Banking on Change

CHAPTER 9RIP Libor

Richard Northedge

Richard Northedge examines how Libor developed, why it became unfit for purpose and what it tells us about the evolution of financial markets.

The London Interbank Offered Rate was created in the late 1960s as a way to buffer the exposure of banks, which were lending long term, to fluctuations in their short-term funding costs.¹ When Libor was conceived, financial markets were very different. Capital and banking markets were domestic, with little cross-border activity, and most corporates had a ‘house bank’ that handled all of their business. Market participants tended to know each other personally and corporate governance was not necessarily codified. Market misbehaviour could often be tackled with social sanctions. The Governor of the Bank of England, for example, was supposedly able to stem bad behaviour by raising his eyebrows, something that might not be particularly effective today.²

Despite the relative cosiness, it was a time of change. In particular, the so-called ‘eurobond’ market had just started, with its home in London. As the associated ‘euromarkets’ grew, so did the need for interbank funding. Then, as City banks increased in size, complexity and global reach, the importance of Libor increased with them and it was adopted as an international benchmark for short-term interbank loans in the mid-1980s. Libor not only allowed the banks to compare their short-term funding costs with the market rate, it was itself treated ...