A market for loans (known as interbank loans) that are extended and assumed between banks and financial institutions within the same banking sector. Interbank markets are typically perceived to be dominated by overnight deposits and repos. These consist of short-term instruments traded in rather risk-avert set-ups. These loans represent certain means by which banks can co-insure short-term liquidity risks.

It is an informal market where banks borrow from and lend to each other with pre-set internal limits defined by a bank’s risk appetite. The interbank market plays a vital role at the level of local financial systems because in this market central banks regulate all operating banks by means of setting policy interest rates, and through well-functioning interbank markets, efficient liquidity transfer can occur between surplus and deficit banks.

An efficient interbank market can also allow risk sharing between individual banks. It also allows banks to adjust the size of their assets and liabilities (i.e., balance sheets)  as well as to manage the interest rate risk and exchange rate risks that arise from dealings with their customers.