Interbank lending is banks borrowing from and lending to each other — usually overnight or for very short periods. At the end of each business day, some banks have excess reserves while others fall short. The interbank market lets them balance out.
The interest rate on these loans is the interbank rate — one of the most important rates in finance. In the US, it is the Federal Funds Rate. In the UK, it was LIBOR (now replaced by SONIA). In India, it is the call money rate. Central banks target this rate to control monetary policy.
When interbank lending freezes, the entire financial system is in danger. During the 2008 crisis, banks stopped trusting each other and refused to lend — even overnight. Interbank rates spiked, credit markets seized, and central banks had to inject trillions in emergency liquidity to prevent a total collapse.