Euro LIBOR: What it is, How it Works, Going Forward

What Is the Euro LIBOR?

Euro LIBOR is the London Interbank Offered Rate (LIBOR) denominated in euros. This is the interest rate that banks offer each other for large, short-term loans made in euros. The rate is fixed once a day by a small group of large London banks but fluctuates throughout the day. This market makes it easier for banks to maintain liquidity requirements because they are able to quickly borrow from other banks that have surpluses.

Understanding the Euro LIBOR

The London Interbank Offered Rate is the world’s most widely-used benchmark for short-term interest rates. It serves as the primary indicator for the average rate, at which contributing banks may obtain short-term loans in the London interbank market.

Currently, there are 11 to 18 contributor banks for five major currencies (US$, EUR, GBP, JPY, and CHF). LIBOR sets rates for seven different maturities. A total of 35 rates are posted every business day (number of currencies times the number of different maturities).

Euro LIBOR's primary function is to serve as the benchmark reference rate for debt instruments, including government and corporate bonds, mortgages, student loans, credit cards; as well as derivatives, such as currency and interest swaps, among many other financial products.

For example, take a Floating-Rate Note (FRN) (or floater) that pays coupons based on Euro LIBOR plus a margin of 35 basis points (0.35%) annually. In this case, the Euro LIBOR rate used is the one-year Euro LIBOR plus a 35 basis point spread. Every year, the coupon rate is reset in order to match the current one-year Euro LIBOR, plus the predetermined spread.

If, for instance, the one-year Euro LIBOR is 4% at the beginning of the year, the bond will pay 4.35% of its par value at the end of the year. The spread usually increases or decreases depending on the creditworthiness of the institution issuing debt.

Euro LIBOR vs. EURIBOR

LIBOR represents the average interest rate that leading banks in London estimate they would charge for lending to other banks, the Euro Interbank Offered Rate, known as EURIBOR, is a similar reference rate derived from banks across the Eurozone. While EURIBOR is only available in euros, LIBOR is available in 10 different currencies.

The Future of the Euro LIBOR

LIBOR, which is a global benchmark, is under fire, especially since the 2012 LIBOR fixing scandal. In Europe, Sterling Overnight Interbank Average rate (SONIA) will replace LIBOR as the benchmark by 2021. SONIA is based on actual bids and offers from the contributing banks and not indicated levels. The latter are subject to manipulation if the contributing bank wants to hide or enhance its capital position.

The replacement push centers on LIBOR since it is the globally recognized standard, but all similar rates, including HIBOR in Hong Kong and SIBOR in Singapore, are facing obsolescence. The U.S. Federal Reserve introduced the Secured Overnight Financing Rate (SOFR), a new reference rate created in cooperation with the U.S. Treasury Department’s Office of Financial Research.

The Federal Reserve and U.K. regulators are urging banks to wrap up contracts using LIBOR. An announcement from the Fed and U.K. regulators in November 2020 stated that banks should stop writing contracts using LIBOR by the end of 2021. After 2021, the rate will no longer be published. In addition, contracts using LIBOR should wrap up by June 30, 2023

For some time, the Fed has been warning banks to start preparing for a transition to SOFR. Instead of relying on bank quotes, SOFR will use rates that investors offer for bank securities such as loans and assets backed by bonds.