Interbank market: where banks trade currencies

Behind the currency rates you see, there is a giant market where banks trade with each other. It is called the interbank market. This guide explains what it is and why it matters for the rates everyone else pays.

Quick answer

The interbank market is the part of the foreign exchange market where large banks trade currencies directly with each other, in very large amounts. It sets the core exchange rates that flow through to businesses and individuals. The interbank market is wholesale, so ordinary people trade at rates derived from it, not at the interbank rate itself.

Key takeaways

• The interbank market is where banks trade currencies with each other.
• It deals in very large amounts, so it is a wholesale market.
• It sets the core exchange rates for the wider market.
• Ordinary people trade at rates derived from it.
• It is central to how the forex market works.

What is the interbank market?

The interbank market is the top layer of the foreign exchange market. It is where the world's large banks trade currencies directly with each other, usually in very large amounts. It is a wholesale market, meaning it deals in big volumes.

Because so much money flows through it, the interbank market sets the core exchange rates. These rates then flow down to companies, smaller banks and individuals, who trade at prices based on them.

How does the interbank market work?

Banks trade with each other to meet their own needs and those of their clients. A bank that needs dollars for a client can buy them from another bank. These deals happen constantly, keeping the market liquid and prices moving.

Trades are often arranged directly between banks or through electronic platforms and brokers. The size of a typical interbank deal is far larger than what an individual would ever trade.

Why does the interbank rate matter?

The interbank rate is the base or reference rate for a currency. When you exchange money at a bank or trade currency derivatives, your price is derived from the interbank rate, usually with a small margin added by the provider.

So the interbank market is the source of the exchange rate that eventually reaches you. When news says the rupee touched a certain level against the dollar, that level comes from the interbank market.

How does it relate to the rates I get?

You will almost never trade at the exact interbank rate. Banks and other providers add a margin or spread to cover their costs and profit. So the rate you get to exchange money or send it abroad is a little worse than the interbank rate.

The bigger and more standard your transaction, the closer you may get to the interbank rate. Small retail transactions usually carry a wider spread. Knowing this helps you understand why quoted rates differ from the headline market rate.

Why does the interbank market matter to investors?

The interbank market is the engine of the forex market. It is where the true price of a currency is discovered, and that price affects imports, exports, inflation and company profits. A move in the interbank rate ripples through the whole economy.

For investors, understanding that a real wholesale market sits behind currency rates helps make sense of how exchange rates are set and why they move. It is the foundation of the entire currency system.

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