The Euribor, the benchmark interest rate for trillions of euros of financial products, is set to undergo a major overhaul from next year. The aim is to attract more banks to contribute to its calculation and to better reflect changes in market conditions.
What is Euribor and why does it matter?
The Euribor, or Euro Interbank Offered Rate, is the average interest rate at which a panel of banks lend to one another in the eurozone interbank market. It is calculated daily for different maturities, ranging from one week to 12 months.
The Euribor is used as a reference rate for various financial products, such as mortgages, car loans, derivatives, bonds and swaps. According to the European Money Markets Institute (EMMI), the Brussels-based administrator of the Euribor, the total notional value of contracts referencing the rate was estimated at 180 trillion euros as of June 2020.
The Euribor is also an indicator of the health and liquidity of the eurozone banking system. A high Euribor means that banks are reluctant to lend to each other, implying a shortage of funds or a higher perceived credit risk. A low Euribor means that banks have ample liquidity and trust in each other’s solvency.
What are the proposed changes to Euribor?
The EMMI has announced that it is proposing a revamp of the Euribor methodology from next year, following a public consultation that will run until November 19. The main changes are:
- To eliminate the need for banks to provide bespoke estimates in certain circumstances when actual transactions are not available. This would reduce the burden and cost for banks to contribute to the rate, and hopefully encourage more banks to join the panel.
- To introduce a new formula for calculating the rate that would better reflect changes in interest rates and credit risks. The formula would use a weighted average of transactions and estimates, with more weight given to transactions when they are more representative of market conditions.
- To update the criteria for selecting the panel of banks that contribute to the rate. The criteria would include factors such as geographical diversity, market share, credit rating and compliance record.
Why is Euribor being revamped?
The Euribor revamp is part of a global reform of interbank offered rates (IBORs), which were tarnished by a series of rigging scandals in the aftermath of the 2008 financial crisis. The most prominent IBOR, the London Interbank Offered Rate (Libor), has been discontinued this year and replaced by alternative overnight rates compiled by central banks.
Unlike Libor, which was based on unsecured lending between banks, Euribor is based on both secured and unsecured transactions. This makes it more resilient and representative of the eurozone money market. However, Euribor still faces challenges such as low transaction volumes, regulatory scrutiny and legal uncertainty.
The EMMI has already implemented some reforms to Euribor since 2019, such as adopting a hybrid methodology that combines transactions and estimates, and obtaining authorisation from the Belgian Financial Services and Markets Authority (FSMA) under the EU Benchmarks Regulation.
The EMMI hopes that the new proposed changes will further enhance the robustness and reliability of Euribor, as well as its compliance with international standards and best practices.
How will Euribor affect consumers and investors?
The Euribor revamp is expected to have minimal impact on consumers and investors who use products linked to the rate. The EMMI has stated that it does not anticipate any material change in the level or volatility of Euribor as a result of the new methodology.
However, consumers and investors should be aware of the terms and conditions of their contracts that reference Euribor, especially in case of any contingency events or fallback scenarios. They should also monitor any announcements or updates from the EMMI or their product providers regarding the implementation of the new methodology.
