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What is an ESTR and how should it be used?

What is an ESTR and how should it be used?

In this article, we would like to investigate the euro’s short-term rate (ESTR). This indicator could be useful for anyone who has an interest in using financial markets in Europe. Therefore this article will give a short summary of what the ESTR is and how one can use it.

The ESTR, also known as the €STR, is a very important figure for banking in the eurozone. To be specific, it is the interest rate benchmark for the costs of borrowing money from eurozone banks overnight. Previously there existed the euro overnight index average and the euro interbank offered rate. These two indicators did not meet the requirements of the EU benchmark regulation. The EU’s new regulations stated that these rates must now have a basis on real data rather than data from surveys and estimations. This new rate should streamline this process for the euro area considerably, becoming the benchmark for the EU and the European Free Trade Association (EFTA).

Collecting data for the ESTR

The ESTR’s reliability comes from its use of a wide range of data. It uses transaction data from 52 different banks within the eurozone. The rate is renewed every day. It, therefore, requires data from these banks every single day as well, meaning it is always up-to-date. The calculation tries to use data that is large in volume and non-anonymous so that the interest rates it represents are representative of real possible rates. The ECB then publishes this rate.

Calculation of the rate

Now that we have a basic understanding of the rate, we will need to describe the calculation of the ESTR. As we stated before, this calculation uses real data from bank transactions. They calculate the average interest rate of these transactions and weigh this with the volume of these transactions. They firstly take all transactions above € 1 million and order them by interest rate. Then aggregation of this data is necessary at several levels. They remove half of the data, a quarter from the top and a quarter from the bottom in order of trade volume. They then calculate the average ESTR rate from this remaining data.

Advantages and the new ESTR rate

There are several factors we can mention that are in favor of switching to the ESTR over the previous rates. The rate’s calculation relies on data that is transparent and follows regulations. This data is regulated under the guide of the EU Money Market Statistical Reporting Regulations. Such a regulatory system should ensure the data has not undergone any tampering and gives financial sustainability. It only accepts legitimate trades that real financial institutions would end up using for their customers. This makes it quite reliable for the average person using eurozone financial systems. The ESTR data also takes a large number of banks into account, giving a more accurate average overall between all banks, which should also be representative of market rates.

The post What is an ESTR and how should it be used? appeared first on FinanceBrokerage.

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