Interbank trading entails the worldwide trading in financial instruments carried out between banks. It is done on the interbank market involving money, securities, foreign exchange, varieties, precious metals or derivatives at interbank prices.
For money lending internationally recognized reference rates such as EURIBOR, LIBOR or the EONIA interest rate calculation are used. EURIBOR (Euro Interbank Offered Rate) is an internationally representative rate of the euro money market interest rate paid by banks on unsecured euro-deposits with a maturity of twelve months.
LIBOR (an abbreviation for London Inter Bank Offered Rate) was introduced for the first time in January 1986, as the reference rate for short-term loans (overnight to 12 months). It is determined daily under the auspices of the British Bankers’ Association (BBA) for unsecured deposits in other currencies.
EONIA (Euro Overnight Index Average) is an average rate of unsecured overnight deposits in the interbank market, employed since April 1999, it is aso calculated on on a basis in relation to actual sales.
The banks participate in the interbank market for two reasons, either to take on open positions that were previously developed in the retail trade, own or operate proprietary trading before closing out. And to make the interbank market as an allocation mechanism with the objective of efficient allocation of bank risks.
All transactions on the interbank market are subject to the provisions of the solvency regulations and other laws. And are monitored for supervisory purposes, because open positions are supported with equity.
Inter-bank foreign exchange market constitutes exchange intermediation services by banks on behalf of their clients. This is an international market and foreign banks can participate; applicable exchange rates are employed.
On a full inter-bank market, all financial institutions interact with each other without discrimination, whereas an incomplete interbank market is characterized by the fact that some banks are ignored as market participants. This has a contagion effect as it can translate to theoretically incomplete interbank markets.
The interbank market is not without risk. By abstracting typical commercial risks (market risk) that can be minimized by offsetting transactions or even eliminated. There remains in all the transactions in the interbank market counterparty or default risk. The underlying factor in this risk is that a transaction partner may not fulfill its obligations, because it has become insolvent.
Inter-bank relations are forged as financial institutions interact in the context of two-way payment and securities settlement transactions. However, threats to such mutual activities is borne out of the possibility of disturbances in cases of far-reaching systemic or financial crises.