Interbank Deposits: What it Means, How it Works

What Are Interbank Deposits?

The term interbank deposit refers to an arrangement between two banks in which one holds funds in an account for another institution. The interbank deposit arrangement requires that the holding bank opens a due to account for the other. This is a general ledger account with funds payable to another party. In the arrangement, the correspondent bank is the one that waits for the deposit.

Understanding Interbank Deposits

Interbank deposits are part of the interbank market. The interbank market is a system used by banks and other financial institutions to trade currencies. This system excludes retail investors—individuals who buy and sell securities for their personal account instead of for another company or organization—and other, smaller trading parties. Most interbank trading conducted on the market is proprietary, meaning banks do so between and for each other. There are instances, though, where this type of banking takes place for large, institutional customers.

In the interbank market, banks borrow and lend money between each other in order to manage liquidity and meet the reserve requirements that regulators place on them. A reserve requirement is the amount of money a bank must keep in their vaults. Deposits, as well as loans, are among the many types of transactions that take place between banks that help them meet these conditions. These transactions also provide the market with a great deal of liquidity.

When two banks make an arrangement for an interbank deposit, the holding bank sets up a due to account for the corresponding bank— the institution that makes the deposit. The due to account is a holding account, also known as a payable account.

Banks use a special interest rate on deposits and short-term loans. This rate is known as the interbank rate. The interbank rate depends on maturity, market conditions, and the credit ratings of the institutions involved. The Intercontinental Exchange London Interbank Offered Rate (ICE LIBOR) is a benchmark rate, which some of the world’s leading banks charge one another for short-term loans.

Special Considerations

As mentioned above, the bank for which the due to account is held is referred to as the corresponding bank. This designation is generally held for deposits that take place between domestic banks. But the terms change when the correspondent bank is a foreign institution. In this case, the due to account is a nostro—derived from the word ours in Latin—account for the bank holding the deposit. Put simply, this is an account held by a bank in a foreign currency at another institution. This is in contract to a vostro—the Latin word for yours—account for the foreign correspondent bank. A vostro account is the term bank uses to describe accounts that other firms have on their books in their home currency. So the correspondent bank will call its account at the holding bank a nostro account, while the holding bank calls it a vostro account.

Here's an example to help make it easier to understand. Let's say Bank A makes an interbank deposit with Bank B, which is in a different country. The account is called a nostro account—our account on your ledger—to Bank A, while it's a vostro account or your account to Bank B.