In this paper, we investigate the capacity performance of an in-band full-duplex (IBFD) amplify-and-forward two-way relay system under the effect of residual loop-back-interference (LBI). In a two-way IBFD relay system, two IBFD nodes exchange data with each other via an IBFD relay. Both two-way relaying and IBFD one-way relaying could double the spectrum efficiency theoretically. However, due to imperfect channel estimation, the performance of two-way relaying is degraded by self-interference at the receiver. Moreover, the performance of the IBFD relaying is deteriorated by LBI between the transmit antenna and the receive antenna of the node. Different from the IBFD one-way relay scenario, the IBFD two-way relay system will suffer from an extra level of LBI at the destination receiver. We derive accurate approximations of the average end-to-end capacities for both the IBFD and half-duplex modes. We evaluate the impact of the LBI and channel estimation errors on system performance. Monte Carlo simulations verify the validity of analytical results. It can be shown that with certain signal-to-noise ratio values and effective interference cancellation techniques, the IBFD transmission is preferable in terms of capacity. The IBFD two-way relaying is an attractive technique for practical applications.