Libor rate

By THIS IS MONEY
Updated: 05:53 EST, 17 November 2008

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The Daily Mail City team explains how banks set rates on the money they lend to each other...

Is that Tony Blair again?

No, not new Labour. New Libor refers to an overhaul in the way big banks set the rate they lend to each other, known as the 'inter-bank rate'. Libor is the London Inter-Bank Offered Rate and is one of the global benchmarks for the cost of borrowing.

The British Bankers' Association has been calculating Libor since 1985, setting rates for £175trn of financial products.

So what's happening?

Well, there have been concerns the credit crunch has rendered Old Libor unreliable.

Bankers are suspicious that rivals might be understating their true borrowing costs to avoid looking desperate for cash, which distorts the true picture.

So the BBA plans to increase its scrutiny of banks that contribute to Libor-setting, raise the number of contributors to some of its rate-setting panels and introduce a second rate-fixing process for US dollar Libor.

Why do we care?

The evaporation of trust between large financial groups in the City and on Wall Street is one of the main reasons the global economy is faltering. The collapse of the US sub-prime mortgage market left banks jittery about lending to each other.

Any distrust of the inter-bank rate-setting system only adds to the market paranoia and exacerbates the credit crunch. Beefing up the system will hopefully address these concerns.

• See the latest Libor rate