This piece first appeared on the Saga Magazine website 12 September 2007
The text here may not be identical to the published text

Libor-rate your savings

You have probably never heard of Libor. But it is Libor which is responsible for the record amounts we can earn on our savings and the rising rates we have to pay when we borrow money on credit cards or mortgages. Its full name is the London Interbank Offered Rate and, as that name suggests, Libor is the rate of interest the High Street banks charge each other to borrow money. This inter-bank lending is the oil that keeps the financial wheels turning smoothly. When we borrow to buy a house or run up Christmas on our credit card, the chances are that the money the bank lends us has been borrowed somewhere else more cheaply. The difference between the rate they borrow at and the rate they charge us is how the banks make their money.

Normally the Libor rate stays very close to the base rate announced each month by the Bank of England. That is currently 5.75%. But instead of being 5.85% or 5.9% Libor is soaring. This week it reached a 10 year high of more than 6.9% for money borrowed over three months.

The rise in Libor is caused by a growing crisis in the banking sector. It began when American banks lent low income people money they could not afford to buy a home. The banks then sliced up those debts, mixed them up with other debts, and put them into nicely wrapped packages which they sold to investors – often other banks – around the world. Then interest rates in the USA rose and house prices fell by 6% so many homeowners began to default on debts their homes could not cover. The returns on the packages of sold-on debt plummeted. Banks who did have money stopped lending it out in case they got a share of these bad debts. As the supply of lending dried up the price of borrowing rose. And that is why Libor is now more than one percentage point above the base rate.

The banks are so afraid of the risk of borrowing from each other that they are now turning to those with cash – savers. Last week a bidding war broke out and the rate offered on cash savings rose to 6.9% for money that was left in for a year with Allied Irish bank. And yesterday Norwich & Peterborough building society offered a six month bond at 6.76% a year. These are astonishing rates when inflation is just 3.8%.

I said here five weeks ago that cash was king. This week it has been crowned by Libor.

 


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