What is the 'Interbank Market'

The interbank market is the financial system of trading currencies among banks and financial institutions, excluding retail investors and smaller trading parties. While some interbank trading is done by banks on behalf of large customers, most interbank trading is proprietary, meaning that it takes place on behalf of the banks' own accounts.

BREAKING DOWN 'Interbank Market'

The interbank market for forex serves commercial turnover of currency investments as well as a large amount of speculative, short-term currency trading. According to data compiled in 2004 by the Bank for International Settlements, approximately 50% of all forex transactions are strictly interbank trades.

Background

The interbank foreign exchange market developed after the collapse of the Bretton Woods agreement and following the decision by U.S. President Richard Nixon to take the country off the gold standard in 1971. Currency rates of most of the large industrialized nations were allowed to float freely at that point, with only occasional government intervention. There is no centralized location for the market, as trading takes place simultaneously around the world, stopping only for weekends and holidays.

The advent of the floating rate system coincided with the emergence of low-cost computer systems with allowed increasingly rapid trading on a global basis. Voice brokers over telephone systems matched buyers and sellers in the early days of interbank forex trading, but they were gradually replaced by computerized systems that could scan large numbers of traders for the best prices. Trading systems from Reuters and Bloomberg allow banks to trade billions of dollar instantaneously, with daily trading volume topping $6 trillion on the market's busiest days.

Largest Participants

In order to be considered an interbank market maker, a bank must be willing to make prices to other participants as well as asking for prices. The minimum size for an interbank deal is $5 million, but most transactions are much larger, and can top $1 billion in a single deal. Among the largest players are Citicorp and JP Morgan Chase in the United States; Deutsche Bank in Germany; and HSBC in Asia.

Credit and Settlement

Most spot transactions settle two business days after execution; the major exception is the U.S. dollar vs. the Canadian dollar, which settles the next day. This means that banks must have credit lines with their counterparts in order to trade, even on a spot basis. In order to reduce settlement risk, most banks have netting agreements that require the offset of transactions in the same currency pair that settle on the same date with the same counterpart. This substantially reduces the amount of money that changes hands and thus the risk involved.

RELATED TERMS
  1. Interbank Call Money Market

    A short-term money market, which allows for large financial institutions, ...
  2. Interbank Rate

    The rate of interest charged on short-term loans made between ...
  3. Stockholm Interbank Offered Rate ...

    The official interbank offer rate for short term loans in Sweden. ...
  4. Reverse Floater

    A floating-rate note in which the coupon rises when the underlying ...
  5. Panel Bank

    The name given to the group of banks contributing to the Euro ...
  6. London Interbank Mean Rate - LIMEAN

    The mid-market rate in the London Interbank market, which is ...
Related Articles
  1. Insights

    London Interbank Offered Rate (LIBOR)

    Learn more about this rate which banks use to determine the amount of interest to charge other banks.
  2. Trading

    Forex Trading: A Beginner’s Guide

    As businesses continue to expand to markets all over the globe, the need to complete transactions in other countries’ currencies is only going to grow.
  3. Insights

    Inside National Payment Systems

    Investopedia explains: The global interconnection of U.S. payment systems makes commerical and financial transfers possible.
  4. Trading

    The Forex Market: Who Trades Currency And Why

    The forex market has a lot of unique attributes that may come as a surprise for new traders.
  5. Trading

    How To Trade Forex Right Now

    With the expected continued world volatility in the near future, there is a lot of money to be made in the forex market. How can you make the most of it?
  6. Trading

    Market Makers Vs. Electronic Communications Networks

    Learn the pros and cons of trading forex through these two types of brokers.
  7. Personal Finance

    Retail Banking Vs. Corporate Banking

    Retail banking is the visible face of banking to the general public. Corporate banking, also known as business banking, refers to the aspect of banking that deals with corporate customers.
  8. Trading

    Price Shading In The Forex Markets

    This practice puts brokers ahead of their clients, but it doesn't have to be a negative for traders.
RELATED FAQS
  1. What is the difference between LIBID and LIBOR?

    Both LIBID and LIBOR are rates primarily used by banks in the London interbank market. The London interbank market is a wholesale ... Read Answer >>
  2. What is the difference between LIBOR, LIBID and LIMEAN?

    LIBOR, LIBID and LIMEAN are all reference rates used to benchmark short-term interest rates. The London Interbank Offered ... Read Answer >>
  3. What is a liquidity squeeze?

    A liquidity squeeze occurs when a financial event sparks concerns among financial institutions (such as banks) regarding ... Read Answer >>
  4. What are the differences between the Federal Funds Rate and LIBOR?

    Learn the key differences between the federal funds rate and the London Interbank Offered Rate, including currency denomination ... Read Answer >>
  5. Who determines the LIBOR rate?

    Learn about what the LIBOR rate is, how it is determined and calculated, and who determines what the LIBOR rate on a daily ... Read Answer >>
  6. How do I find out my bank's bid-ask spread for currency conversions?

    Learn how to find your bank's bid-ask spreads for currency conversions, and understand why you should consider alternative ... Read Answer >>
Hot Definitions
  1. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  2. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  3. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  4. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  5. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  6. Merchandising

    Merchandising is any act of promoting goods or services for retail sale, including marketing strategies, display design and ...
Trading Center