The Euro Overnight Index Average (EONIA) was the primary overnight reference rate at which European banks lent to one another in euros. This rate played a crucial role in the interbank market and was a key benchmark until European regulatory changes led to its replacement by the Euro Short-Term Rate (ESTER) in January 2022.
Key Highlights
- Interbank Lending: EONIA served as the lending rate for one-day loans between European banks.
- ECB Calculation: The rate was calculated by the European Central Bank (ECB) based on transactions made by a select group of 28 panel banks.
- Regulatory Reforms: Due to European regulatory reforms, EONIA was replaced by the more comprehensive Euro Short-Term Rate (ESTER) in 2022.
How the Euro Overnight Index Average (EONIA) Functioned
EONIA was a daily reference rate expressing the weighted average of unsecured overnight interbank loans across the European Union and the European Free Trade Association (EFTA). Managed by the ECB, this rate was derived from the transactions of 28 major panel banks.
Banks have to comply with reserve requirements set by the central bank, maintaining a specified percentage of total deposits on hand rather than lending them out. These reserves protect the banks and ensure they have sufficient liquidity to cover potential loan losses. At times, banks may face short-term cash flow shortages, which could force them to borrow from other banks with liquidity surpluses. The interest rate for these overnight loans was EONIA.
Comparing EONIA and EURIBOR
Though EONIA is similar to the Euro Interbank Offered Rate (EURIBOR)—both being interbank rates—there are significant differences:
- Calculation by Institutions: While EONIA was calculated by the ECB, EURIBOR is determined by the European Money Markets Institute (EMMI) through Global Rate Set Systems Ltd.
- Maturities: EONIA is strictly an overnight rate. EURIBOR includes multiple rates for loans maturing between one week and twelve months.
- Panel Banks: EONIA considers 28 panel banks, whereas EURIBOR data comes from 18 banks.
EURIBOR also serves as an essential benchmark for various financial products, including mortgage rates and savings accounts.
The Transition to ESTER
In 2018, the European Central Bank initiated efforts to introduce a new benchmark rate for the European banking system to curb the drawbacks of quote-based interest rates. As a result, ESTER, short for Euro Short-Term Rate, was introduced to replace EONIA.
ESTER is a more robust overnight interest rate generated from a broader range of wholesale rates across Europe. Unlike EONIA, which was based on transactions of 28 banks, ESTER draws on a larger set of participating institutions, thereby offering a more comprehensive and reliable benchmark.
In summary, the EONIA was a fundamental aspect of the European interbank lending market until its replacement by ESTER in 2022, reflecting significant advancements in financial risk management and regulatory oversight in the European financial system.
Related Terms: EURIBOR, overnight rate, interbank lending, reserve requirements.
References
- European Central Bank. “What Is the Transition from EONIA to €STR (€uro Short- Term Rate)”, Page 2.
- The European Money Markets Institute. “Eonia”.
- Euribor. “What Is Euribor”.
- The European Money Markets Institute. “About the Institute”.
- The European Money Markets Institute. “About EURIBOR”.
- Euribor. “Current Euribor Rates”.
- The European Money Markets Institute. “EURIBOR: Panel Banks”.
- European Central Bank. “Private Sector Working Group on Euro Risk-free Rates Recommends ESTER as Euro Risk-free Rate”.
