Interbank Market

An Interbank market is a marketplace where several banks trade currencies between them. Also called a currency market, the main purpose of an interbank market is to facilitate the exchange of funds within private-based banks of several countries at the international level. 

The interbank market consists of four main components- spot market, forward market, swap trade, and SWIFT. It is an informal market dealing only in currencies. Trades in this market occur either in spot or cash markets. However, factors like market volatility can affect the interbank market. 

• An Interbank market is a marketplace where financial institutions like banks can trade and settle currencies with other countries' banks. 
• The four main components of this market include swap trade, spot, forward, and SWIFT market. 
• Its history started in the mid-18th century (1752) in Scotland, where Gaskin bank and other relatively smaller banks had a mutual acceptance agreement.
• The only difference between the interbank and FOREX market is that the former involves only banks, whereas the forex market includes everyone.  

The Interbank market is an international marketplace that authorizes several banks to trade currencies within themselves. It falls under the subcategory of the interdealer market. Banks and other financial institutions trade assets on the client's behalf. It is vital as it helps banks regulate interest risk and exchange trade. 

According to interbank market regulations, it follows a floating rate system where the currency rate depends on the demand and supply forces. As a result, the transactions often happen in bulk trades, more than $100 million in a few seconds. However, certain interbank market regulations matter during transactions. Let us look at them:

• Currency transactions are settled in two business days. However, USD (United States Dollar) to CAD (Canadian dollar) settled in one day. 
• Delays in settlements lead to netting agreements where banks have to get credit from their counterparties. 
• The bid price is the price a bank has to pay, and the ask price is the value they will receive. However, there are commissions and transaction fees included at the payment gateway.  

The Forex interbank market operates internationally and has four main components. Let us look at them:

• Spot Market: A financial institution can buy currency at the exact trade point. As a result, it enables on-the-spot currency transactions.
• Forward Market: It acts similarly to the forwards and options. Here, the parties exercise their rights on the agreed price and future date. 
• Swap Trade: Swap trade is a combination of both spot and forward trade. It allows the bank to buy at the spot (current price) and sell as per the forward trade. 
• SWIFT (Society for Worldwide Interbank Financial Telecommunications): SWIFT allows the parties to send and receive information about transactions safely and securely. 

The history of the interbank market dates back to the mid or late 18th century. In 1752, there was a mutual acceptance of trade between the two largest banks (i.e., Gaskin and other small private banks). During the late 1780s, banks in Scotland developed exchanges that conducted inter-regional settlements. Between 1887 to 1902, ten clearing houses were set up that eased the currency transactions in Canada.

Later, in the 19th century, interbank transactions grew in the United States. As a result, in the early 1900s, England's banks saw a rise in currency used in deposits. Likewise, in the second half, states in Canada also started such interbank market transactions. 

During the 1970s, the international banking system and the forex market increased tremendously. Thus, as the economy developed, more people engaged in interbank market trades. In 1981, the international interbank market between U.S. banks accounted for more than 70%. As a result, by the late 1990s, New York became the apex city to perform inter-regional transactions. 

Let us look at some examples of the interbank forex market to understand the concept better:

Example #1

Suppose Bank of America enters into an interbank transaction with another bank. As per the regulations, this American bank conducted spot trade with a Scottish bank, exchanging currency at the current rate. However, a few months later, Asian banks engaged with a European interbank market where the currency settlement occurred on a future date.

During the first transaction, the American bank traded at a bid price, and the Scottish bank received an asking price. Similarly, it happens for the second transaction between Asian and European banks. 

Example #2

According to the interbank market data, in November 2022, financial institutions transferred funds from the interbank market to Beijing's green and low-carbon sectors. Likewise, from January to September, $34 billion was raised through interbank settlements.

According to the National Association of Financial Market Institutional Investors, it rose to 15.5%. In addition, the interbank market data rate of the U.S. rose from 0.14% to 2.76% in September. 

Although interbank and open market rates operate at the international level, there is a slight difference between them. The former is the rate paid by the banks for accessing short-term loans. In contrast, the central banks pay the latter on buying any debt instrument from the open-market operations. While the former depends on the Federal fund rate, the latter depends on the changes in the demand and supply of the money supply.  

Although interbank and forex markets deal in currency, they differ slightly. In the former case, the banks of various nations deal in currency settlements with each other. In contrast, anyone can perform the trade in the forex market, unlike the former. Compared to others, the former allows banks to minimize interest risk and increase the exchange rate. However, the latter focuses on enabling overall acceptance of a market where everyone can deal in currency using spots, forwards, and futures. 

This has been a guide to what is Interbank Market. Here, we explain it with its examples, comparison with open and forex market, components, and history. You can learn more about it from the following articles –

• Forex Market
• Fixed Income Market
• TED Spread