Banks lend to each other constantly. Some have more cash than they need. Others are short. The interbank market matches them, moving enormous sums overnight and for short terms. It is the plumbing of the financial system, and when it clogs, the effects are immediate and severe.

The market operates in several ways. In the unsecured market, banks lend to each other on trust, with no collateral. The interest rate on those loans, such as LIBOR historically or SOFR today, serves as a benchmark for trillions of dollars in loans and derivatives. In the secured market, banks lend against collateral, usually government securities. Repurchase agreements, or repos, are the largest segment. In a repo, one bank sells securities to another and agrees to buy them back the next day at a slightly higher price. The difference is the interest.

When banks lose confidence in each other, the interbank market freezes. In 2008, banks stopped lending overnight because no one knew which institutions held toxic mortgage assets. Central banks stepped in as lenders of last resort, injecting liquidity and guaranteeing deposits. The same happened in 2020, when the pandemic caused a dash for cash.

The interbank market is invisible to the public, but it determines the availability and cost of credit throughout the economy.