REFILE-UPDATE 2-German watchdog in special probe of Euribor banks
* Deutsche, Portigon under Euribor investigation-sources
* Deutsche Bank Euribor probe follows Libor special probe
* Bafin probes four banks over Euribor manipulation-paper
FRANKFURT, Jan 28 (Reuters) - German financial watchdog Bafin has escalated an investigation launched last year into possible manipulation of the euro interbank offered rate (Euribor) to include a special probe of German banks, a spokesman said on Monday.
Bafin began checking Euribor interest rate-setting procedures at banks last year in the wake of an investigation by international regulators into possible manipulation of another key interest rate, the London interbank offered rate (Libor).
Euribor and Libor, both based on estimates by large banks of how much they believe they have to pay to borrow from each other, are used as benchmark rates for trillions of dollars in contracts, from Spanish home mortgages to derivatives.
As the credit crisis intensified between 2006 and 2008, allegations started mounting that Libor no longer reflected the real rate banks were paying for funds.
Authorities have been examining whether traders tried to influence the rate to profit on bets on the direction it would go.
An escalation to a 'special probe' by Bafin, which has been looking at how banks organise Euribor desks and whether risk-management was adequate, entails intensified scrutiny of a bank to include on-site inspections by Bafin or external auditors.
"I cannot say how many banks or which banks are involved in the special probe," the Bafin spokesman said, adding that more than one bank was targeted.
German bank supervisors have been on site at the country's flagship lender, Deutsche Bank, and Portigon , the successor bank to former regional state-backed lender WestLB, in connection with investigations into interest rate manipulation, sources close to the lenders told Reuters.
Daily Sueddeutsche Zeitung newspaper reported on Monday that four banks were targets of the special probe, including Deutsche and Portigon. The paper did not identify the other lenders.
Deutsche and Portigon declined comment.
Deutsche Bank is already being subjected to a Bafin special probe in connection with Libor.
The lender has said it is cooperating with investigations in the United States and Europe in connection with setting rates between 2005 and 2011.
Swiss bank UBS was fined a record $1.5 billion last month for manipulating Libor interest rates, the latest in a string of debacles.
Britain's Barclays Bank has paid a $450 million fine and the Royal Bank of Scotland is expected to be fined up to 500 million pounds ($800 million) for its part in the scandal.
In July, Reuters reported that several banks under investigation for suspected rigging of Euribor intensified cooperation with EU antitrust regulators in the hope of lower fines.
Bafin President Elke Koenig said last week that interest rates based on banks' estimates were vulnerable to manipulation, particularly at times when real transactions in the market place -- which would normally serve as a guide --- dry up.
Regulators needed to work not just on reforming the benchmark interest rate system but also on replacing it, Koenig said.
More than 40 banks contribute to the Euribor inter-bank lending rate, but the Euribor-EBF group running it warned recently that more banks could leave following recent bad publicity.
Earlier this month German bank BayernLB said it has withdrawn from the Euribor panel, effective at the start of 2013, citing "strategic reasons".