What it means
Banks regularly lend each other money overnight to manage their daily cash needs. EONIA captured the typical rate on those loans, weighted by the size of each transaction.
It therefore acted as a barometer of how tight or loose money was in the euro banking system. Many financial contracts were tied to the rate.
Overnight index swaps, which exchange a fixed rate for a floating rate based on an overnight index, used EONIA as the floating leg. Banks and corporate treasuries also used it to price short-term deposits and to value other instruments.
Its replacement came about because regulators wanted benchmarks based on real transactions in large, active markets. The euro short-term rate, usually written as the euro STR, is calculated by the European Central Bank from reported overnight borrowing by banks.
For a transition period, EONIA was calculated as the euro STR plus a small fixed spread, and it then ceased to be published. For finance teams, the main lesson is practical.
Contracts written before the change may refer to EONIA, and a fallback rate had to be agreed so that payments could continue. Legal and treasury staff reviewed loan agreements and derivatives to make sure they referred to the new benchmark.
A nuance is that EONIA was an overnight rate for unsecured loans, so it differed from term rates, which apply for longer periods, and from secured rates based on loans backed by collateral. Understanding which rate is used matters when comparing offers or assessing risk.
The episode also showed how benchmarks can be reformed after concerns about their reliability. It helps to remember where the rate sat in the wider family of benchmarks.
Longer-term euro rates such as Euribor are set for periods of one week to twelve months and include a bank credit element, while overnight rates strip most of that away. Treasurers choose between them depending on how long their cash will be lent or borrowed.
In practice
Real-world examples.
Example
A corporate treasurer places surplus cash in an overnight deposit that pays a rate linked to EONIA less a small margin. She earns a modest return while keeping the money available the next day. The treasury report records the daily interest.
Example
A bank enters an overnight index swap to protect itself against a rise in short-term rates. The swap pays a floating amount based on EONIA, and the bank compares it with its funding costs. When rates rise, the swap offsets some of the extra cost.
Example
A lawyer reviews an old loan agreement for a manufacturer and finds a clause that refers to EONIA. She advises the finance team to amend the clause to refer to the euro short-term rate. The amendment prevents confusion over how interest should be calculated.
Formula
Calculation
Overnight interest = Principal x Rate x Days / 360
Suppose a bank lends $50,000,000 overnight at a rate of 2.00%. Interest for one day = 50,000,000 x 0.02 x 1 / 360 = $2,777.78. Over a three-day weekend, the loan would accrue 50,000,000 x 0.02 x 3 / 360 = $8,333.33. Euro money markets conventionally use a 360-day year, which is why the divisor is 360 and not 365.Case study
Seen in the real world.
Calder Industrial Finance is a fictional company, and this story is illustrative. It had several loans and derivatives that referred to EONIA and, as the benchmark was phased out, the treasurer feared that payment calculations could become unclear. She compiled a list of every contract that referred to the rate.
For each contract she contacted the bank and agreed on a replacement based on the euro short-term rate, with an adjustment so that neither side gained unfairly. The review took two months and uncovered one agreement with no clear fallback, which was fixed before it could cause a dispute. The treasurer later added benchmark reference checks to the company's contract review process.
The treasurer shared her list with the legal team so that every new contract would be checked for references to benchmarks that might be retired. The company now keeps a register of the rates used in its debt and derivatives, with the contact at each bank, which made later benchmark changes much easier to manage.
Watch out
Common mistakes.
- Assuming EONIA is still published, when contracts should now refer to its replacement.
- Mixing up an overnight rate with a longer-term rate such as one-month or three-month rates.
- Forgetting that interest accrues on a 360-day basis in euro money markets when doing calculations.
Questions
People also ask.
What replaced EONIA?
The euro short-term rate, published by the European Central Bank, replaced it as the main overnight benchmark for the euro area.
Why was EONIA retired?
Regulators wanted benchmarks that rely on transactions in deeper markets and comply with updated benchmark rules.
Does the change affect old contracts?
Contracts that referred to EONIA needed fallback language or amendments, and many were updated to refer to the new rate.
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