What Is LIBOR Flat?
LIBOR flat is an interest rate benchmark that is based on the London Interbank Offered Rate (LIBOR). It refers to the LIBOR rate with no additional spread added. In order to adjust for credit risk and other factors, banks and other institutions add (or subtract) a spread to the LIBOR flat benchmark when calculating the rates to charge various borrowers or the rates that they pay to depositors. LIBOR flat simply means the base benchmark interbank rate without these adjustments.
- LIBOR flat is the unadjusted benchmark London Interbank Offered Rate (LIBOR) before a spread is added (or subtracted) to set a rate for a given transaction.
- Banks and other financial institutions use LIBOR as a reference to set interest rates for borrowers, depositors, and other financial transactions.
- Some transactions, such as interest rate swaps, may use LIBOR flat as a basic contract rate or a rate to be paid under certain contingencies.
Understanding LIBOR Flat
LIBOR flat is often used in interbank lending and interest rate swap contracts. LIBOR flat represents one of the best global interest rates available for short-term lending in the current market. As a universal lending rate, LIBOR is also used by banks as a base rate for which a risk generated spread level is added for non-interbank lending. This includes business loans, home mortgages, or interest paid on savings accounts. Based on the creditworthiness of borrowers and other factors, banks set interest rates that they charge (or pay) based on a reference rate (such as LIBOR) plus or minus any adjustments.
The Intercontinental Exchange (ICE), the authority responsible for LIBOR, will stop publishing one-week and two-month USD LIBOR after Dec. 31, 2021. All other LIBOR will be discontinued after June 30, 2023.
LIBOR stands for London Interbank Offered Rate. LIBOR is an important interest rate followed in the financial services industry. It is generally a gauge of short-term rates. Global banks primarily use LIBOR in their interbank lending as a central interest rate reference. The one-year LIBOR can also be used as a proxy for savings account rates that pay annual interest.
LIBOR offers seven different maturities: overnight, one week, and one, two, three, six, and 12 months. Thus, its yield curve formation will vary from a longer curve of yields such as the Treasury yield curve which spans from short term to 20+ years.
Like U.S. Treasury yields, the LIBOR rate changes daily based on the current market environment. Global banks will also often use LIBOR with an additional spread as their base rate for commercial and consumer lending.
Due to the LIBOR scandals, the Intercontinental Exchange (ICE) has laid out plans to stop the publication of LIBOR. ICE has laid out a tentative date of Dec. 31, 2021, to stop publication of one-week and two-month USD LIBOR, and June 30, 2023, for all other LIBOR. The U.K. Financial Conduct Authority (FCA) and other regulators have been advising end-users to shift away from LIBOR use by 2022.
LIBOR and Swaps
LIBOR and LIBOR flat are also commonly used in the interest rate swap market which is heavily utilized by banking institutions. Interest rate swaps are constructed with a fixed and floating rate component. Counterparties in an interest rate swap will take either a fixed or floating rate position based on their balance sheet exposure and outlook for interest rate levels.
LIBOR flat consists of a designated LIBOR rate with no additional spread. In a simple interest rate swap example, LIBOR flat can serve as the base interest rate. The fixed rate payer may contract to pay interest at the LIBOR rate quoted at the time the transaction commences. This would allow the fixed rate counterparty to pay a fixed LIBOR rate throughout the contract.
The floating rate counterparty may agree to pay LIBOR flat throughout the life of the contract. This would mean the floating rate counterparty pays the market’s LIBOR rate of interest at each required interval payment with no additional spread. In this scenario, the floating rate counterparty would benefit when LIBOR decreased while the fixed rate counterparty would benefit when LIBOR increased.