Interbank rate

Definition

The interbank rate refers to the interest rate at which banks lend funds to each other in the interbank market. 

What is an interbank rate?

The interbank rate facilitates the flow of funds between banks, allowing them to borrow or lend money to meet short-term liquidity needs or to manage their balance sheet positions. Banks may borrow funds in the interbank market to cover temporary shortages of cash or to fulfill reserve requirements.

The interbank rate is determined through a competitive process in the interbank market, where banks submit bids to borrow or lend funds for various maturities, typically ranging from overnight to several months. The current interbank rate for a specific currency and maturity is influenced by factors such as supply and demand dynamics, market interest rates, central bank policies, and overall market conditions.

Furthermore, the interbank rate plays a key role in financial markets by influencing the cost of borrowing and lending for banks and serving as a benchmark for pricing various financial instruments. Changes in the interbank rate can have a broader impact on interest rates throughout the economy, impacting consumer lending rates, corporate borrowing costs, and overall monetary policy effectiveness.

Example of an interbank rate

In the interbank market, Bank A agrees to lend $10 million to Bank B for a period of one month. The agreed-upon interest rate for the loan is set at 2.5% per annum. This means that Bank B will repay the principal amount of $10 million plus interest of $20,833 ($10 million x 2.5% / 12) at the end of the one-month period.

In this example, the interbank rate of 2.5% per annum represents the interest rate at which funds are borrowed and lent between banks in the interbank market for the specified period of one month.