Euro Overnight Index Average (EONIA): Understanding the Benchmark, Transition to ESTER, and Implications

The euro overnight index average (EONIA) served as a fundamental metric in the European interbank lending ecosystem, indicating the average overnight reference rate for euro transactions. In this article, we delve into the mechanics of EONIA, its functionalities, and the subsequent transition to the euro short-term rate (ESTER) due to regulatory changes in 2022.

EONIA, a daily reference rate calculated by the European Central Bank (ECB), was derived from unsecured overnight interbank lending transactions. This calculation involved data from 28 panel banks, reflecting the weighted average in the European Union and the European Free Trade Association (EFTA). The rationale behind EONIA lay in addressing short-term cash flow challenges faced by banks at the end of business days, providing a platform for institutions with cash shortages to borrow from those with surpluses at an overnight rate.

EONIA shared common ground with Euro Interbank Offered Rate (EURIBOR), both products of the European Money Markets Institute (EMMI). However, their differences were substantial. EONIA, focusing on overnight rates with 28 panel banks, contrasted with EURIBOR, which incorporated various maturities ranging from one week to 12 months and involved 18 contributing banks. Notably, EURIBOR played a crucial role in determining interest rates for financial products, including mortgage loans and savings accounts.

In response to historical scandals associated with quote-based interest rates, the ECB initiated the establishment of a new benchmark rate for Europe in 2018. This led to the birth of euro short-term rate (ESTER), designed to replace EONIA in 2022. While both rates represent overnight interest, ESTER extends its scope by incorporating a broader range of contributing banks, aiming to enhance the reliability and robustness of the benchmark rate in Europe.

EONIA served as a vital metric by representing the average overnight reference rate, offering insights into one-day loans between European banks, crucial for short-term liquidity management.

Regulatory reforms in 2022 were the driving force behind replacing EONIA with ESTER, aiming to establish a more comprehensive and robust benchmark for overnight rates in Europe.

ESTER differs by encompassing a broader range of contributing banks, providing a more inclusive average wholesale rate in comparison to EONIA’s narrower scope.

EURIBOR is another interbank rate, distinct from EONIA and ESTER. It includes various maturities and is crucial in determining interest rates for financial products such as mortgage loans and savings accounts.