Libor this. Libor that. What is it?

Libor is the London InterBank Offered Rate which is an interest rate at which banks lend to each other – or really the average of the rates banks say they will charge each other. In banks we trust. There’s a rate for different time periods (day, week, month, 3 months etc) and for different currencies. Why do we care?

Banks (allegedly) evaluate loan applications on their merits. But what is the right interest rate for a loan since it isn’t written in the stars? What banks do is benchmark against something else. If you’re the UK Government and a greater risk than the US Government then if the US pays 2.5% the UK might pay 2.5%. BP might borrow at 3% and ASmallBiz Ltd 9%.

Since interest rates (aka “stomach for risk”) change constantly, banks hate being tied to a single rate for a long time. So they charge a rate that moves around with risk and Libor is the chosen benchmark. So, ASmallBiz might pay Libor (e.g. 0.5%) + 8.5% = 9%. If Libor moves to 1% then the rate is 9.5% and if Libor goes to 0.2% …

This means that as Libor so goes the cost of business and affects what ASmallBiz charges or can pay suppliers and employees. The interest paid goes to the bank. But who sets Libor?