Interbank Rate

An interbank rate is a price set in transactions between banks. The term has two common meanings. In foreign exchange, it is the wholesale exchange rate at which large banks and dealers buy and sell currencies with each other, usually in large amounts and with narrow spreads. In money markets, it is the interest rate at which banks lend to and borrow from each other for short periods, such as overnight or three months. Both meanings describe the cost of money in the wholesale market, which is typically better than the rates offered to retail and business customers.

In payments and consumer finance, "interbank rate" is mostly used in the FX sense, as a benchmark for judging the cost of currency conversion. It is often treated as similar to the mid-market rate, although strictly the interbank market has bid and offer prices like any other market. In lending and derivatives, the interest rate meaning is linked to benchmarks such as LIBOR in the past and to newer reference rates today.

The interbank FX market is where the largest banks and liquidity providers trade currencies with each other, either directly or through electronic platforms and brokers. Trades are usually for millions of units and settle on the spot date. Because of the size and competition, spreads are very tight for major currency pairs. Prices move continuously during trading hours in response to orders, economic news and central bank actions.

Customers rarely receive the interbank rate. Banks, card networks and money transfer providers add a margin, known as a currency conversion markup or FX markup, to cover costs and earn profit. Comparing the rate a provider offers with the interbank or mid-market rate shows how much the customer is paying for conversion. Card networks publish daily conversion rates close to wholesale levels, while some fintech providers advertise conversion at or near the interbank rate and charge a separate fee instead.

Banks lend surplus funds to each other in the money market to manage daily liquidity. The rates on these loans reflect central bank policy rates, the supply and demand for liquidity and the perceived credit risk of borrowing banks. For decades, interbank offered rates such as LIBOR, EURIBOR, TIBOR and local equivalents like KIBOR were calculated from panel banks' submissions and used as benchmarks for loans, mortgages and derivatives worth many trillions of dollars.

After manipulation scandals and a decline in actual unsecured interbank lending, regulators led a move away from LIBOR towards risk-free reference rates based on actual transactions, such as SOFR in the United States, SONIA in the UK and €STR in the euro area. Most LIBOR settings ceased to be published by the end of June 2023. EURIBOR continues with a reformed methodology, and several other interbank offered rates remain in use in their markets.

• Benchmark for FX costs. Consumers and businesses use interbank or mid-market rates to evaluate conversion offers.
• Pricing loans and derivatives. Floating-rate loans, bonds and swaps are priced as a reference rate plus a margin.
• Forward pricing. The difference between interbank interest rates in two currencies determines forward points in FX forwards.
• Monetary policy signals. Movements in interbank rates show how central bank decisions are passing through to the wider economy and can signal stress in the banking system.

During periods of financial stress, interbank lending rates can rise sharply relative to central bank rates as banks become reluctant to lend to each other. In the 2007 to 2009 financial crisis, the gap between LIBOR and expected policy rates widened dramatically, signalling a breakdown of trust between banks, and central banks responded by providing large amounts of liquidity directly. In FX markets, stress can widen interbank spreads and cause sudden moves, particularly in less liquid currencies, which feeds through to the rates customers receive for currency conversion.

Because "interbank rate" has more than one meaning and there is no single official interbank FX rate, the phrase can be ambiguous in marketing and customer communications. Regulators in some jurisdictions require providers to disclose conversion costs against defined reference rates, such as central bank reference rates, rather than a vaguely described interbank rate, to make comparison easier for customers.