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You might have heard the term LIBOR when people are quoting interest rates.

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Or they're saying "Hey I'm gonna lend you money a few percentage points above LIBOR"

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You will hear...LIBOR quoted on some of the financial news channels.

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And what it is, is just an average of the interest rates that banks are lending to each other.

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And it is calculated by the British Bank Association.

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It's actually calcuated by Thomson Reuters for the British Bank Association.

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But it's there to kind of provide a benchmark for other types of securities and financial transactions.

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And it literally stands for the London Interbank Offered Rate.

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So...it's the..... in London...it's the rate..the offered rate between banks.

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The London Interbank Offered Rate.

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To understand that a little bit better we have set up two banks over here

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Bank A and Bank B. And you might have already known that

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when you go and deposit your money in banks,

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the bank won't leave all that money around.

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The way it makes money is lend a good bit of money to other people as loans.

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And it keeps just enough cash on hand

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That things well you know, people would actually come and ask for money from their checking account.

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We have enough on hand

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You could imagine....every now and then that bank might get low on cash.

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or it might get close to kind of a reserve requirement

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that the central bank in that country requires a bank to have on it.

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So in those situations ...say bank A is getting to that...that situation.

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They said "let me go borrow some money"

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Let me go borrow money from another bank.

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So this is interbank borrowing.

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Bank B over here they are flushed with cash

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So they say we don't like to keep so much cash around.

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We want to lend it. So we can actually get interest. We get no interest on cash

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So maybe bank B lends money to Bank A

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So maybe they lend this much cash

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So that's the new cash that bank A got.

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Right over there ...the new cash

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And of course it is a loan

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So this is a new loan. To offset it, remember

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assets are equal to liabilities plus equity.

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So liabilities is this whole thing over here.

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So this is loan from B for this cash.

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They have a little bit better of a cushion.

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And now B, their loan has increased and their cash has decreased.

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So this is a loan, loan to A.

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Right now, they took this cash and they gave to bank A

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And that rate that they lent it at,

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maybe it was that 1% annual rate.

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And of course it is to be renewed everyday, it is overnight rate.

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This rate is an interbank rate.

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So what they do is on behalf of the British Bank Association

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They go survey a bunch of banks in London

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eight, twelve, sixteen banks in London.

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So they said "Hey what was the rate in which you all transacted"

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and they will quote that

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They quote that as the overnight LIBOR

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So they quoted it, say hey 1.2% across all of the banks that we surveyed

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But what's interesting about the LIBOR, it is done in ten currencies

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It is not just in the sterling, the dollar

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or the yen...It is in ten currencies

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That's what really differentiate it amongst other things

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But really differentiate it from the effective Federal Funds Rate which is another interbank borrowing rate

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But that's in the United States

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And that's more revolving around policy concerns.

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The Federal Bank actually tries to change it.