Interbank markets cover the short-term buying and lending that commercial banks do with one another. How much should banks pay to borrow short term? Interest rates are quoted in annual terms, but most interbank loans are made for periods less than one year. How much money must be paid to borrow short term? Monetary policy is the most direct impact on interbank markets. We learn how short-term lending can be described in annual terms. In this brief segment, we examine the calculation of interest rates on short-term lendering. After reviewing this segment, you should be able to; one, calculate required interest payments for short-term interbank lending using the annualised interbank rate. short-term interbank lending is an active segment of the money market. The most closely watched interbank interest rate is often the overnight rate. Many of the key interbank rates that are used for targeting monetary policy are also an overnight interest rate. This graph shows the quantity of loans of different maturities outstanding in Thailand's interbank market at the end of 2016. Commercial banks have relatively easy access to short-term funds from their depositors and also need to provide liquidity to their accounts holders. Thus banks may be the most active day-to-day participants in the money market both as borrowers and lenders. As a result, the market for lending between banks, the interbank market is the core of the short-term lending market. We see that the largest category of lending is for overnight lending which is more than 30 billion baht larger than the lending levels at all other maturities less than six months. Let's develop some notation first. Start with the interest rate in its simplest form. Consider the interest on a loan that will be repaid in full in exactly one year. The lender transfers the principal, say $10,000,000, to the borrower at the beginning of the year. The borrower will repay the principal at the end of the year plus interest. The loan will side an interest rate which is the premium over the initial principal repaid by the borrower, say five percent. The repayment will exceed the principal by five percent. For calculation purposes, we consider the interest rate in standard form. Defined small i's and net interest rate which is the annual percentage interest rate divided by 100. So, if the lender quotes an interest rate of five percent, then i will be equal to 0.5. Mathematically, the final repayment after one year would be calculated as the initial principal multiplied by quantity one plus i. So if the initial principle is 10,000,000, the final payment would be 10,500,000. It is important to understand the precise meaning of the interest rate in money markets. Interest rates, even very short run interest rates, are quoted in annual terms. There is a simple formula to calculate how much interest would be paid on a short-term loan given a specific annualized interest rate. The interest payable on a loan over a period of less than one year is the quoted interest rate i multiplied by how long the loan lasts as a fraction of the year multiplied by the original principal. For the purposes of such calculations, every economy has its own day count convention governing the number of total days in the money market year. In some countries, number of days in the year is set as the actual number of days, usually 365. Other markets may use the round number of 360 to make calculation easier. Consider an example. A loan with a principal of 10,000,000 and an annualized interest rate of five percent is to be repaid in one week, assume a 365 day year. At the end of seven days, the borrower repays 10,000,000 times five percent divided by 100 multiplied by seven over 365. This is almost $9,600. After viewing this segment, you should be able to: one, calculate required interest payments for short-term interbank lending using the annualized interbank rate. As we wrap up, let's conclude by summarizing the key question. How much do banks pay to borrow short term? We've seen interest payments and short-term loans are proportional to the product of the annual interest rate times the principal. The factor of proportion is a fraction of the year that the money is lent.