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The foreign exchange market Forex: Interbank Explained

The foreign exchange market is the largest and most liquid financial market globally, with an average traded value of $5,000,000,000. Currency trading allows you to buy and sell currency pairs at their exchange rates to gain profit which is, for some, a hobby where they invest a percentage of their income to forex, while some forex trading is where they make a living.

There are two levels of the forex market which are the over-the-counter (OTC) and Interbank forex market. Interbank market usually consists of major players (traders), or you can say “more formal.” On the other hand, OTC is less formal and much more popular with individual traders, given you can trade any time of the week with this.

Interbank FX Market

What is the Interbank Forex market? The term “interbank” refers to transactions and balances among banks and financial institutions, regardless of country, kept entirely in an electronic database. These systems make transferring currencies instantly and fairly simple between banks without the need for multiple intermediaries. It is essential to understand what these systems do and why they are important for your financial well-being. The interbank market protects investors, companies, and consumers against systemic risks and further facilitates financial services by making trading more transparent and convenient.

The international interbank market is the largest in the world for financial instruments. It consists of trading across twelve time zones and thirty-two countries. The prices for these instruments are quoted in US dollars and vary by dealer, the underlying asset, and other factors. Because the market is global, forex traders may execute orders from any country at any time. The primary participants in the exchange include major banks, broker-dealers, trust companies, and financial institutions such as banks, brokerage firms, investment firms, and subsidiaries of these institutions.

Interbank Pricing

The primary factors that determine interbank forex pricing include the Federal Reserve’s policy on payments between banks, changes in funding practices such as short-term funding programs and longer-term bilateral agreements between central banks, as well as changes in bank industry regulations. Following the Great Recession, standard theories about bank pricing were challenged – particularly, how such broad-based factors as capacity limits, capital adequacy, and profitability can influence interbank pricing across various currency pairs globally and in a practical way.

When you are currency trading in an interbank broker, your profit or loss depends upon whether your broker has a good reputation and sources of liquidity (i.e., banks with large money reserves that they can use to lend directly to borrowers). A good reputation often results in lower transaction fees and more favorable pricing for borrowers.

Interbank Bid-Ask Spread

The interbank bid-ask spread refers to the difference in the prices that banks are willing to pay for US dollars and other currencies. This spread reflects the actual cost of financing for lenders and borrowers across the financial system. Lenders use it to help determine how much credit should be available in an environment of tight liquidity. By establishing a consistent price for financial instruments for most financial institutions, the interbank bid/ask spread fair and efficient global market pricing for financial instruments available for trading across financial markets.

Bid-ask spreads represent what banks charge each other to exchange dollars for other currencies. For example, if the euro is being traded at USD 1.072, then the largest bank in France will have to pay their counterpart at least USD 1.072 to take their dollar and give it to them electronically. The spread represents how much each bank pays each other for facilitating the trade, both in terms of overhead costs (time, staffing, etc.) and revenue (checking and savings accounts vs. investments/trading assets/etc.).

Interbank Participants

Interbank participants are often the world’s largest banks, such as Deutsche Bank in Germany, HSBC in Asia, Citicorp, etc. The interbank market is also used by the government and large trade firms. Finally, most interbank brokers only accept major currencies like the US dollar, Canadian dollar, and Japanese yen.

Key Takeaway

The interbank FX market is a significant and liquid financial market that giant financial institutions and the government use. The interbank is where the market is more situated to people who prefer a forex market that is “more formal” since the interbank is a subset of the forex market where big financial markets and the government itself use to trade currencies.

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