Know About Interbank Lending Market Specifics: No matter how bigger a private or a government-owned bank is, they might require fundings to stroll their projects and offer loans or debts to people and companies. So, in case of the shortage of money, Interbank lending markets come into play.
In this, banks lend money to each other for a specific time or term. Most of the interbank loans come capped with a week or lesser time for return, and some of them mature overnight.
These loans create at the overnight or interbank rate.
The Relevance of The Interbank Lending Market
The significant contribution to the lending market was the recession of 2007-2008, that saw funds drying up and the volumes of transactions catapulting reversely. It led to the multifarious financial institutions collapsing like a pack of cards. The economic crisis deepened so much that it started gloating on banks as well.
Duties of Banks
Almost all banks have to keep a sufficient amount of liquid assets that revolves around funds or cash to provide customers when they withdraw their belonging for some reason. And in the absence, a bank borrows money from other banks and pays them back when replenished with enough resource.
The banks with an excess of liquidity at their end pass it to the one in need through the interbank market connectivity. However, a slight interest rate gets charged on it.
The interest charged on them is the interbank rate. It gets levied for short-term loans between banks. The exchange of money also assists in meeting the reserve requirements.
Dependence of the Rate of Interest
The charges of interest rates are directly proportional to the availability of cash in the market. Also, some criteria include the duration, the current prevailing rate and the contract terms.
Some of the most published and prevalent rates of interbank include Eurozone (Euribor), USA (federal funds rate), and UK (Libor), to name a few.
Money Market and Segmentation
It is, in one sense, the subsidiary of a bank to bank transactions, which uses the money market as a platform to accomplish the task.
Financial markets have a subset in the money market when looked at a higher canvas. Here the borrowing period remains somewhere between a year to less than a year. Using the method of purchase and sell conceptualised by money market instruments for transferring the funds. It includes highly liquid short-term loan securities.
The instruments enjoy the value equivalent to cash as they sell quickly in the market at a low cost. Their issuance happens in the unit of at least one million. The maturity date for them dwindles between three months or less.
Investors have options for secondary markets where they can sell their holdings before the maturity occurs. The facility is available to all money market instruments alike. It is an OTC market (Over-The-Counter).
Banks relish a significant role in every figment of the money market. Short-term uncollateralised loans get sold and bought by banks for meeting the need for daily liquidity quotient and meeting the reserved requirements. It all takes place at the federal funds market.
If banks are looking for loans for longer maturity, then they can seek the asylum of the Eurodollar market. Eurodollars are liabilities of banks that are dollar-denominated. Their location remains outside the US.
The banks of the United States can use their subsidiaries and branches to draw money from the Eurodollar market. On the other hand, they can also issue certificates of deposits. The bank holds the authority for their issuance. It means that a certain amount has been deposited to be withdrawn during maturity and with interest.
Repos or repurchase agreements and reverse repos are another funding source where a borrower pens a promise to sell securities to some lender.
The securities then repurchase after a specified time and price with an applicable interest rate. On the contrary to the federal funds, repos secure loans.
Contribution Interbank Lending Market
Transfer of Created Funds
It helps in the creation of credits and then transferring them subsequently to another bank. It fabricates the requirement for the money-lender bank covering the need of the depositor (customer) along with the borrower-bank for a short-term.
In the presence of only one commercial bank, the need for the interbank lending would detract as the money created would get re-deposited in the same bank, keeping the liquidity suffice.
Efficient Banking System
For the well-being of the banking system, interbank lending is pivotal. Banks are subject to regulate their funds and reserve. Hence, in that case, they may face scarcity of liquidity some times. So, the intermittent shortage gets channelised from the help of other banks, and the functioning of the entire system runs smooth. It manages the funding liquidity risk.
Know What is Liquidity Risk
It gets holds of the incapacity of a financial intermediary to comes to terms with the financial liabilities hovering over them for the are inept. Banks are majorly involved in these perils as finance and money is their forte. During lending and borrowing of credit may cut lose their interests or money. Their business model revolves around short-term to long term dispensation and hoarding the loan money. Also, they have deposits to pay with interests.
At times when interbank markets go kaput, then the funding source may risk in insolvency due to the liquidity crunch.
Sources of Funds
For driving the deposits from customers, banks are using short-term liability tactics, which is proving to be tacit considering the competitions. They are increasingly banking upon repurchase agreements, brokered deposits, certificates of deposits, commercial papers, and swapped foreign exchange liabilities.