The London interbank offered rate — which is set daily by asking banks what they would charge to lend to other banks — has formally existed since the 1970s, when the acronym Libor was first coined.
As a concept, however, it goes all the way back to 1797. It was known as “the bank rate,” and it referred to the one that the Bank of England would charge for an emergency loan. In effect, this rate became a barometer of market conditions, measuring the anxiety of borrowers and lenders alike.
The “bank rate” quickly became a trans-Atlantic benchmark, and by 1798, it was published in every major newspaper in Britain, the U.S. and Europe. It became the base rate for loans to farmers, homeowners and businesses around the world. The international cost of credit indirectly determined the price of flour in Baltimore and the price of slaves in New Orleans.
Setting the rate was simple during the 19th century and most of the 20th century. Britain’s biggest state-sponsored bank counted the gold in its vaults. If there was too much, the bank was sitting on unproductive gold and the rate needed to drop. If there was too little, too many ships were at sea, and the rate needed to go up. Over time, Bank of England governors (and government officials in Whitehall) discovered that the bank rate worked as an accelerator or a brake on the economy: Lower the rate to speed the economy, raise it to slow things down.
President Woodrow Wilson pushed a bill through Congress that created the Federal Reserve in 1913, freeing the U.S. from the British “bank rate.” U.S international financial supremacy emerged during World War I, allowing Americans to set “the rate,” which dictated merchants’ interest rates from China to Peru. The Federal Reserve measured its own gold reserves to set rates in the same way as the Bank of England had.
After the U.S. went off the gold standard in 1971, lenders around the world complained about the U.S. government’s tendency to push down interest rates to keep the economy booming. Lenders demanded a proxy, a mechanism that resembled the “bank rate” that the Bank of England had set from 1797 to 1913 and the Federal Reserve had set from 1913 to 1971. This prompted the creation of Libor.