What is the LIBOR-OIS spread?

The LIBOR-OIS spread is the difference between the London Interbank Offered Rate (LIBOR) and the Overnight Index Swap (OIS) rate for the same maturity. Because an OIS is a derivative tied to the overnight risk-free rate (formerly Fed Funds, now SOFR), it carries minimal credit risk. LIBOR, by contrast, reflected the rate at which banks would lend to each other on an unsecured basis for a specified term. The spread between the two, therefore, isolated the credit and liquidity premium that banks charged each other above the risk-free rate.

During normal market conditions, the 3-month LIBOR-OIS spread typically ranged from 5 to 15 basis points, reflecting minimal perceived counterparty risk in interbank lending. During periods of financial stress, the spread widened dramatically. In August 2007, as the subprime crisis emerged, the 3-month LIBOR-OIS spread surged from 10 to over 90 basis points. After the Lehman Brothers collapse in September 2008, it exploded to over 350 basis points, reflecting near-total breakdown in interbank trust. Banks hoarded liquidity rather than lending to peers they feared might fail.

With the transition from LIBOR to SOFR (completed for new contracts by mid-2023), the specific LIBOR-OIS spread is no longer quoted. However, the conceptual equivalent persists in various credit-sensitive spread measures: the SOFR-OIS basis, the FRA-OIS spread (using forward rate agreements), and term SOFR versus overnight SOFR. These measures continue to capture the credit and term premium in interbank funding markets.

For market participants, LIBOR-OIS and its successors serve as early warning indicators of banking system stress. Unlike equity markets, which can remain elevated during the early stages of a credit crunch, interbank spreads tend to respond quickly to deteriorating counterparty confidence. A rapid widening in these spreads, even from low absolute levels, warrants attention as it may signal emerging liquidity problems that have not yet been reflected in other asset prices.