ECB pushes to overhaul Euribor as it can be manipulated like Libor

Reuters reports that the ECB is pushing to overhaul how Euribor is calculated as it is calculated the same way Libor is and therefore is subject to the same type of manipulation.

Regular readers know that the fix for Libor is to base it off of actual trades that are part of the disclosure that banks make when providing ultra transparency and disclosing their current asset, liability and off-balance sheet exposure details.

Ultra transparency is needed so that the banks in the interbank lending markets can independently assess the risk of each bank and adjust the amount and price of their exposure to each bank based on this assessment.  In the absence of ultra transparency, the interbank lending market is prone to freezing as banks with deposits to invest cannot tell who is solvent and who is not.

This fix is needed for Libor and Euribor because the rate is suppose to reflect the cost of funds to banks in the unsecured interbank debt market.

The European Central Bank is putting pressure on the organisers of Euribor for an overhaul to shore up faith in the benchmark interest rate following a scandal over the manipulation of the Libor standard, sources familiar with the matter said.... 

Now the ECB is calling for a rethink on Euribor, including possibly shifting the basis of the calculation to actual lending rates instead of the current system, which like Libor's uses banks' assessments of what they expect to be charged. 

Regulators fear the existing set-up allows too much discretion....

The push to change Euribor, launched with the euro in 1999 and which takes estimates from many of the same banks as Libor, comes as regulators investigate whether banks deliberately underestimated their borrowing costs to depress or fix the rate.

Euribor, the euro interbank offered rate, and larger counterpart Libor, are the key gauges of how much banks pay to borrow from peers and underpin swathes of financial products from Spanish mortgages to derivatives contracts sealed in London. 

Regulators have not yet shown evidence of manipulation in Euribor, and the benchmark's organisers - an arm of the European Banking Federation - say the number of banks involved in determining the rate would make it difficult to fix. 

"The big choice one has to make is whether you want posted rates or actual rates ... so at the end of the day, banks say what transaction they had at which price," said one central bank source. "If you use actual transactions you would have solved the problem."

 Nice to see the support for my solution.

A second source familiar with the matter said: "Everyone would like to go for this solution. The question is the timing. And the other question is whether you use a panel (of banks) or if you can work on it with global data."...

There is no reason not to have both.

Ideally, by requiring ultra transparency, the "Mother of all Financial Databases" is built to capture all of the data from the banks.  With this data, market participants can choose whether to use a panel of banks or a broader universe of banks.

One of the main candidates for a supervisory role is the ECB. The Frankfurt-based ECB and the euro zone's 17 national central banks have hundreds of money market operations experts who deal with traders involved in setting Euribor and Libor daily.... 

The ECB declined to comment on whether it could become more hands-on, but the minutes of one of its regular meetings with money market experts show the issue of the Euribor and Libor credibility came up back in March. 

At the time, one of its top officials, Paul Mercier, said benchmarks were best left to the market, but ECB insiders are aware that with the bank now set to get new oversight powers from next year, the task of watching Euribor may be thrust upon them.

"If the conclusion (of the Commission's investigation into Euribor) is that the market mechanism cannot be trusted, then the only option is to turn to a public institution," said one euro zone central banker. 

"We are not pushing for that, but the ECB might be a candidate. It is not easy to find an alternative."

Constructing the 'Mother of all Financial Databases' allows both the market and the ECB to provide oversight. 

The ECB is already involved in setting one of Europe's key market rates, Eonia, an overnight lending rate that ECB monetary policy is designed to steer in order to control inflation. 

Unlike Euribor and Libor, which are based on banks' theoretical 'average' borrowing price, Eonia is priced from real transactions provided by a panel of banks..... 

Replicating this for Euribor could, however, be complicated by the current reluctance of banks to lend to one another, which would make it difficult to establish actual rates. 

"If you use actual rates, it is unlikely that you would have liquid markets up to 12 months every day," said one central bank source. "So it can be very unstable. Liquidity on the unsecured market has suffered a lot."

One of the primary reasons for requiring the banks to provide ultra transparency is that it unfreezes the interbank lending market and prevents it from refreezing.  At all times, the banks looking to invest deposits can assess the risk of the banks looking to raise funds.

The reason liquidity is currently drying up is no one can tell which banks are solvent and which are not because they are 'black boxes'.  Ultra transparency provides the answer to the question of solvency.