Background
The London Interbank Offered Rate (Libor) is the expected
interest rate for leading banks in London to borrow money from other banks. Libor
rates are calculated for five currencies and seven borrowing periods ranging
from overnight to one year. It is considered to be the most important number in
the financial world because at least $350 trillion in derivatives and other
financial products are tied to it. (Article)
The Libor was invented by Minoz Zombanakis, who tried to let
banks lend $80 million to the cash-strapped Iran in 1969. Banks hesitated to
lend money at a fixed rate for long periods, because of the rising inflation in
UK. Zombanakis offered a solution in which the interest rate would be
recalculated every few months. He marketed the deal to a variety of local and
foreign banks that could each take a slice, and the banks in the syndicate
would report their funding costs just before a loan-rollover date. The weighted
average plus a spread for profit became the price of the loan for the next
period, and the rate was called London interbank offered rate (Article).
In 1984, the British Bankers’ Association (BBA) established
the BBA standard for interest rate swaps including the fixing of BBA
interest-settlement rate, which was later officially called BBA Libor in 1986.