See explanation below.
Explanation
1. In the admin center, select the Compliance admin center.
2. Select Classification > Sensitivity labels.
3. Select Create a label, and when the warning appears, select Yes.
4. Enter a Label name, Tooltip, and Description. Select Next.
5. Turn on Encryption. Choose when you want to assign permissions, whether you want your users' access to the content to expire, and whether you want to allow offline access.
6. Select Assign permissions > Add these email addresses or domains.
7. Enter an email address or domain name (such as Contoso.org). Select Add, and repeat for each email address or domain you want to add.
8. Select Choose permissions from preset or custom.
9. Use the drop-down list to select preset permissions, such as Reviewer or Viewer, or select Custom permissions. If you chose Custom, select the permissions from the list. Select Save >Save > Next.
10. Turn on Content marking, and choose the markings you want to use.
11. For each marking that you choose, select Customize text. Enter the text you want to appear on the document, and set the font and layout options. Select Save, and then repeat for any additional markings. Select Next.
12. Optionally, turn on Endpoint data loss prevention. Select Next.
13. Optionally, turn on Auto labeling. Add a condition. For example, under Detect content that contains, select Add a condition. Enter the condition; for example, add a condition that if passport, Social Security, or other sensitive information is detected, the label will be added. Select Next.
14. Review your settings, and select Create. Your label has been created. Repeat this process for any additional labels you want.
15. By default, labels appear in Office apps in this order: Confidential, Internal, and Public. To change the order, for each label, select More actions (the ellipsis), and then move the label up or down. Typically, permissions are listed from the lowest to highest level of permissions.
16. To add a sub-label to a label, select More actions, then Add sub level.
17. When finished, choose Publish labels> Choose labels to publish > Add. Select the labels you want to publish, and then select Add > Done > Next.
18. By default, the new label policy is applied to everyone. If you want to limit who the policy is applied to, select Choose users or groups > Add. Select who you want the policy to apply to, and then select Add > Done
> Next.
19. If you want a default label for documents and email, select the label you want from the drop-down list.
Review the remaining settings, adjust as needed, and then select Next.
20. Enter a Name and Description for your policy. Select Next.
21. Review your settings, then select Publish.
Reference:
https://support.office.com/en-us/article/create-and-manage-sensitivity-labels-2fb96b54-7dd2-4f0c-ac8d-170790d
https://docs.microsoft.com/en-us/microsoft-365/compliance/sensitivity-labels?view=o365-worldwide