What Are Interbank Deposits?
Let me explain interbank deposits directly: this term describes an arrangement where one bank holds funds in an account for another bank. In this setup, the holding bank must open a 'due to' account for the other institution. This is essentially a general ledger account that holds funds payable to another party. Here, the correspondent bank is the one depositing the funds and waiting for the arrangement to take effect.
Key Takeaways
To break it down, an interbank deposit is simply an agreement between two banks where one maintains funds in an account for the other. This requires the holding bank to establish a 'due to' account. Remember, most interbank trading in the market is proprietary, meaning banks handle it directly between themselves and for their own purposes.
Understanding Interbank Deposits
You should know that interbank deposits form part of the broader interbank market. This market is a system where banks and financial institutions trade currencies, but it excludes retail investors—those are individuals trading for personal accounts rather than for companies or organizations—and smaller players.
Most trading in this market is proprietary, done between banks for each other. However, there are cases where it serves large institutional customers.
In the interbank market, banks borrow and lend to one another to manage liquidity and satisfy reserve requirements set by regulators. A reserve requirement is the minimum amount of money a bank must keep in its vaults. Deposits and loans are key transactions that help meet these needs, and they add significant liquidity to the market.
When two banks agree on an interbank deposit, the holding bank creates a 'due to' account for the correspondent bank making the deposit. This account is a payable holding account.
Banks apply a specific interest rate to these deposits and short-term loans, called the interbank rate. This rate varies based on maturity, market conditions, and the credit ratings of the involved banks. These are the lowest rates available at any time, reserved exclusively for major banking institutions.
What Is Correspondent Banking?
As I mentioned, the bank for which the 'due to' account is held is the correspondent bank. This term usually applies to deposits between domestic banks. But when the correspondent bank is foreign, the terminology shifts.
In that scenario, the 'due to' account becomes a nostro account—from the Latin for 'ours'—for the bank holding the deposit. This is an account in a foreign currency held at another bank. Conversely, it's a vostro account—Latin for 'yours'—for the foreign correspondent bank. A vostro account is how a bank refers to accounts other firms hold on its books in its home currency.
Consider this example to clarify: if Bank A deposits at Bank B in a different country, Bank A calls the account a nostro—our account on your ledger—while Bank B calls it a vostro, or your account.
Frequently Asked Questions (FAQs)
Why do banks make interbank loans and deposits? Banks borrow from others to secure liquidity for immediate needs or lend and deposit excess cash. These are short-term, often overnight, and seldom exceed a week.
What's the difference between ACH and interbank deposits? An ACH transfer is for businesses and individuals in retail banking, processed through an interbank system for verification. Interbank deposits, however, are strictly between financial institutions.
What is a 'due to' account used for in interbank deposits? In such arrangements, the holding bank sets up a 'due to' account for the depositing correspondent bank. It's a payable holding account.
The Bottom Line
To wrap this up, an interbank deposit is an arrangement where one bank holds funds in an account for another, requiring a 'due to' account—a general ledger with payable funds. The correspondent bank is the depositor. These deposits are typically limited to financial institutions and not available to individuals or non-financial businesses.
Other articles for you
A Tax Identification Number (TIN) is a unique nine-digit identifier used by the IRS to track taxpayers and administer the U.S
Historical cost is an accounting method that records assets at their original purchase price on the balance sheet.
Deleveraging is the process of reducing debt to lower financial risk and improve balance sheet health.
Death benefits provide tax-advantaged financial support to beneficiaries upon the death of the insured through life insurance, annuities, or pensions.
A window guaranteed investment contract is a low-risk investment where investors make installment payments to an insurance company for guaranteed returns over time.
An implied contract is a legally binding agreement formed by actions or circumstances rather than explicit words.
A wet loan is a mortgage where funds are disbursed before all documentation is complete, allowing faster property purchases but with higher risks.
Interest rate swaps allow parties to exchange interest payment streams to manage rate fluctuations or secure better terms.
The marginal rate of substitution (MRS) measures how much of one good a consumer is willing to give up for another while keeping the same level of satisfaction.
A variable-rate CD is a savings account with a fixed term but changing interest rates tied to market factors, offering potential gains if rates rise but risks if they fall.