Interbank Market

Banks' cash positions change constantly as customers deposit and withdraw money and make payments. At the end of each day, some banks have more cash than they need, while others are short. The interbank market allows them to lend and borrow among themselves to balance their positions.

Interbank loans can be unsecured, based on trust in the borrowing bank, or secured, through repurchase agreements in which the borrower provides collateral such as government bonds.

For example, a bank with surplus reserves at the end of the day might lend 100 million overnight to another bank that needs to meet its reserve requirements, earning interest for one night.

Interest rates in the interbank market are closely watched because they reflect banks' funding costs and confidence in the banking system. During the 2008 financial crisis, banks became reluctant to lend to each other, interbank rates rose sharply and lending dried up, forcing central banks to step in. Benchmark rates based on overnight transactions, such as SOFR in the United States, SONIA in the United Kingdom and €STR in the euro area, are used to price many financial products.