What Is an Inter-Dealer Broker?

An inter-dealer broker (IDB) is a specialized financial intermediary who helps with transactions between investment banks, broker-dealers, and other large financial institutions. The inter-dealer broker focuses on trades where there is no formal exchange or market maker system. As such, it operates in the over-the-counter markets, servicing municipal, government, corporate, and other bonds. IDBs work with large blocks of securities where there is low trading volume.

Key Takeaways

  • IDBs are characterized as sales and networking professionals in less liquid markets.
  • IDBs are motivated by commissions and spreads that are larger than with mainstream securities.
  • In times of market stress IDBs help creative transactions get done to help smooth markets.

Understanding Inter-Dealer Brokers

Because over-the-counter markets, by definition, are decentralized, liquidity and transparency are limited. Inter-dealer brokers (IDBs) take on a crucial role, providing pricing information, liquidity, and privacy for their trading actions. In a way, they are each mini-exchanges where other financial institutions can find bids and offers for their activities. However, because IDBs buy from one dealer to sell to another, they act similarly to market makers.

IDBs play a critical role in connecting buyers and sellers of lesser known fixed-income products. In this field where some products become too specialized to attract a large number of market participants, connecting a willing buyer and a motivated seller is important to allow a transaction to occur--thus creating price discovery for securities with low liquidity.

Another function provided by IDBs is to smooth the market during times of stress. At times, IDBs, except for municipal bond IDBs, are often the only players willing to buy securities that appear to be undervalued and take the risk that the market will return to a more stable level. If they are correct, they will make a profit on the bonds on top of the commissions earned by buying and selling to dealer banks. This is critical to maintaining liquidity during extreme times.

Inter-Dealer Broker Benefits

Inter-dealer brokers add value to financial institution traders in several ways. IDBs improve price discovery and transparency by posting a bid, offer, and size of available securities for trading. This listing assists with the flow of information and provides market liquidity and efficiency in a space where there are not many players. Dealers are allowed anonymity and privacy as they work through the inter-dealer broker system. Traders may also experience lowered trading costs. Inter-dealer brokerages operate on small spreads, but they handle substantial transactions.

As with most areas of financial transactions and record keeping, inter-dealer brokers adapt to the changing electronic landscape. Previously, employees spent their days on the telephone, to the point that they were called "voice brokers." After hours, a good deal of effort was made to build and maintain their customer bases with travel and entertainment. Competition for business was fierce.

Now, an increasing amount of trading takes place electronically, and buyers and sellers are matched on IDB systems. These platforms allow traders to trade directly with one another, although each side's identity remains hidden. However, after-hours marketing of the firm is still required to keep customers happy.