What Is the Interbank Rate?
Let me explain the interbank rate directly: it's the interest rate that U.S. banks charge each other for short-term loans. You see, banks borrow from one another to maintain the liquidity they need right away, or they lend out extra cash they have. This whole system is built for the short term—usually overnight, and it seldom goes beyond a week.
The term also covers the interest rate involved when banks do wholesale deals in foreign currencies with banks abroad.
Key Takeaways
Here's what you need to know: the interbank rate, which you might hear called the federal funds rate, is the interest on those short-term loans between financial institutions. It can also mean the foreign exchange rates banks pay when trading currencies with each other. In both scenarios, these are the absolute lowest rates available at any time, and they're strictly for the major banking players.
How the Interbank Rate Works
Federal regulators require banks to keep enough cash in reserve for everyday customer withdrawals. Banks handle this by borrowing to fill any gaps or lending out surpluses to earn a bit of interest.
The interest on that money ties directly to the current federal funds rate. This rate—also called the interbank or overnight rate—is set by the banks in the deal, not dictated by the Fed. But the Fed does influence it through the discount rate they control, aiming to keep the federal funds rate within a target range.
Think of the federal funds rate as the Fed's lever for adjusting the overall cash in the system. A low rate pushes banks to borrow more, while a high one holds them back.
During the 2008 crisis that started the Great Recession, the Fed dropped the target to 0%–0.25% and held it for seven years to boost borrowing and investment. They raised it gradually to 2.25%–2.5% by December 2018. Then, with the 2020 economic hit, they slashed it back near zero. Post-pandemic, it's climbed step by step, and as of July 2024, the target sits at 5.5%.
Don't expect to snag these near-zero rates yourself as a consumer. They're only for the biggest, most reliable financial institutions. That said, all borrowing or saving rates—like for mortgages or credit cards—start from this federal funds rate and add a premium on top.
Important Note
Let me be clear: you, as a consumer, won't ever get the interbank rate on a loan. It's reserved for the largest and most creditworthy institutions.
The Interbank Rate in Foreign Exchange
The other side of the interbank rate comes into play in the global interbank market, where financial institutions buy and sell foreign currencies. Here, the interbank rate—or interbank exchange rate—is simply the current value of one currency against another, shifting by tiny amounts constantly while the market's open.
Banks mostly do this trading to handle their own risks with exchange and interest rates, though they sometimes act for big institutional clients.
When you check two currencies in an online converter, that's the interbank rate you're seeing. But just like with interest rates, consumers don't get that exact rate when exchanging money. You'll pay the interbank rate plus a markup, which is the profit for the exchange service.
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