Friday, 3 October 2008

Libor - bid only

Let me explain: LIBOR is the London Interbank Offer Rate, it's the interest rate banks use to lend to other banks and is usually a little above base rate; unlike the interest rate they use to lend to you which is usually a lot above base rate. The difference between base rate and LIBOR is called the "spread". LIBOR is different for different currencies, eg sterling versus US dollar and is different depending on how long the borrower wants the cash for. You can borrow overnight (this is the minimum term) three months is more of a metric and is the usual term; and in theory you could borrow all the way up to 30 years - fat chance of that in the current economic climate though.

The wider the "spread", the more over the odds the borrower is paying for his short term loan. When the spread widens it means the lender doesn't really want to lend and has to have his money prised out of him by the premium interest rate. Spreads have been widening through-out the credit crunch. They are routinely up above 2% compared with a more usual 0.2%. That's painful, but not the end of the economic world.

The next factoid you need to know is that most of the mega-rich household-name corporations aren't cash rich at all. They work on "lines of credit". They have treasury departments which organise their financial situation continually borrowing and repaying loans on the short-term market using the LIBOR system. Their total debt isn't necessarily growing; they pay off the debt in time, but then they re-borrow almost immediately. For example at the end of each month they may need a big cash pile to pay all their staff - so they borrow, but then they repay over the coming month until they need to borrow all over again at the end of the next month.

So what does "Libor - bid only" mean? Well, "bid" is bidding to borrow money, and "offer" is offering to lend money and any bank which says "bid only" is saying we'll borrow but won't lend to anyone at any price.

"Libor - bid only" is the state the financial markets reached today. So it's just as well we aren't near a month end, isn't it?


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- David