Euro zone banks adopt ECB rate after Euribor scandal

FRANKFURT (Reuters) - The euro zone's top lenders decided on Thursday to adopt the European Central Bank's interest rate of overnight inter-bank lending as their new benchmark, in a first move to reform a crucial market compromised by manipulation scandals.

The ECB's euro short-term rate (Ester) will replace Eonia as the gauge of how much banks charge for lending to each other for a day, a key metric of the health of the banking system and the basis for pricing trillions of euros worth of financial contracts.

The decision by a panel of 23 institutions, organised by the ECB and mostly comprising large commercial banks, marked the first concrete move away from the Euribor series of interest rates after manipulation scandals in 2012 undermined market faith in them.

"Ester will also provide a basis for developing fallbacks for contracts referencing the Euribor," the working group said in a press release published by the ECB.

Once banks' lifeblood, unsecured wholesale funding has steadily lost prominence since the financial crisis as banks switched to safer ways of financing themselves, such as borrowing against collateral or directly tapping the central bank for cheap cash.

This has eroded the relevance and reliability of Eonia - the Euro Overnight Index Average which, like the Euribor series of longer-term rates, is provided by industry organisation the European Money Markets Institute (EMMI).

In addition, the rigging scandals that hit Euribor and its UK counterpart, Libor, meant that many banks became reluctant to provide data.

Eonia volumes have dwindled to just over 2 billion euros ($2.3 billion) from 80 billion euros at their peak in 2008 and the number of banks providing data has fallen to 28 - with the top five accounting for 80 percent of the volume.

"Eonia as it stands will no longer meet the criteria of the EU Benchmarks Regulation and will therefore see its use restricted as of 1 January 2020," the working group, which was meeting on Thursday, said in the press release.

By contrast Ester, scheduled to go live by October, will be based on transactions between 52 banks on a volume of some 30 billion euros per day according to a presentation on the ECB's website.

The ECB developed Ester after an industry attempt to come up with its own benchmark failed earlier this year, in a sign that banks were still reluctant to commit to any private initiative after costly litigation that followed the Euribor scandal.

Yet some analysts expressed concerns about the way Ester is calculated, with German and French banks accounting for 58 percent of all volumes between August 2016 and January 2018, according to ECB calculations.

"Having such a strong skew of transactions towards better rated banks is a fatal flaw in this rate, we feel," Mizuho analyst Peter Chatwell wrote in a recent note.

Some members of the working group also insisted at their July meeting on extending the panel of banks to improve its diversity.

($1 = 0.8607 euros)

(Reporting By Francesco Canepa; Editing by Balazs Koranyi and John Stonestreet)