What is the Interbank Rate
The interbank rate is the rate of interest charged on short-term loans made between banks. Banks borrow and lend money between each other in the interbank market in order to manage liquidity and meet the reserve requirements placed on them by regulators; the rate depends on maturity, market conditions and credit ratings. The interbank rate can also refer to the price at which banks conduct wholesale foreign exchange transactions in both the spot and forward market; spreads are tighter than for smaller retail transactions.
BREAKING DOWN Interbank Rate
Interbank rates in both the interest rate and foreign exchange markets are available only to the largest and most creditworthy financial institutions.
Interbank Interest Rates
Banks are required to hold an adequate amount of liquid assets to accommodate withdrawals from and payments by clients. Day-to-day liquidity needs are generally managed by borrowing to cover any shortfall and lending any excess liquid assets.
The Intercontinental Exchange London Interbank Offered Rate, known as ICE Libor, was previously known as the BBA Libor rate. Following a rate-rigging scandal in 2015, ICE assumed responsibility for the daily survey that sets benchmark rates for five currencies (U.S. dollar, Swiss franc, euro, British pound and Japanese yen) over seven maturities. Between 11 and 18 banks are surveyed for each rate setting. Libor rates are used for many interest rate swap and floating rate loan resets as well as loans between banks.
Interbank trading is especially active in the overnight eurodollar market, which is for U.S. dollars held in offshore branches. Transactions generally take place at or near the fed funds rate, which is the Federal Reserve Bank's target rate. Many of the banks' trading rooms are physically located in the United States, even though transactions are nominally booked offshore.
Interbank Foreign Exchange
The spot foreign exchange market is by far the largest in the world, with more than $5 trillion changing hands daily. The largest portion of the activity takes place in the interbank market, in which the largest trading rooms execute transactions that range from $25 million to over a billion dollars each. The most actively traded currency pairs are the euro vs. the U.S. dollar; the dollar vs. the Japanese yen; British pound vs. the dollar; and the Swiss franc vs. the dollar. The forward market, which includes any transaction with a maturity longer than spot, is most active in the same currency pairs.
Interbank trading is dominated by several large multinational banks, led by Citibank, Deutsche Bank, HSBC and JP Morgan Chase. Much of the business is done via electronic platforms such as Reuters 3000 and Bloomberg.