What is the LIBOR curve
The LIBOR curve is the graphical representation of the different maturities of the London Interbank Offered Rate (LIBOR), which is the short-term variable rate at which large banks with high credit ratings lend themselves to each other. The LIBOR curve is generally represented for short-term periods of less than one year.
Breaking the LIBOR curve
LIBOR is the most widely used benchmark in the world for short-term interest rates. It serves as the main indicator of the average rate at which contributing banks can obtain short-term loans on the London interbank market. Currently, there are 11 to 16 contributing banks for five main currencies (USD, EUR, GBP, JPY, CHF). LIBOR is set for seven different deadlines. The LIBOR curve plots the rates according to the corresponding maturities.
The LIBOR curve and the Treasury rate curve are the most widely used substitutes for risk-free interest rates. Although not theoretically risk-free, LIBOR is considered a good indicator against which to measure the risk / return trade-off for other short-term floating rate instruments. The LIBOR curve can be predictive of longer-term interest rates and is particularly important in the pricing of interest rate swaps.
Phasing out LIBOR?
The abuse of the LIBOR system for personal gain was discovered in the aftermath of the financial crisis that started in 2008. Massive upheavals in global banking have allowed people working in contributing banks to manipulate LIBOR rates. In 2020, the Financial Conduct Authority (FCA) of the United Kingdom took over LIBOR regulations. Currently, plans are underway to phase out the LIBOR system by 2021 and replace it with a benchmark based on US Treasury repo rates or the average of the Sterling Overnight index.