Libor (London interbank offered rate) had its origins in 1984. The British Bankers Association sought to stabilize various new investment markets that were being created and one method was to set, on a daily basis, the cost prime banks charged other prime banks to borrow money over differing periods of time (i.e a day, a month, two months and on).
This led to the BBAIRS (British Bankers Association Interest Rate Settlement). Now, prime banks who borrowed from other prime banks knew what their costs to borrow was going to be for that day and time period. With this information they wouldn't have to shop around for the cheapest money. They could now invest in the new market instruments and loan money at an interest rate profitable to them. Banks also knew what they had to pay out to investors in their banks.
Other bank regulators in other nations liked this concept and integrated it into their national systems. In 1986 BBAIRS morphed into Libor.
"The design of bbalibor has seen one significant change since its inception. Up until 1998, banks submitted quotes to the BBA LIBOR process line with the question: 'At what rate do you think interbank term deposits will be offered by one prime bank to another prime bank for a reasonable market size today at 11am?'
During 1998 this question changed, and has up until today* been : 'At what rate could you borrow funds, were you to do so by asking for and the accepting inter-bank offers in a reasonable market size just prior to 11am?
The quote goes on to note that a definiton of prime bank could no longer be accurately defined and also that Libor interest rates were now submitted on each banks market activity rather than on an hypoththetical market.
So what does this have to do with you? The costs of borrowing money by banks filters down to your mortgage loans, credit card rates and other consumer loans. Barclays is currently the bank on the hot seat, but there will be others. As you will see from the NewYork Times Economix, Barclays actually lowered their Libor rate more than they raised it. So if your APR consumer loan was tied to Libor it went down more than it went up. That, of course required other banks to collude on the daily Libor. Why would the want to help you? They don't, but it seems to be developing that lowering the Libor also lowered the interest these banks paid to investors that invested in the bank's investment funds. In many cases these were big investors like pension funds. Counterintuitive? Yes. Illegal? Yes.
*Not certain what day, "today" is.
Sources:
bbalibor
New York Times; Business Day Section; Economix Blog, "The Libor Scandal's Consumer Upside", by Annie Lowery, 07-09-2012
LIBOR, information about the London InterBank Offered Rate
This explains in some detail how the rate is calculated.
New York Times; DealB%k Blog, "Q&A:Understanding Libor" by Michael J. De La Merced, 07-10-2012
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