benchmark based entirely upon transactions may be robust but may not fully capture economic risk. A benchmark that reflects credit conditions may provide more useful information but could face challenges relating to liquidity and methodology. The search for the ideal reference rate is therefore less about finding perfection and more about balancing competing priorities.

What makes the LIBOR story so important is that it demonstrates how deeply embedded financial infrastructure can become. Most people never thought about LIBOR, yet it influenced the pricing of everything from mortgages to derivatives. It became part of the plumbing of the financial system, quietly connecting institutions, markets and economies. When that plumbing had to be replaced, the process took years of planning, coordination and execution.

The irony is that LIBOR may be gone, but the fundamental question it attempted to answer remains as relevant as ever. Financial markets still need a reliable measure of the cost of money.

In that sense, LIBOR is not really dead. The name has disappeared, the benchmark has been retired and the systems have been migrated. Yet the challenges that LIBOR sought to solve continue to shape financial markets.

The ghost of LIBOR remains present in every discussion about risk-free rates, credit-sensitive benchmarks and the future architecture of global finance. The benchmark may have vanished, but the problem it was created to solve remains very much alive.