What is Interbank Market?

Published by Thomas Herold in Economics

'Interbank Market' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

The Interbank Market refers to the modern day financial system which involves banks trading cash and other instruments with other financial institutions and banks. This never involves banks trading money with non-financial businesses, consumers, or retail investors. It is possible for interbank trading to be pursued by banks for the benefit of their bigger customers, yet in general such trading between banks proves to be proprietary. This means that it happens between banks on the behalf of their own company accounts.

Interbank markets also involve FOREX foreign exchange services in a commercial capacity of buying and selling currency pair investments. There can be long-term trading as well as huge quantities of shorter term, speculative nature currency trading. The Bank of International Settlements stated in information which they compiled and analyzed in 2004 that around fifty percent of all transactions on the world FOREX markets are strictly interbank market trade.

It was after the failure of the Bretton Woods agreement and the catastrophic decision of then-American President Richard Nixon to abandon the gold standard back in 1971 that the present-day form of the interbank market arose and developed. Currency exchange rates for the majority of the big and economically important industrial countries became freely floating at this time. It was only on occasion that the various national governments chose to intervene in the interbank markets where their own currencies were concerned.

These markets do not have any central or single location or authority. Instead, the trading occurs all over the world in every time zone and during six days per week from Sunday afternoon through Friday afternoon. The only exceptions to this schedule are the few internationally and unanimously recognized holidays, such as New Year’s Day.

The arrival of this new floating rate system of exchange happened to occur as the inexpensive computer systems and program revolution emerged. This happy coincidence permitted for quickly executed, globally-based exchange trading for the first time in history. At first, voice brokers utilized the phone and later fax machines to match up sellers and buyers in these earliest days of the interbank FOREX trading. These eventually became replaced by the new fast and far more cost-effective computer systems.

The computer systems which became connected by the Internet in time could scan huge volumes of traders and obtain the most optimal price in this way. Thanks to both Bloomberg and Reuters who created impressive trading systems which became ubiquitous around the world, banks gained the ability to trade literally billions of dollars in transactions at the same time. On the busiest days in the FOREX and interbank markets nowadays, daily trading volume exceeds more than $6 trillion.

The biggest market participants are the interbank market makers. Such financial institutions have to be both willing and able to extend pricing to other players in the market besides requesting prices for themselves and their own interest in trades. Interbank market deals have minimums which start at $5 million. The majority of transactions are vastly larger. Sometimes they exceed a full billion dollars in only a single transaction. The biggest players in the interbank markets by far are United States market makers JP Morgan Chase Bank and Citicorp, German and European market maker Deutsche Bank, and Asian market maker (London- based) HSBC.

The majority of such spot transactions agreed on the interbank markets will settle two business days following the trade execution. The biggest exception to this policy lies with the American dollar versus the Canadian dollar. It settles the following day. This settlement delay requires banks to maintain extensive credit lines (even when these are current spot trades) with their peer financial institutions so that they can trade continuously.

To lower the risks inherent with settlement, most banks engage in netting agreements. These agreements require that an offsetting transaction must be done within the identical currency pair which will settle on the exact same day as the opposing transaction. In such a way, the banks are able to drastically reduce the quantity of money which must change hands, as well as the default risks which could happen if one trading bank suddenly and unexpectedly encountered financial problems.

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The term 'Interbank Market' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.