Euro Overnight Index Average (EONIA): Definition, Switch to ESTER

What Is the Euro Overnight Index Average (EONIA)?

The Euro Overnight Index Average (EONIA) is the average overnight reference rate for which European banks lend to one another in euros. The EONIA is the interest rate for one-day loans between European banks and is considered an interbank rate. However, European regulatory reforms resulted in the EONIA rate being replaced by the ESTER (Euro Short-Term Rate) effective January 2022.

How the Euro Overnight Index Average Works

EONIA is a daily reference rate that expresses the weighted average of unsecured overnight interbank lending in the European Union and the European Free Trade Association (EFTA). It is calculated by the European Central Bank (ECB) based on the loans made by 28 panel banks. 

Banks must meet certain reserve requirements that are typically set by the central bank. A reserve is the amount or percentage of total deposits that a bank must keep on hand and not lend out. A reserve requirement helps protect banks so that they have enough cash or liquidity in case of loan losses. However, banks can experience short-term cash flow shortages at the end of a business day, such as when there are unexpected cash withdrawals. As a result, the banks that are short on cash can borrow from other banks that have cash flow surpluses. The rate that banks borrow from each other is called the overnight rate.

In Europe, EONIA represents the average overnight rate of 28 of the most established banks called panel banks.

EONIA vs. EURIBOR

EONIA is similar to EURIBOR, which is short for Euro Interbank Offered Rate. EURIBOR is also an interbank rate and is comprised of the average interest rates from large European banks that are used for lending to one another. However, EURIBOR has various maturities in which each maturity has its own interest rate.

Both benchmarks are offered by the European Money Markets Institute (EMMI), which is a non-profit organization founded in 1999. However, EURIBOR is calculated by a benchmark administrator called Global Rate Set Systems Ltd., and not by the ECB.

The key difference between EONIA and EURIBOR is the maturities of the loans upon which they are based. EONIA is an overnight rate, while EURIBOR has five interest rates based on loans with maturities that range from one week to 12 months. Also, EURIBOR has 18 banks that contribute to the rates while EONIA has 28 panel banks.

EURIBOR is important since it is the benchmark rate used by banks when determining the interest rate for various financial products, including mortgage loans and savings accounts.

ESTER

In 2018, the ECB formed a working group to help establish a new benchmark rate for Europe. Historically, bank scandals have occurred using quote-based interest rates as benchmarks. As a result, banking reforms led to ESTER or "€STER," which is short for Euro Short Term Rate, replacing EONIA.

ESTER is also an overnight interest rate but represents an average of the wholesale rates in Europe. These wholesale rates are typically used with banks and institutional investors such as pension funds. One of the key reasons for the switch to ESTER is that there will be more banks contributing to the average ESTER rate than currently with EONIA.