Business, Legal & Accounting Glossary
The interbank market refers to the market where banks make loans to each other. A bank in need of additional funds to meet its liquidity requirements, for example, will take out a loan from another bank in the interbank market. On the flip side, a bank with excess funds can participate in the interbank market to extract more value out of its liquid assets. A bank can also use the interbank market to quickly raise the capital it needs to fund a venture. Various interest rates are used in the interbank market, including the widely used London Interbank Offered Rate (i.e. LIBOR). Other rates used in interbank market transactions are the Euro Interbank Offered Rate (i.e. EURIBOR) and the Tokyo Interbank Offered Rate (i.e. TIBOR). The interbank market is watched closely to assess credit risk and measure the state of the economy. Indeed, in a credit crunch situation, interbank market activities will slow down significantly or even freeze up (i.e. banks don’t trust that other banks taking out loans in the interbank market will be able to repay). Such uncertainty in the interbank market can cause LIBOR rates to spike and the TED spread to widen.
The interbank market is an exclusive market where large financial institutions borrow and lend money for a specified term at the interbank rates. The loans are usually for a very short duration of time, lasting no longer than a week, and are often used to help banks meet cash reserve requirements. Banks are required by law to hold an adequate amount of liquid assets. If a bank cannot meet these liquidity requirements, it will borrow money in the interbank market to cover the shortfall. On the other hand, some banks have excess liquidity, above and beyond the requirements. These banks will lend money, receiving interest on the assets. The interest rates charged on short-term loans between banks depend on the availability of money in the market, and on the specific terms of the contract, such as the duration for which the loan is required. One of the major contributing factors to the financial crisis of 2007 was the low transaction volume in the interbank lending market.
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This glossary post was last updated: 30th December, 2021 | 0 Views.