What is the Interbank Rate?
The interbank rate or interbank exchange rate is a financial concept used to express foreign exchange rates, which are paid by banks when they conduct currency trading with other banks. Interbank, or “between banks,” is when a bank pursues business with another bank.
Somewhat similar to the stock market, interbank currency trading occurs from 5:00 p.m. Sunday Eastern Standard Time to 4:00 p.m. Friday Eastern Standard Time.
An alternate definition of the interbank rate refers to the interest rates charged on short-term loans made between two U.S. banks.
How Interbank Rates Work
As mentioned, interbank rates are the foreign exchange rates that are set when one bank decides to engage in currency trading with another bank. However, interbank rates are not similar to regular foreign exchange rates.
For example, let’s say that the foreign exchange from the United States dollar to the Australian dollar is 1.31. It means that it takes 1 USD to purchase 1.31 AUD. It would not be the same rate used on the interbank market.
Several other factors come into play when dealing with other banks on the interbank market, such as the market condition, relationships, and business fees.
1. Market Condition
Like the stock market, the buying and selling of foreign currencies directly influence the price of a monetary unit. For example, if HSBC thinks that the price of the Japanese yen may rise, it will attempt to buy a large number of Yen from another bank, thus driving up the price of JPY due to high demand.
Interbank trading platforms allow banks to become price makers because they are able to set whatever interbank rate they deem reasonable. Since the banks can act as price makers, achieving and maintaining strong relationships with other interbank counterparts becomes crucial.
A strong relationship does not pertain to price-fixing, however. Banks are unable to fix the interbank market by conducting unreasonable business with one another.
3. Business Fees
In most cases, interbank rates are generally higher due to business fees. For example, a bank may charge business fees during foreign exchange because they hold a limited supply of one specific currency.
Why would the business give up all of their supply of NZD (assuming it’s limited) without first charging a higher rate to make up for the absence/loss in supply of NZD?
To put it more bluntly, banks may charge business fees just for doing business with them.
Interbank Trading Platforms
Considering interbank rates only occur when banks conduct business with one another, specialized interbank trading platforms such as EBS and Refinitiv now exist. EBS is considered more popular and widely renowned within North America and Europe, while Refinitiv is the main interbank trading platform in Asia.
The interbank trading platforms allow banks to directly call their interbank counterparties and ask for a price on the desired currency. In addition, international banks can provide prices to the systems (becoming a price maker) or execute transactions (buy/sell) on published prices (becoming a price taker).
The platforms continue to grow in popularity due to the increased liquidity created by directly communicating with other banks and negotiating prices almost immediately.
However, the direct communication mechanism may also adversely affect liquidity. When banks start to pester their peers about prices, it could reduce the chance of a developed relationship or continued price discussion.
Dominant Interbank Market Players
Foreign exchange conducted between two banks is conducted on the interbank market. There is an assortment of multinational banks that use interbank trading platforms to conduct business with their respective interbank counterparts within the market.
Some of the largest multinational banks that use the platforms deal with negotiating interbank rates on a day-to-day basis. Some of the more notable banks that heavily conduct interbank trading include:
- Citicorp (based in the United States)
- JP Morgan Chase (based in the United States)
- HSBC (based in Asia)
- Deutsche Bank (based in Germany)
Considering the stature of the multinational banks above, it is not unexpected to see trades of up to $100 million occur between the said banks in a matter of seconds.
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