Euribor

Euribor Definition

Euribor or Europe Interbank Offered Rate is an equivalent euro lending rate based on the average rates at which a selected list of large banks known as panel banks operating in Europe borrow from one another.  The Euribor rates are normally available for the standard period of one week, one month, three months, six months and one year.

It is sponsored by the European banking federation and published by Reuters at 11.00 am Central European time daily. Euribor is administered by the European money market institute and the first-rate was published for the value 04^th January 1999.  In short Euribor rates are the benchmark rates based on which various Euro Interbank Term Deposits, Derivative Instruments, and Mortgage loans are offered by one bank to another within the European Union.

Euribor Rates for Different Maturities

Euribor rates are published daily. An extract of Euribor rates for different maturities is presented below:

Euribor rates are determined by the contribution from financial institution popularly known as ‘panel banks’ as per the benchmark determination methodology. Financial Institutions become ‘panel members’ based on their on-balance sheet and off-balance sheet exposure in the euro money market. The number of banks which form part of panel banks varies depending upon certain factors.

Who Contributes to Euribor?

The Panel Banks which contribute to Euribor consist of 16 banks namely:

The list of Banks as mentioned above collectively known as “Panel Banks” are selected based on the volume of business exposure in Euro Zone Market and also to ensure proper representation and diversity. The number of banks as such keeps changing as the volume of business changes.

Formula for Determining Euribor

Euribor rates are determined through a complex three-level process managed by European Money Markets Institute (EMMI). A briefer about the three levels are mentioned below:

Source: EMMI

An important point to mention here is that the contributions at each level are based on actual transactions to the extent possible and to minimize using a hypothetical transaction to derive rates which are nearest to the actual rates being offered by banks to each other. Once the rates are received from all banks, the highest and the lowest 15% rates are removed and the remaining 70% rates submitted are averaged out to derive the Euribor rate.

Euribor rates are important and find their utility across any type of business dealings undertaken by banks between them for uncollateralized loans.

Euribor Examples

Let’s understand this with the help of a few examples:

Example #1

Axon International issued floating rate bonds which are linked to Euribor as the reference rate. The bonds pay 6 months Euribor plus 50 bps with semi-annual resetting. At the time of issue of such bonds, the six-month Euribor rates were 2.15%. Thus Effectively axon international will pay 2.65% interest to its investors. After six months the six-month Euribor rates fall to 2% and effectively axon international will pay 2.50%. Thus the change in Euribor rates impacts the interest cost for businesses and also the return of investors who invest in instruments which are benchmarked to Euribor.

Example #2

Let’s take one more example of how Euribor rates are used in derivative contracts and their implications.

Zero Bank headquartered in Italy entered into an interest rate swap contract with one bank having a notional amount of $50 million. Zero Bank is the fixed payer and one bank is the floating ratepayer. Zero banks believe that the floating rate i.e. they will increase over the period and as such decided to pay fixed interest coupons of 1.5% payable quarterly against receipt of 3-month Euribor rates plus 20 bps. The current rate at the time of inception of the contract was 1.3% to be same for both banks with no profit no loss. Now if at the end of next quarter Euribor rates increases to 1.5% then zero banks will pay a fixed rate of 1.50% and will receive 1.70. Thus Euribor rates impact banks not just their day to day lending but also impacts the large off-balance sheet exposures which banks have with each other.

Advantages

Some of the advantages are as follows:

• First and foremost advantage of Euribor is the determination of pricing of all our floating rate loans and deposits. Loans and Deposits are linked to Euribor rates and change in these rates directly impact the lending and deposit rates.
• Euribor rates trend can help in identifying the movement of interest rates which can be used for various analytical purposes and enable monetary policy and allow central bankers to make better policy decisions.

Disadvantages

One of the biggest disadvantage which has time and again emerged is the collusion and manipulation observed by panel banks affecting the determination of fair and transparent Euribor rates.

Important Points

Conclusion

It is an important benchmark rate calculated and determined by an independent body and acts as an important yardstick for determination of cost of funding for banks in the eurozone. An increasing trend in Euribor rates is a sign of increasing cost which has ripple effects and impacts the entire credit cycle and the resulting economic system.

Recommended Articles

This has been a guide to what is Euribor and its definition. Here we discuss Euribor rates for different maturities and list of the panel banks along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –

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• Term Structure of Interest Rate