What is the Interbank Market?

The interbank market is the forum through which banks trade currencies. It is a foreign exchange market, which means that it trades only in the currencies of various countries, as opposed to stocks, mortgages, or other assets. This market is important because the currencies of most countries have floating exchange rates. Their values fluctuate based on the value of other countries. Trade on the interbank market helps to set those values.

The buyers and sellers on the interbank market are generally banks or other financial institutions. Through their trading, these banks set the value for international currency similar to the way that stock trading sets the value of companies and commodities in the United States. Banks that participate in the interbank market are known as market-making banks.

When trading on the interbank market, banks can choose to trade directly with each other or go through an intermediary. These intermediaries are called electronic brokering platforms. The two largest electronic brokering platforms are Electronic Broking Services (EBS) and Reuters Group Limited. Before EBS was created, Reuters Group Ltd. had a near monopoly on the electronic brokering market. EBS was created by a partnership of large market-making banks in the foreign exchange market.

Three forms of operation work together to create the interbank market. These are the forward market, the spot market, and the Society for Worldwide Interbank Financial Telecommunication, or SWIFT. The spot market trades for cash on the spot. In most cases, the currencies trade hands within two business days, the amount of time it used to take banks to move money from one bank to the other before electronic banking became common. By contrast, in the forward market traders create a contract for future delivery of a given amount of currency.

Unlike the other two, SWIFT is not a market. It provides a standardized way for banks all over the world to communicate with each other. As of fall 2010, SWIFT could pass messages between more than 9,000 financial institutions all over the world. SWIFT is owned by member banks and is headquartered out of Brussels, Belgium.

SWIFT offers banks several advantages to communicating on their own. First, SWIFT sends payment messages in a very secure format for the protection of financial information. Second, all SWIFT messages follow a standard format. This means that banks all over the world are able to read messages sent by others. SWIFT is now the industry standard for message formatting and content, even when the message is not sent over the SWIFT system.