What is Libor?

If you're a bit confused about what exactly Libor is, read on....

Libor stands for the ‘London Interbank Offered Rate’ and is the rate of interest at which banks borrow from each other in the London market. There are actually lots of different Libor rates depending on the currency and duration of the loan.

Two examples are the overnight sterling Libor rate and the one-year US dollar rate. The one-year US dollar rate is the rate at which banks are willing to lend to each other in dollars for a  year.

The different Libor rates are set by Thomson Reuters and the British Bankers' Association (BBA). The big banks are asked every day for the rates at which they’re borrowing and lending to each other. Thomson Reuters then calculates the averages for the different rates and those rates are then announced to the markets shortly after 11 AM.

If you hear people talking about Libor as though it’s one single rate, they’re probably referring to 3-month Sterling Libor. You can find out the latest 3-month figure from the BBA twitter feed. I’m going to refer to the 3-month rate for the rest of this article.

Does Libor matter?

Until 2008, Libor didn’t make a huge difference to most people's lives. The rate moved pretty much in line with the Bank of England’s base rate and was typically around 0.15% higher than the base rate.

Admittedly, many mortgages were – and are – set in relation to Libor, but given that Libor was normally so close to the base rate, most folk could just focus on the base rate.

However, as the credit crunch took hold in 2008, Libor became much more volatile and the gap between Libor and the base rate grew massively. Banks had become nervous about lending to each other because they feared that some banks might go bust and not pay back their debts. As a result, lending banks demanded a higher interest rate to compensate for the increased risk.

By 2010, the gap between Libor and the base rate had gone back to a more normal level although it went back up last year as worries increased about the health of banks in the Eurozone. Here’s a table showing the recent history of Libor:

What about mortgages?

You may have read that Libor affects mortgage rates. And that’s true to an extent. Basically, the rates for many variable rate mortgages are affected by Libor.  Indeed some mortgages are directly linked to Libor – so if Libor rises by 0.1%, your mortgage rate will rise by 0.1% too. That said, most variable rate mortgages are directly linked to the base rate not Libor.

Fixed rate mortgages, however, are driven by ‘swap rates’ which reflect longer-term borrowing costs.  

When Barclays was attempting to manipulate Libor in the years running up to 2008, it’s possible that your mortgage rate will have been affected as a result. But I should stress that the difference will have been small.

What’s more, Barclays will have sometimes triggered a cut in the rate not an increase. Barclays traders won’t have cared in which direction Libor was moving. All they wanted was advance notice of what was going to happen, so they could make money.

So there you have it, a quick primer on Libor. Hopefully, it’s made things a little clearer.

More: 

Four thoughts about the Libor scandal 

A shock slump in mortgage debt