Interbank Rate - Explained
What is the Interbank Rate?
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Table of ContentsWhat is the Interbank Rate?How Does the Interbank Rate Work?Interbank Rate in Foreign Exchange
What is the Interbank Rate?
Banks or financial institutions borrow money from other banks to finance certain operations and ensure high liquidity to meet their needs. Such loans are short-termed, usually overnight loan or a loan repayable within a week. Banks that have excess money in their reserve can also lend money to other banks. Such lending transactions are done in the interbank lending market and there are rules guiding such markets including the interbank rate. In the United States, the interbank rate refers to the interest rate banks charge one another in the interbank lending market. It refers to interest charged on short-term loans issued or received by banks.
How Does the Interbank Rate Work?
The interbank rate is otherwise called the federal funds rate. This rate is not applicable to customers who take loans from bans, rather, it is used between financial institutions due to their creditworthiness. The interbank rate is also defined as the foreign exchange rate that banks pay when they engage in currency trades with other banks. In the United States, there is a reserve rate that all banks are expected to maintain, this is the minimum amount of cash they must have in their reserve. Banks that do not meet this requirement can take a loan from other banks, such loans attract interbank rate. Interbank rates can be low or high when it is low it encourages free lending and borrowing between banks while high interbank rates discourage borrowing between banks.
Interbank Rate in Foreign Exchange
The interbank rate is commonly used in the global market for foreign exchange transactions between banks in different countries or for banks that want to exchange different currencies. In this context, the interbank rate refers to the present value of a currency as against the value of another currency. The interbank exchange rate is not static, it fluctuates depending on the current value of the currency. When two currencies are to be traded for each other, the interbank rate is used. However, it is important to point out that interbank exchange rates are not used when consumers want to exchange foreign currencies, the rates are only available for multinational banks. Here are the important things you should know about the interbank rate;
- The interbank rate refers to the interest rate charged when banks lend/borrow money to/from other banks on a short-term basis. In the United States, the interbank rate is otherwise called the Federal funds rate.
- The interest rate charged fro foreign exchanges between multinational banks is also known a the interbank rate or interbank interest rate.
- Interest rates are not used for consumers, they are only used between banks.