Federal Deposit Insurance Corporation 

FDIC
 

Banking

Review
 2000
 

Volume 13, No. 1
 

EUROPEAN UNION o Size and

Composition o The Single Market in

Banking o Setting the Stage o Single 

Market Legislative Framework o 

Approach to Cross Border Banking

o Banking Directives o Barriers and

the Second Banking Directive o 

Capital Ade uacy o Effects of

Second Banking Directive and

Capital Standards o Deposit Protec

tion o Summary of Single Market

Initiatives in Banking o The Single

Currency: Background, Conver

gence Criteria, and Central Bank o 

High Degree of Price Stability o 

Sustainable ,overnment Financial

Position o Long Term Interest Rates

o Participation in the Narrow Bands

of the ERM o Implications for

Banking: Development of Money

and Capital Markets o Assessments

of the Single Market Program in

Banking, Past and Future o RE

CENT DEVELOPMENTS o Regula

tory Agency Actions o FDIC o FRB o 

OCC o OTS o FHFB o NCUA o 

European Union 

Financial 

Developments 

Recent 

Developments 

Affecting 

Depository 

Institutions 
Table of Contents 

FDIC
 

Banking

Review
 2000
 

Volume 13, No. 1
 

Chairman 

Donna Tanoue 

Division of Research 

and Statistics, 

Director 

Wm. Roger Watson 

Deputy Directors 

Barry Kolatch
 

Steven A. Seelig
 

Editor 

Steven A. Seelig 

Editorial Committee 

Jack T. Reidhill
 

Detta Voesar
 

Managing Editor 

Detta Voesar 

Editorial Secretary 

Cathy Wright 

Design and Production 

Geri Bonebrake 

The views expressed are 

those of the authors and do 

not necessarily reflect official positions of the Federal 

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reprinted or abstracted if 

the FDIC Banking Review 

and author(s) are credited. 

Please provide the FDIC’s 

Division of Research and 

Statistics with a copy of any 

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Single-copy subscriptions 

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be mailed to: FDIC Banking 

Review, Office of Corporate 

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Deposit Insurance Corporation, 550 17th Street, N.W., 

Washington, DC 20429. 

European Union Financial Developments: 

The Single Market, the Single Currency, and Banking 

by Neil B. Murphy Page 1 

The author examines how the European Union is dealing with forces of 

deregulation, globalization, financial innovation, and other changes. 

Recent Developments Affecting Depository Institutions 

by Lynne Montgomery Page 19 

This regular feature of the FDIC Banking Review contains information on 

regulatory agency actions, state legislation and regulation, and articles and 

studies pertinent to banking and deposit insurance issues. 
European Union Financial Developments 

European Union Financial
 

Developments:
 

The Single Market, the Single
 

Currency, and Banking
 

by Neil B. Murphy*
 

I

n the past decade, the financial and banking structure of the 15-member European Union (EU) has 

changed substantially. In 1993 the single market 

in banking was inaugurated, transforming the legislative and regulatory environment for banking and 

financial markets. Then on January 4, 1999, 11 of the 

15 member states embarked on a dramatic alteration 

of their monetary arrangements, initiating a single currency (the euro) and a single central bank (the 

European Central Bank [ECB]). Conversion to the 

single currency will be complete in the year 2002, at 

which time national banknotes and coins will be 

replaced by euro notes and coins. Clearly, implementation of the single currency will significantly affect 

the process of consolidation already under way in 

banking and financial markets. In addition, the EU’s 

size and structure are expected to change. Many 

nations of Central and Eastern Europe that were formerly behind the Iron Curtain have been working to 

transform themselves from socialist, command-style 

economies into market economies. A number of them 

are preparing to join (accede to) the European Union 

and are therefore designing their new banking and 

monetary systems to be compatible with the EU’s. 

The single market in banking and the single currency are important in their own right, given the EU’s 

size and financial depth, but combined with the EU’s 

expansion eastward they will be even more important 

in the future. As the United States faces its own 

changes in the structure and regulation of financial 

institutions and markets, it is instructive to examine 

another system to learn how it is dealing with the same 

forces of deregulation, globalization, financial innovation, and technological change. 

After surveying the size and composition of the 

European Union, the article discusses first the single 

market in banking and then the single currency. 

Topics under the single market in banking are the legislative framework, the approach taken, and the directives that address (a) barriers to cross-border banking, 

(b) capital adequacy, and (c) deposit protection. 

Topics under the single currency are the new currency, the criteria that must be met by nations wanting to 

join the single-currency area, and the single central 

bank system. Discussed next are the implications of 

all of these developments for banking, particularly 

with respect to the money and capital markets. The 

conclusion assesses the past and future of the singlemarket program in banking. 

*	 Neil B. Murphy is Professor of Finance, Department of Finance, 

Insurance, and Real Estate, School of Business, Virginia 

Commonwealth University. The research for this article was undertaken while the author was a visiting scholar in the FDIC’s Division of 

Research and Statistics. 

I have benefited greatly from discussions with Edward P. M. 

Gardener, Philip Molyneux, and Jonathan Williams (all of the 

University of Wales, Bangor), Jean-Pierre Daloz (University of 

Southern Europe, Monaco), and Leonard Lapidus (formerly U.S. 

Treasury Department). 

1 
FDIC Banking Review 

Size and Composition of the 

European Union 

The starting point in discussing the EU, and in 

comparing its financial arrangements and issues with 

those of the United States, must be the EU’s size and 

composition. In 1958 six nations—Belgium, France, 

Germany, Italy, Luxembourg, and the Netherlands— 

formed the European Common Market, and over the 

years those six nations were joined by nine other 

Western European nations. As a practical matter, it is 

useful now to think of the EU as all of Western Europe 

except Norway and Switzerland. (In the future, the 

EU will include member nations in Central and 

Eastern Europe as well.) 

After passing through a selection process as outlined below, 11 of the 15 member nations embarked 

on the single currency. The four nonparticipants are 

Denmark, Greece, Sweden, and the United Kingdom. 

In the popular press, the nations in the single currency 

are sometimes referred to collectively as “Euroland.” 

Tables 1 and 2 list the population, gross domestic 

product (GDP), and financial depth (the ratio of financial assets to GDP) of the EU, Euroland, and the 

United States. The population of the EU is larger 

than that of the United States, while Euroland’s population is approximately the same. In GDP and financial depth, the EU is similar to the United States. 

However, as discussed below, the EU and the United 

States are quite different in the composition of their 

financial assets and in the use of their currencies in 

international trade. The proportion of financial assets 

represented by bank deposits is much higher in the 

EU than in the United States, a difference reflecting 

the broad and deep money and capital markets in the 

United States. And the U.S. dollar is widely used in 

international trade and finance, whereas no single 

European currency is. (See Appendix for tables.) 

In summary, the EU and Euroland are large, 

wealthy entities whose banking, financial, and monetary arrangements have changed dramatically in the 

past decade and will undoubtedly continue in change. 

The Single Market in Banking 

The stage was set for the single market in banking 

in 1958, and specific directives on barriers, capital 

standards, and deposit protection were issued in 1989, 

1992, and 1994. In the interim, important decisions 

were made about the place of each member nation’s 

legislative and supervisory framework and about the 

approach that would be taken to cross-border banking 

(what activities would be permitted, and would the 

host country or the home country control the status of 

foreign banks). The intent of all of this was to allow 

banks to be able to do business anywhere in the EU so 

that the benefits of competition would accrue to businesses and households—but, to ensure that competition would not result in banks taking excessive 

financial risks, identical standards of capital adequacy 

were imposed on all banks. 

Setting the Stage 

The goal of the original Common Market in 1958 

was to establish an area with no internal barriers to the 

movement of goods, services, labor, and capital. 

Banking services were among those for which internal 

barriers were to be eliminated. 

After many years of balancing this goal with the prerogatives of sovereign nations, the European 

Economic Community assessed the progress made. 

Its assessment was published in Completing the 

Internal Market, White Paper from the Commission to 

the European Council (1985), hereinafter referred to 

as the White Paper. The White Paper listed measures 

that would have to be adopted if the goal of free circulation of people, goods, services, and capital within 

the EU were to be achieved. The White Paper also 

contained 300 proposals for legislation that would have 

to be enacted if barriers were to be removed. Among 

the proposed measures and legislation were some that 

applied to banking services. 

Another important document leading to change was 

the Price Waterhouse/Cecchini Report (1988), which 

dealt exclusively with banking. The report’s basic 

findings were as follows: 

� The nations of Europe had fragmented banking 

systems characterized by relatively small size, 

high concentration, excess capacity, and lack of 

competition. 

� Gains could be achieved if the average size of 

banks was larger (economies of scale). 

� Gains could be achieved if the products and services offered by banks in many countries were 

expanded (economies of scope). 

� Beyond achieving economies of scale and scope, 

banks could also achieve gains in efficiency if 

there were incentives for banks to adopt “best 

practices.” 

2 
European Union Financial Developments 

� To ensure that all of these gains accrue to bank 

customers, barriers to competition would have 

to be removed. 

� If economies of scale and scope, increased efficiency, and enhanced competition were 

achieved, the benefits to consumers would be 

substantial—an estimated .7 percent of GDP 

for the nations under study. 

In summary, first the White Paper indicated that 

the process of achieving the internal market was not 

complete, and it made specific proposals to that end. 

Then the Price Waterhouse/Cecchini Report specified 

the nature of the costs of not having an integrated, 

competitive banking market in the European Union. 

The stage was set for the development of the singlemarket program in banking.1 

Single-Market Legislative Framework 

Three principles guide the EU’s approach to the 

single market in banking. First, each nation retains its 

own banking supervisory and regulatory agencies. 

Second, there is to be minimal harmonization from a 

level above the national level. Most of these are related to safety and soundness. That is, individual countries may have their own regulatory and supervisory 

regimes, but all banks and nations within the EU must 

abide by certain minimal standards. Third, “directives” are to be issued at the EU level. That is, 

nations will be required to take legislative action, but 

the exact content of the legislation will not be dictated to them. There is normally a timetable that the 

nations must meet, and when they have enacted their 

legislation, it is submitted to the EU to ensure its consistency with the original directive. 

Approach to Cross-Border Banking 

In general, the activity of foreign banks doing business in another country is approached in one of two 

major ways, assuming such activity is permitted. The 

first approach is called national treatment: a host 

nation allows banks from foreign nations to conduct 

business on the same terms as banks that are domiciled in that host nation. This is the approach the 

United States takes. Foreign banks abide by the same 

rules and regulations as U.S. banks. Of course this 

approach implies that some banks will find they cannot do certain things in the host country that are permitted in their own nation. For example, the amount 

of investment banking activity conducted by banks in 

the United States has been limited. Thus, a foreign 

bank (say, German) may find that in the United States 

activities are forbidden that in Germany are quite 

legal. By the same token, U.S. banks in nations that 

have universal banking and national treatment will 

find they have far greater powers abroad than they do 

in the United States. 

The second approach taken to the activity of foreign banks doing business in another country is called 

mutual recognition. This means that a host nation 

allows a foreign bank to do whatever is permitted in 

that bank’s domestic environment; in other words, the 

host nation recognizes the primacy of home-country 

control. This approach implies that banks in the same 

market may have different powers. That is, a nation 

that simultaneously allows mutual recognition and has 

a restrictive regulatory environment may find that foreign banks coming from a more liberal home-country 

environment will have more powers than, and therefore a competitive advantage over, their domestic 

counterparts. 

In developing the single market in banking, the EU 

took the mutual recognition approach internally. That 

is, the host nation recognized the primacy of the home 

nation’s regulation of banks. Thus, the host nation 

would have to adapt its own regulatory environment or 

else stand by while foreign institutions might have 

advantages in the host nation’s domestic market. This 

approach to the single market in banking allowed for a 

“market” in regulation, in that nations would strive to 

ensure that implementing EU requirements would 

not mean putting their own domestic banks at a competitive disadvantage. Of course, the danger is that 

such a situation may result in a competition in laxity 

whereby some nations seek to attract the business of 

banks by maintaining a lax set of rules and regulations. 

To forestall such a situation, the EU imposed some 

minimum standards for all banks in the EU. 

Banking Directives 

The minimum standards are contained in several 

banking directives. These address barriers, capital 

adequacy, and deposit protection. 

Barriers and the Second Banking Directive. 

The cornerstone of the single market program is the 

1 Other documents and assessments of European banking were published at this time, some of them critical of the White Paper and Price 

Waterhouse/Cecchini. For a review, see Molyneux, Altunbas, and 

Gardener (1996), chapter 2. For an earlier analysis of European banking, see Gardener and Molyneux (1990). A thorough econometric 

analysis of economies of scale and scope as well as efficiency can be 

found in Molyneux, Altunbas, and Gardener (1996). 

3 
FDIC Banking Review 

Second Banking Directive, which was adopted in 1989 

to be implemented at the beginning of 1993.2 Thus, 

by the end of 1992 all nations had to have in place laws 

and regulations consistent with this directive. It has 

three major components. First, it defined exactly 

what is meant by “banking.” Across the EU, there 

were differences in the activities that could be undertaken by banks, but for purposes of the Second 

Banking Directive, banking activities were specified 

(see table 3). Taken together, these activities constitute “universal banking.” 

The second component of the directive is the principle of home-country control, or mutual recognition. 

That is, banks will be regulated by, and will conform 

to, the regulation and legislation of their home country. If a bank does business in another EU nation, the 

regulatory authorities of the host nation recognize the 

primacy of the home nation. 

The third component of the Second Banking 

Directive is the concept of a “single passport.” That 

is, a bank licensed to do business in any EU nation is 

allowed to do business in any other EU nation on 

whatever basis it considers most advantageous. A 

bank may establish a branch or subsidiary, or may 

acquire another bank, in any other nation. The host 

nation is not allowed to impose any barriers to such 

action. Previously, cross-border activities had been 

permitted, but nations had routinely required separate 

capital for branches located in their borders. A combination of capital requirements, called endowment capital, and the need to seek and obtain permission made 

it somewhat difficult for banks to conduct cross-border 

activities. The Second Banking Directive removed all 

such barriers. 

As a result of mutual recognition and the single 

passport, a bank located in a nation with permissive 

laws about activities would be able to enter a nation 

with a restricted set of activities and conduct business 

that would not be permitted to domestic banks. Thus 

each EU nation, in passing the legislation required by 

the Second Banking Directive, has an incentive to 

consider all specified banking activities (table 3) as 

permissible activities for its domestic banks, since to 

do otherwise would put domestic banks at a competitive disadvantage. Hence, the principle of mutual 

recognition is used to create incentives for nations to 

enact legislation that makes universal banking the 

norm in the entire EU.3 

Capital Adequacy. The amount of capital a bank 

holds has an effect on its competitiveness, its financial 

strength, its profitability, and its incentives to take 

risk. It also represents a cushion against losses elsewhere in the bank, standing between those losses and 

potential losses to depositors and/or (in nations with 

deposit insurance programs) the taxpayer.4 

Because of the crucial role of capital in banking, the 

EU promulgated a series of directives intended to 

ensure that all banks in the EU had the same capital 

standards. The first two directives (the Own Funds 

Directive and the Solvency Ratio Directive) defined 

what is meant by bank capital and what is considered 

to be adequate. In these directives, the EU adopted 

the definitions, approach, and standards of the Basel 

(Bank for International Settlements) Committee of 

the Group of Ten. 

In the absence of capital standards, a low capital 

ratio allows a bank to price loans aggressively and still 

meet a return-on-capital target. But, if all banks face 

the same capital standards, there are no capital-related 

incentives to price loans overly aggressively. A high 

capital ratio implies financial strength and, in the 

absence of deposit insurance, can result in an 

enhanced ability to attract deposit funds easily and 

cheaply. Of course, if a credible deposit protection 

program covers any potential losses, the incentive for 

depositors to monitor and assess the financial strength 

of banks is removed. But the deposit guarantor has 

the same incentive as the now-protected depositor 

would have had to monitor financial strength, and can 

be expected to favor strong capital standards. 

The third capital-related directive was the one on 

Monitoring and Controlling Large Exposures of 

Credit Institutions. It requires that the maximum 

lending exposure to a single client cannot exceed 25 

percent of a bank’s capital, and a bank must report to 

its supervisor any exposure greater than 10 percent of 

capital. This requirement is designed to avoid concentration of risk in a single client whose financial difficulties could substantially affect an individual bank. 

2 There was a First Banking Directive that made some progress toward 

integration. Under it, however, banks needed authorization from 

host-country supervisors; host-country legislation determined permissible activities; banks had to earmark endowment capital for new 

branches as though they were new banks; and capital controls restricted cross-border financial activities. 

3 Of course, EU nations’ adoption of universal banking has implications 

for the transition economies of Central and Eastern Europe, which are 

designing their banking systems. To be compatible with the EU, such 

nations have an incentive to adopt the universal banking model. 

4 The EU requires that all member nations have a deposit protection 

program, as discussed below. 

4 
European Union Financial Developments 

Effects of Second Banking Directive and Capital 

Standards. The approach taken by the directives discussed above may be set against the objectives mentioned by the White Paper and the concerns expressed 

in the Price Waterhouse/Cecchini Report. Freedom of 

movement, as advocated by the White Paper and Price 

Waterhouse/Cecchini, implies that banks may conduct 

business in any part of the EU. The Second Banking 

Directive imposes no apparent regulatory restrictions 

that would keep a bank from realizing economies of 

scale by expanding via branching and/or merger and 

acquisition, throughout the EU. In addition, because 

of home-country control with a single passport, all EU 

nations have adopted a broad array of banking powers, 

allowing banks to realize economies of scope. All 

nations’ banking markets have become contestable, a 

development implying that either existing banks in a 

market will change their conduct to forestall external 

entry or foreign banks could indeed enter a market. 

Thus, the Second Banking Directive sets the stage for 

cross-border activity, deconcentration of markets, and 

the ability of larger banks to produce efficiently by 

realizing economies of scale and scope and having 

incentives to adopt “best practices” in conducting 

their banking activities. 

But although the pro-competitive aspects of the 

Second Banking Directive should lead to lower loan 

rates, higher returns to depositors, and higher-quality 

services, the combined effect of the capital directives 

is in the opposite direction. Higher capital standards 

should result in higher loan rates and lower returns to 

depositors. That is, the net interest margin should be 

higher than would be the case if capital ratios were 

lower and the bank was still trying to meet a return-oncapital target.5 

The fact that the Second Banking Directive and the 

capital directives have opposing effects may seem contradictory, but it is not. The combination is designed 

to achieve for consumers the maximum benefits from 

competition that is constrained by safety-and-soundness standards, as these are manifested in capital 

requirements. 

Deposit Protection. The EU issued a Deposit 

Guarantee Scheme Directive to be effective on July 1, 

1995. This directive indicated that all member nations 

had to have a deposit protection scheme (analogous to 

deposit insurance in the Unites States): deposit protection was to be mandatory for all member nations 

and for all banks within member nations. The directive put a floor on coverage, �20,000 per depositor, but 

contained no requirements for funding the scheme, 

nor did it say whether the deposit insurance agency 

should be public or private or, if public, whether it 

should be an independent agency, part of a bank 

supervisory agency, part of the central bank, or part of 

the ministry of finance. The scheme could be funded 

either in anticipation of any problems (so that the 

deposit insurance agency would have the resources to 

deal with problem situations) or after the fact (so that 

other members of the scheme would be assessed to 

deal with problems). The directive also indicated that 

depositors should be paid quickly (no more than three 

months after a deposit became “unavailable”). 

Those drafting the directive recognized that the 

principles of mutual recognition and the single passport could cause difficulties for deposit protection 

schemes. If the deposit protection provided by a 

home country were much less than that of a host country, a branch within the host country might be at a 

competitive disadvantage. That is, the deposit products and services that it offered to the public would 

have a deposit guarantee that was smaller, or might 

have a requirement for co-payment in which the 

depositor shared in losses up to some specified 

amount. This competitive disadvantage seemed 

inconsistent with the spirit of the single market in 

which banks can enter markets and compete for the 

business of the public. For that reason, the directive 

allowed a bank with a low-coverage home-country 

scheme to enter a high-coverage market and join the 

host-country scheme for the difference. Doing this is 

referred to as “topping up.” Thus, the host-country 

scheme provides deposit protection coverage in excess 

of what the home-country provides.6 

In contrast, branches of banks with high homecountry coverage do not have symmetrical treatment. 

That is, these branches cannot “export” their higher 

coverage to low-coverage countries and acquire a competitive advantage. 

5	 For an assessment of the likely consequences of the single-market program, see Dermine (1993). 

6	 Massachusetts illustrated a similar arrangement: a state-sponsored 

deposit insurance fund for savings banks provides 100 percent coverage. For Massachusetts savings banks that are also insured by the 

Federal Deposit Insurance Corporation, the Massachusetts deposit 

insurance agency provides a guarantee for deposits in excess of the 

FDIC’s maximum, $100,000. 

5 
FDIC Banking Review 

As a result of this directive, a number of different 

deposit protection schemes operate side by side in the 

single market, as table 4 indicates. Coverage varies 

greatly, ranging from �20,000 to �114,000. This variation implies a large difference in the amount of safety 

that can be provided from one country to the next. To 

be sure, the combination of topping up and no export 

implies that within a country, banks are offering the 

same guarantee. Yet as electronic banking and the single currency evolve, consumers will be able to access 

banking services originating anywhere in the EU, and 

the competitive implications of deposit protection 

may change. Another important competitive factor is 

the cost of delivering deposit services, including the 

guarantee. Even if the coverage for the deposit protection schemes of two countries is identical, banks 

may face different costs depending upon the method 

of funding the deposit protection scheme.7 

In any event, the EU nations are relatively new at 

providing deposit protection schemes. Most of the 

schemes were set up either in anticipation of the 

Deposit Guarantee Scheme Directive or in reaction to 

a banking crisis. How this system of differently structured schemes can coexist in the context of a single 

market and single currency will have to be carefully 

evaluated, especially in a technological environment 

in which physical location of customer and bank matters less and less. 

Summary of Single-Market Initiatives in 

Banking 

The pieces for the single-market program in banking are now in place. All countries have enacted the 

legislation required by the directives; all EU countries 

now have the universal banking model;8 all banks are 

permitted to enter into other nations’ markets by 

branching, acquisition, and/or solicitation of business 

across borders by remote means; all consumers can 

deal with banks in their nations knowing that their 

deposits are protected; and all banks have the same 

capital rules, both as to how capital is measured and as 

to how much is sufficient. 

However, until early 1999 all transactions across 

borders within the EU involved currency risk and 

transactions costs. Each nation had its own currency, 

and, for example, a bank that made a loan in a currency other than its own had to consider not only the normal credit risk but also the risk that the value of the 

other currency would change in relation to its own currency. Banks had to consider the risk involved in setting the price of the loan or had to engage in costly 

hedging activities to reduce these risks. In addition, 

the process of exchanging currency involved in these 

transactions entailed transactions costs. Finally, the 

quotation of prices and rates in many differing currencies reduced transparency and made it more difficult 

for consumers, businesses, and banks to make the 

comparisons necessary for markets to become more 

integrated. 

On January 4, 1999, however, all of this changed, as 

the European Union launched its single currency for 

11 of its 15 member nations. 

The Single Currency: Background, 

Convergence Criteria, and 

Central Bank 

The single currency began with the signing of the 

Maastricht Treaty (Treaty on European Union) by all 

EU heads of state in 1992. Appended to it was the 

Statute of the European System of Central Banks and 

of the European Central Bank. 

The Maastrict Treaty set the stage for an historical 

change: sovereign nations agreed to go without their 

own monetary policy, give up the possibility of an 

exchange-rate policy, and accept limited flexibility in 

fiscal policy. For the nations participating in the single 

currency, there would be a single monetary policy. 

And because they would no longer have their own currency, it would no longer be possible for them to 

change the exchange rate to accomplish some national objectives. For example, a nation whose product 

prices were not competitive in world markets would 

not be able to effectively reduce those prices by lowering the value of its currency. Finally, the conditions 

for being considered for participation in the single currency required many EU nations to adopt restrictive 

fiscal policies regardless of the phase of their business 

cycle. 

7 In the United States, there has been much debate among savings institutions, commercial banks, and credit unions over the cost of delivering virtually identical deposit guarantees to the public. 

8	 Of course, having the power to conduct particular types of business 

does not imply that all banks will do all things. Indeed, it is likely, for 

example, that a relatively small number of banks will be involved in 

investment banking activities. 

6 
European Union Financial Developments 

Before the Maastricht Treaty, the EU had adopted 

a policy in which the central banks of the member 

nations would maintain the value of their currencies to 

each other within an agreed range. This was known as 

the Exchange Rate Mechanism (ERM). However, the 

policy did not work, partly because different nations 

were in different phases of their business cycles and, 

for some, maintaining the currency value resulted in a 

degree of monetary restrictiveness that was inappropriate for their domestic economy. The Exchange 

Rate Mechanism broke down in 1992. 

With that experience in mind, those who wrote the 

Maastricht Treaty had two guiding principles: first, no 

nation is required to participate, and second, in order 

to participate, each nation has to satisfy convergence criteria. The convergence criteria were designed to 

ensure that all nations were starting from similar positions regarding inflation, public debt, interest rates, 

and exchange rates. The convergence criteria are as 

follows: 

� High degree of price stability. Each country 

must attain an average rate of inflation that does 

not exceed the average inflation rate of the 

three best-performing member countries by 

more that 1.5 percentage points. 

� Sustainable government financial position. 

The ratio of government deficit to gross domestic product (GDP) cannot exceed 3 percent, and 

the ratio of government debt to GDP cannot 

exceed 60 percent. 

� Long-term interest rates. In the year preceding admission, a country’s average nominal longterm interest rate may not exceed the average of 

the three best-performing member countries by 

more than 2 percentage points. 

� Participation in the narrow bands of the 

Exchange Rate Mechanism (ERM). In the 

two years preceding admission to the single currency, the currency of each member country 

must have remained within the normal bands of 

the ERM without experiencing severe tension. 

In 1994 the EU established the European 

Monetary Institute (EMI) as a sort of “shadow central 

bank” and as a forum for coordinating the monetary 

and fiscal policies of the member nations in preparation for the single currency. Time passed, and some 

nations decided not to participate. In May of 1998, the 

participating nations were chosen (as listed in table 5). 

On January 4, 1999, the transformation took place. 

On that date, for the participating nations, all government debt was denominated in euro, all stock market 

transactions and prices were in euro, and all monetary 

policy operations were in euro. Bank deposits and 

credit-card transactions were in either euro or the legacy currencies. At the outset there were no euro banknotes so coin and currency would still be denominated 

in the legacy currencies. The domestic legacy currency of each participating nation now had a fixed relationship to the euro. An analogy is the relationship of 

a U.S. ten cent piece (a dime) to a U.S. dollar: there 

are always ten dimes to a dollar. Similarly, there are 

always 6.55957 French francs to the euro, and so on for 

each nation. (The relationship of each legacy currency to the euro is shown in table 6.) The effort required 

was monumental, since all banks, all central banks and 

their large-value payment systems, all governments, 

and all financial institutions, stock exchanges, and 

business firms had to reprogram their computer systems extensively to accommodate the new currency. 

In addition, a new large-value payment system for 

euro, the Trans-European Automated Real-Time 

Gross Settlement Express Transfer system (TARGET), was implemented. 

The monetary policy of the new single currency is 

conducted by the European System of Central Banks. 

This system includes the National Central Bank 

(NCB) of each country in the EU as well as the 

European Central Bank (ECB), located in Frankfurt, 

Germany. The ECB has two major parts, the 

Executive Board and the Governing Council. The 

six-member Executive Board (a president, vice president, and four directors) is appointed by the European 

Council, a body comprising the heads of state of the 

member countries. The Governing Council consists 

of the Executive Board and the heads of the membercountry National Central Banks, who are appointed by 

their national governments. 

The ECB’s primary objective is to maintain price 

stability. To pave the way for it to do this, the treaty 

and appended statute give it considerable independence from the national governments and from the 

Community institutions. 

This article leaves it to others to discuss the conduct 

of the EU’s monetary policy, the political reality of the 

ECB’s degree of independence, the difficulties that 

arise when countries have cyclical problems different 

from those of Euroland as a whole (asymmetric 

7 
FDIC Banking Review 

shocks), the exchange value of the euro, the euro’s role 

in the international monetary system, and other 

macroeconomic considerations. The focus here is on 

the implications of the single currency for the EU 

banking system. 

Implications for Banking: 

Development of Money and 

Capital Markets 

The European Union has now developed a regulatory framework for a single banking market and has 

implemented a single currency. All banks are subject 

to the same capital rules, and all member nations have 

installed deposit protection schemes. To the extent 

that the general conclusions of Price Waterhouse/ 

Cecchini are valid, banking and financial markets in 

the European Union can be expected to change greatly. That is, consolidation should lead to economies of 

scale; with universal banking a choice for all banks in 

all nations, some banks can realize economies of 

scope; and greater competition should encourage all 

banks to become more efficient. As noted above, the 

extensive empirical tests conducted by Molyneux, 

Altunbas, and Gardener (1996) and Economic 

Research Europe, Ltd. (1997) support the general conclusion that these changes should take place. 

Much discussion of the single market and single 

currency has focused on their implications for banking 

markets, that is, for bank consolidation, cross-border 

mergers, the pricing of bank services, and so forth. 

Not often looked at, however, is one very important 

outcome of the single currency: the movement toward 

more direct finance within the EU, as money and capital markets develop. 

Table 2 shows that the ratio of bank assets to GDP 

is much higher for the EU than for the United States 

but that the United States has a much more highly 

developed market for bonds and equities and much 

more highly developed nonbank institutional 

investors, such as pension funds and mutual funds. 

One of the two main reasons for this observed difference is that the development of money and capital 

markets is enhanced by the existence of a single currency, and the United States has had a single currency 

for several hundred years. This longevity has allowed 

U.S. money and capital markets to develop breadth, 

depth, and resilience. For the EU, in contrast, developing such markets was more difficult because assets 

could not be easily accumulated in any one currency, 

and currency risks were added to the normal credit 

and market risks. The single currency and the largevalue payment system, TARGET, should allow the 

trend toward direct finance to accelerate. 

The second main reason for the observed difference in development of money and capital markets is 

that in the United States, although a single currency 

existed, banking markets were fragmented by the historical prohibitions on interstate banking and the separation of commercial and investment banking 

(Glass-Steagall). Thus, banks could not develop 

nationwide, and entities other than banks were supporting the development and operation of the money 

and capital markets. 

Several observers (Davis [1999], McCauley and 

White [1997], and Prati and Schinasi [1997]) have 

noted that one implication of the single currency is the 

development of broad, deep, and resilient money and 

capital markets in the European Union. 

To understand how this development might affect 

banks, one may review the role of banks in dealing 

with information asymmetries (the theory of financial 

intermediation places a great deal of emphasis on this 

role [Diamond 1984]). Information asymmetry means 

that those who seek funds have more information 

about the prospective risks and returns than the 

potential investor does. The potential investor must 

then expend real resources to obtain the necessary 

information, and this expenditure lowers the return on 

any investment. Moreover, once an investment is 

made, the use of the funds must be monitored. Banks 

are thought to specialize in resolving the informational asymmetries more efficiently than individual 

investors and in monitoring the use of the funds once 

committed. 

However, technological change helps make accurate financial information available to many investors. 

That is, information is available in many forms, some 

of which involve the Internet, and many analysts follow the prospects of firms whose ownership is publicly 

traded. Under these circumstances it becomes progressively easier and cheaper for individual investors 

and nonbank institutional investors to make their 

assessments. Of course, this statement assumes that 

financial information is provided in a timely and accurate manner (transparency). 

Banks are generally compensated for resolving 

informational asymmetries and for performing delegated monitoring by a difference between the interest 

8 
European Union Financial Developments 

rates they pay to suppliers of funds (primarily depositors) and the interest rates they charge to borrowers. 

This difference (net interest margin) can be viewed as 

the cost of intermediation. To the extent that borrowers and suppliers of funds can effectively deal with 

each other directly, the net interest margin that would 

occur with financial intermediation is available to be 

divided between them. For very large transactions, 

the costs per unit of currency (in this case, either dollar or euro) are relatively low; hence such transactions 

will probably be the best candidates for direct finance. 

Thus, the development of money and capital markets in the EU implies that many of the banks’ best 

customers will borrow long term in the bond markets 

and short term in the commercial paper markets. It 

also implies that many of the banks’ largest depositors 

will invest directly in the money and capital markets. 

The result is likely to be a substantial change in the 

size and structure of bank balance sheets over time. 

The very best borrowers will move off the banks’ balance sheets. What is left will be those borrowers for 

whom the bank can make a real contribution to financial intermediation—that is, borrowers whose financial 

information is not easily and cheaply transparent to 

potential suppliers of funds. Fund suppliers who can 

assess the prospects of potential investments in the 

money and capital markets will supply funds directly, 

leaving those depositors who do not have the 

resources to resolve information asymmetries. This 

development will be favorable to the overall level, 

cost, and efficiency of financial activity in the EU, but 

because banks’ share of total finance will decline over 

time, the adjustment will impose costs on banks. 

Although for European banking the prospect of losing 

business over time hardly seems grounds for optimism, there are three offsetting factors. First, large 

corporations with very high credit ratings are paying 

the lowest rates for any of their borrowing. Large corporations with substantial pools of funds available for 

short-term investment will demand the highest rates 

on deposits. Hence, the movement of such activity off 

the balance sheet should result in higher net interest 

margins. In the United States, where banks have a 

smaller share of total finance, net interest margins are 

higher than those in the EU. 

Second, because banks in the United States are 

more profitable than banks in the EU, it seems reasonable to maintain that a smaller share of total finance 

can be consistent with strong profitability. 

Third, because of universal banking in the EU, 

many transactions that flow to the money and capital 

markets will be handled in the investment banking 

departments of the bank rather than in the credit or 

deposit departments. Bonds and shares need to be 

underwritten, and commercial paper may be guaranteed. All such activity must eventually result in placement of securities with investors. The result should 

be fee income. 

Conclusion: 

Assessments of the Single-Market 

Program in Banking, Past 

and Future 

Although the single-market program in banking 

has been in place since 1993, it was the single currency that marked a dramatic change in the EU’s financial 

environment. The single currency, of course, has 

existed for only a short time, so one cannot yet assess 

its affect, but one can review the single-market experience up to and including 1996. One may also make 

reasonable assumptions about the future on the basis 

of an analysis of the EU’s experience with the single 

market and on the prospects now that the single currency is in place. 

The European Union has undertaken a number of 

studies of the effects of the single-market program in 

many areas, such as manufacturing, services, trade, 

and so forth. All of these studies are part of a series 

known as the Single Market Review. Volume 3 of that 

series, entitled Credit Institutions and Banking (1997) 

was prepared by a team of distinguished scholars 

under the auspices of Economic Research Europe, 

Ltd., and contains an exhaustive analysis of the single 

market’s effect on banking. The analysis is based on 

econometric analysis, surveys of bankers, and detailed 

case studies in EU countries. The findings may be 

summarized as follows: 

� The Single Market Program (SMP) has had a 

positive effect on competition and strategy in 

many product lines and in a number of countries. However, barriers to achieving the goals 

of the SMP remain. 

� It is difficult to disentangle the effects of the 

SMP from other factors, such as technology and 

globalization, on the one hand, and the capital 

regulations implemented at the same time, on 

9 
FDIC Banking Review 

the other hand. That is, technology and globalization would enhance the move to greater competition, reducing the spread between rates 

charged to borrowers and rates paid to depositors, while at the same time higher capital regulations would push in the other direction. 

� Although progress in eliminating regulatory barriers has been impressive, it is not complete. 

One sector where obstacles remain is mortgage 

credit. This sector involves a number of issues, 

including access to capital markets, national 

subsidies to housing and mortgage credit, and 

tax law. 

� Differences in taxation and fiscal policy affect 

competition for financial services. For example, 

in some countries the deductibility of mortgage 

interest for income tax purposes depends on the 

borrower’s dealing with a domestic lender. 

Another example: tax-favored investments 

(analogous to IRAs, 401[k] plans, etc.) may be 

tied to domestic institutions. Such incentives 

influence consumer choice of financial services 

in such a way as to constitute a barrier to competition. 

� Restrictive labor laws and regulations make it 

difficult for banks to realize benefits from a 

more competitive environment. The consolidation that occurs when economies of scope and 

scale and increases in efficiency are possible 

implies that labor will probably be displaced. In 

many countries, displacing labor is difficult to 

do. 

� In some cases, large public-sector involvement 

in banking involves implicit or explicit guarantees by the state. These give such institutions a 

competitive advantage not related to the efficiency and effectiveness of their delivery of 

financial services. In addition, national governments are reluctant to close banks, especially 

large ones, and this reluctance gives banks perceived as “too big to fail” an advantage. 

Notwithstanding these restrictions, there is ample 

evidence of pro-competitive behavior by banks: 

� Prices on particular services are converging to a 

lower average value, especially in countries that 

were highly protected before the SMP. 

� Case studies and postal surveys show that banks 

have taken strategic steps to control costs, to 

increase market share and scale by merging, and 

to focus on enhancing shareholder value rather 

than engaging in regulatory capture activities 

and other noncompetitive behaviors. 

� Merger activity, both within countries and 

cross-border, has increased. 

� Measured productive inefficiencies have been 

reduced, and the reduction has moved banks 

closer to the “best practices” frontier. 

What are the prospects for the banking industry in 

the EU? A number of commentators have discussed 

this, but the focus here is on two recent contributions, 

one by White (1998) and the other by the European 

Central Bank (1999). First, though, it should be noted 

that banking in the EU is not homogeneous, even 

though most of the discussion below focuses on the 

entire area. Marked differences exist between, on the 

one hand, the banking system of the United Kingdom, 

the Netherlands, and Ireland and, on the other hand, 

those of the remainder of Western Europe. The banking tradition of the United Kingdom was similar to 

that of the United States, and the tradition is generally referred to as the “Anglo-Saxon” model, with limited banking and limited state involvement in the 

management of individual banks. The Netherlands 

and Ireland are small, open economies with relatively 

free financial systems. The rest of Western Europe is 

characterized by a tradition of universal banking and 

of state involvement in the ownership and management of financial institutions. Moreover, these nations 

tend to have more restrictive labor laws. For that reason, White focuses on the potential changes in 

Continental Europe, and the title of his contribution is 

“The Coming Transformation of Continental 

European Banking?” 

White concludes as follows: (1) Most of the concerns of the Price Waterhouse/Cecchini report still 

apply to banking in Continental Europe: too many 

banks (effects on scale), too many branches (effects on 

scale), too many employees (effects on efficiency). (2) 

There is too much state intervention in these banking 

systems: state-owned banks account for large percentages of banking assets in Italy, Germany, and France, 

the three largest continental economies. (3) 

Notwithstanding these difficulties, increased attention is being paid to cutting costs and to reorienting 

management’s focus on activities that increase shareholder wealth rather than increasing market share. 

Moreover, banks have increased the level of risk in 

their portfolios in part because of the lack of availability of low-risk government securities as a consequence 

10 
European Union Financial Developments 

of the fiscal policies of the Economic and Monetary 

Union. (4) Merger and acquisition activity has 

increased substantially but is focused first on withincountry mergers (cost cutting) and mergers of banks 

with nonbank providers of financial services 

(economies of scope). Cross-border merger activity is 

expected to increase. 

The European Central Bank’s report includes substantial data comparing EU countries with the United 

States and Japan on many aspects of banking activities 

and structure. The report was supported by staff of all 

of the EU members’ national central banks and independent banking supervisors. They agree with many 

of the conclusions reached by White (1998) and 

Economic Research Europe, Ltd. (1997). Their own 

conclusions are the following: 

� Eliminating commissions and fees from foreignexchange trading within the single market will 

substantially affect bank profitability in the 

short run. 

� Money and capital market developments 

spurred by the single currency will force banks 

to face disintermediation. They will need to 

focus on activities to support that shift and will 

need to gain fee income from underwriting and 

placement. 

� Banks will expand both within country and 

cross-border not only to achieve economies of 

scale and scope but also to diversify credit risk 

across a wider geographic area. With currency 

risk eliminated inside Euroland, banks can 

focus on wider geographic patterns of lending 

and therefore on greater diversification. 

� Although concentration ratios for individual 

countries within the EU are quite high, if all of 

the single-market area, or the single-currency 

area, is considered the relevant market, concentration ratios are quite low. Thus, there is room 

for consolidation without too much worry about 

anticompetitive consequences. 

� Merger patterns show that cross-border activities are preceded by a phase of in-country 

defensive moves to mop up excess capacity and 

achieve critical scale levels. There is some evidence that nationalistic sentiments on the part 

of some governments have a dampening effect 

on the free movement of banks across national 

borders. 

� Since markets are contestable and EU banks 

have excess capacity and low profit rates, there 

is no alternative to a restructuring of the banking sector in the medium and long terms. 

� Two related issues must be considered. First, 

the need to increase revenue and profits may 

tempt some banks to take excessive risks. 

Second, building large pan-European banks 

with home offices in small countries raises the 

question of the costs of resolving failures and 

the deposit insurers’ temptation to consider 

some banks “too big to fail.” Well-known moral 

hazard issues are involved. 

In summary, there is substantial agreement that the 

EU financial environment will change dramatically 

over time. The effects of globalization and technology that all banks in all countries are facing will be reinforced by several major initiatives that the EU has put 

in place. Increased competition from money and capital markets will change the nature of banking and 

financial intermediation in Europe. Excess capacity, 

uneconomic size and structures of banks, and inefficiency will all be eliminated over time. Deregulation, 

globalization, technological change, and macroeconomic policy are all exerting pressure in the same 

direction. 

In summary, the implications of the single market 

in banking and the single currency for the EU’s financial system and banking structure are significant. 

Inevitably, money and capital markets will develop for 

the single-currency area, and their existence will 

remove business from both sides of their balance 

sheets. Fortunately, the banks will be able to offer the 

investment banking services to support money and 

capital market development. 

Although it is generally agreed that banking in the 

EU has serious problems of excess capacity and 

uneconomic scale and that adjustment to a more competitive environment will be hampered by restrictive 

labor laws, nonetheless the signals are fairly clear. To 

survive and prosper, banking in Europe will need to 

adapt to the changes in the environment. And with 11 

more nations applying for membership in the 

European Union and working to meet the standards 

for joining,9 the banking and financial context 

described here may eventually encompass a population of 400 million people. 

9 The 11 nations are Bulgaria, Cyprus, the Czech Republic, Estonia, 

Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia. 

11 
FDIC Banking Review 

REFERENCES 

Barth, James R., Daniel E. Nolle, and Tara N. Rice. 1997. Commercial Banking Structure, 

Regulation, and Performance: An International Comparison, Economics Working Paper 97­

6. Office of the Comptroller of the Currency. 

Berger, Allen N., Rebecca S. Demsetz, and Philip E. Strahan. 1999. “The Consolidation of the 

Financial Services Industry: Causes, Consequences, and Implications for the Future.” 

Journal of Banking and Finance. 

Cecchini, P. 1988. The European Challenge in 1992: The Benefits of a Single Market. Aldershot: 

Gower. 

Commission of the European Communities. 1985. Completing the Internal Market. White Paper 

from the Commission to the European Council. Luxembourg: Office for Official 

Publications of the European Communities. 

Davis, E. Philip. 1999. Institutionalization and EMU: Implications for European Financial 

Markets. International Finance. 

Dermine, Jean. 1996. European Banking with a Single Currency. Financial Markets, Institutions, 

and Instruments. 

——, ed. 1993. European Banking in the 1990s. Blackwell. 

——. 1999. The Economics of Bank Mergers in the European Union, A Review of the Policy 

Issues. INSEAD Working Paper. 

Diamond, Douglas W. 1984. Financial Intermediation and Delegated Monitoring. Review of 

Economic Studies. 

Economic Research Europe, Ltd. 1997. The Single Market Review: Impact on Credit Institutions 

and Banking. London: Kogan Page. 

European Central Bank. 1999a. Possible Effects of EMU on the EU Banking Systems in the Medium 

to Long Term. 

——. 1999b. The Effects of Technology on the EU Banking Systems. 

European Union. 1989a. Council Directive 89/299/EEC of 17 April 1989 on the Own Funds of 

Credit Institutions. Official Journal of the European Communities, No. L124. 

——. 1989b. Second Council Directive 89/646/EEC of 15 December 1989 on the Coordination of 

Laws, Regulation and Administrative Provisions Relating to the Taking up and Pursuit of 

the Business of Credit Institutions and Amending Directive 77/780/EEC. Official Journal 

of the European Communities, No. L386. 

——. 1989c. Council Directive 89/647/EEC of 18 December 1989 on a Solvency Ratio for Credit 

Institutions. Official Journal of the European Communities, No. L386. 

——. 1992. Council Directive 92/121/EEC of 21 December 1992 on the Monitoring and Control 

of Large Exposures of Credit Institutions. Official Journal of the European Communities, 

No. L029. 

——. 1994. Directive 94/19/EEC of the European Parliament and of the Council on Deposit 

Protection Schemes. Official Journal of the European Communities, No. L135. 

Garcia, Gillian G. H. 1999. IMF. Working Paper 99/54 Deposit Insurance: A Survey of Actual and 

Best Practices. 

Gardener, Edward P. M., and Philip Molyneux. 1990. Changes in Western European Banking: An 

International Banker’s Guide. London: Routledge. 

12 
European Union Financial Developments 

Key, Sidney J. 1994. Deposit Guarantee Directive. Banking and EC Law Commentary.
 

Kyei, Alexander. 1995. IMF. Working Paper 95/154. Deposit Protection Arrangements: A Survey.
 

McCauley, Robert N., and William R. White. 1997. The Euro and European Financial Markets.
 

In EMU and the International Monetary System, edited by Paul R. Masson, Thomas H. 

Krueger, and Bart G. Turtleboom. IMF. 

Molyneux, Philip, Yener Altunbas, and Edward P. M. Gardener. 1996. Efficiency in European 

Banking. John Wiley & Sons. 

Prati, Allesandro, and Garry J. Schinasi. 1997. EMU and International Capital Markets: Structural 

Implications and Risks. In EMU and the International Monetary System, edited by Paul R. 

Masson, Thomas H. Krueger, and Bart G. Turtleboom. IMF. 

Price Waterhouse. 1988. The Cost of Non-Europe in Financial Services. In Research on the Cost 

of Non-Europe: Basic Findings. Vol. 9 Brussels: European Union. 

U.S. Department of the Treasury. 	1998. National Treatment Study. U.S. Department of the 

Treasury. 

White, William R. 1998. The Coming Transformation of Continental European Banking? Working 

Paper No. 54. Bank for International Settlements. 

Wynne, Mark A. 1999. The European System of Central Banks. Federal Reserve Bank of Dallas. 

Economic Review. 

Zimmerman, Gary C. 	 1995. Implementing the Single Banking Market in Europe. Federal 

Reserve Bank of San Francisco. Economic Review. 

13 
FDIC Banking Review 

APPENDIX 

A SELECT CHRONOLOGY OF EVENTS RELATED TO THE EUROPEAN UNION 

� September 1946—Winston Churchill calls for a United States of Europe. 

� April 1951—Belgium, France, Germany, Italy, Luxembourg, and the Netherlands (the 

Six) sign the Treaty of Paris establishing the European Coal and Steel Community. 

� March 1957—The Six sign treaties establishing the European Economic Community 

(EEC) and the European Atomic Energy Community (Euroatom) in Rome (“Treaties of 

Rome”). 

� January 1958—The Treaties of Rome enter into force. 

� January 1973—Denmark, Ireland, and the United Kingdom join the European 

Community. 

� January 1981—Greece joins the European Community. 

� June 1985—European Commission sends European Council a White Paper on 

Completion of Internal Market by 1992. Later that month the White Paper is approved 

by the European Council. 

� January 1986—Spain and Portugal join the European Community. 

� February 1987—Jacques Delors presents European Commission’s program for 1987 to 

the European Parliament, accompanied by the communication “The Single Act: A New 

Frontier for Europe.” 

� February 1992—Treaty on European Union signed in Maastricht by foreign and finance 

ministers of Member States (“Maastricht Treaty”). 

� January 1993—The Single European Market enters into force. 

� January 1995—Austria, Finland, and Sweden become members of the European Union. 

� May 1998—Eleven Member States satisfy conditions for adoption of the single currency. 

The Governments of the Member States adopting the single currency appoint the president, vice president and the other members of the Executive Board of the European 

Central Bank. 

� January 1999—Eleven Member States adopt the euro as their official currency. 

Source: European Union, Yearly Chronology of the European Union. 

14 
European Union Financial Developments 

Table 1
 

POPULATION AND GROSS DOMESTIC PRODUCT (GDP)
 

EUROPEAN UNION, EUROLAND, AND THE UNITED STATES, 1998
 

Entity Population GDP (� Billion) 

European Union 

Euroland 

United States 

374,566,000 

290,832,000 

266,490,000 

� 7,472.5 

5,776.1 

7,269.4 

Source: Eurostat (Statistical Office of the European Communities), 2000. All data are expressed 

in terms of ECU (European Currency Unit) because the euro did not exist in 1998. However, 

upon adoption of the single currency, 1 ECU = �1. 

Table 2
 

FINANCIAL STRUCTURE OF EUROPEAN UNION, EUROLAND,
 

AND THE UNITED STATES, 1996
 

Government Private 

Equities/ Bonds/ Bonds/ 

GDP GDP GDP 

(Percent) (Percent) (Percent) 

Bank 

Assets/ 

GDP 

(Percent) 

Total/ 

GDP 

(Percent) 

Institution 

Assets/ 

GDP 

(Percent) 

European Union 55% 56% 36% 207% 354% 74% 

Euroland 35 55 34 206 330 59 

United States 117 96 60 73 346 145 

Source: Davis (1999). 

15 
FDIC Banking Review 

Table 3
 

BANKING ACTIVITIES PERMITTED IN THE EUROPEAN UNION
 

� Deposit taking and other forms of borrowing 

� Lending (including consumer credit, mortgage credit factoring, invoice 

discounting, and trade finance) 

� Financial leasing 

� Money transmission services 

� Payments services (including credit cards, electronic funds transfer, point of 

sale, travelers checks, and bank drafts) 

� Providing guarantees and commitments 

� Trading on their own account or for customers in money-market instruments, 

foreign exchange, financial futures and options, exchange and interest-rate 

instruments, and securities 

� Participating in share issues and providing services related to such issues (for 

shares, bonds, and other securities), including corporate advice and arranging 

mergers and acquisitions 

� Money brokering 

� Portfolio management and advice 

� Safekeeping of securities 

� Offering credit reference services 

� Safe-custody services 

16 
European Union Financial Developments 

Table 4
 

SUMMARY OF DEPOSIT PROTECTION SCHEMES IN EUROPEAN UNION
 

Location of 

Deposit Insurance 

Country Funded Coverage Premium Agency 

Austria No � 22,000 ex post, pro rata Private 

Belgium Yes � 20,000 .02% insured Bank supervisory 

liabilities agency 

Denmark Yes � 20,000 .2% insured Bank supervisory 

deposits (max.) agency within 

central bank 

Finland Yes � 27,000 .05% to .3% Supervised by 

(risk-based) on bank supervisor 

insured deposits and ministry of 

finance 

France No � 60,000 on demand, Responsibility of 

but limited bank supervisor, 

part of central 

bank 

Germany Yes 90% of capital .03% of insured Private 

for savings deposits 

banks, 90% of 

deposit up to 

� 20,000 for 

commercial 

banks 

Greece Yes � 20,000 .025% to 1.25% Private 

of deposits 

Ireland Yes 90% coinsurance .2% of insured Private 

to � 22,222 deposits 

Italy No � 114,000 ex-post risk Part of central bank 

adjusted .4% to 

.8% 

Luxembourg No 90% coinsurance ex-post Private 

to � 22,222 

Netherlands No � 20,000 ex-post Private 

Portugal Yes � 20,000, risk-based .08% Private 

coinsurance to .12% of 

to � 45,000 insured deposits 

Spain Yes � 20,000 max. of .2% of Private 

insured deposits 

Sweden Yes � 20,000 max. of .2% of Part of ministry 

insured deposits of finance 

United Kingdom Yes, coinsurance on demand Separate legal 

small (mostly to � 22,222 entity staffed by 

ex post) bank supervisor 

Source: Garcia, (1999). 

17 
FDIC Banking Review 

Table 5
 

NATIONS IN EUROPEAN UNION AND IN SINGLE-CURRENCY AREA
 

European Union Single-Currency Area (Euroland) 

Austria Austria 

Belgium Belgium 

Denmark 

Finland Finland 

France France 

Germany Germany 

Greece 

Ireland Ireland 

Italy Italy 

Luxembourg Luxembourg 

Netherlands Netherlands 

Portugal Portugal 

Spain Spain 

Sweden 

United Kingdom 

Table 6
 

LEGACY CURRENCY VALUES IN RELATION TO THE VALUE OF ONE EURO
 

Number of Units 

Nation and Currency per Euro 

Austria—Schilling 13.760300 

Belgium—Belgian Franc 40.339900 

Germany—Mark 1.955830 

Spain—Peseta 166.386000 

Finland—Markka 5.945730 

France—French Franc 6.559570 

Ireland—Punt .787564 

Italy—Lira 1,936.270000 

Luxembourg—Belgian Franc 40.339900 

Netherlands—Guilder 2.203710 

Portugal—Escudero 200.482000 

18 
Recent Developments 

Recent Developments
 

Affecting Depository
 

Institutions
 

by Lynne Montgomery*
 

REGULATORY AGENCY ACTIONS
 

Interagency Actions 

Gramm-Leach-Bliley Financial Services 

Modernization Act 

On November 12, 1999, President Clinton signed 

into law a bill allowing banking, insurance, and securities firms to affiliate, and creating rules aimed at 

protecting consumers and low-income communities. 

The Gramm-Leach-Bliley Act is the result of approximately two decades of effort to repeal the anti-affiliation provisions of the 1933 Glass-Steagall Act and 

the 1956 Bank Holding Company Act. In general, 

the Gramm-Leach-Bliley Act: lifts restrictions on 

affiliations among banks, securities firms, and insurance companies; expands the financial activities permissible for financial holding companies and insured 

depository institutions; and provides for a greater 

degree of functional regulation of securities and 

insurance activities conducted by banking organizations. The Act will also expand the reach of the 

Community Reinvestment Act (CRA) by requiring 

banks to have at least “satisfactory” CRA ratings to 

take advantage of the new law’s expanded powers. 

In addition, the Act takes significant steps to protect 

consumers’ financial privacy, such as requiring financial institutions to disclose their privacy policies and 

allowing consumers to block their financial institutions from sharing personal financial information 

with third parties. The Act also directs the Treasury 

Department to study the financial-services industry’s 

privacy practices and recommend further legislative 

steps. The Act becomes effective on March 11, 2000. 

BBR, 11/15/99, p. 765–766. 

Independent Audits for Small Banks
 

and Thrifts
 

On September 28, 1999, the Federal Financial 

Institutions Examination Council (FFIEC) issued an 

interagency policy statement on external auditing 

programs of banks and savings associations. The policy statement recommends, but does not require, 

that banks and thrifts with assets under $500 million 

undergo external audits annually. The FFIEC noted 

that approximately 65 percent of smaller institutions 

already undergo external audits. The policy statement is aimed at smaller institutions because larger 

institutions are already required to undergo annual 

audits by independent certified public accountants. 

The policy statement is effective for fiscal years 

beginning on or after January 1, 2000. 

The FFIEC is made up of representatives of the 

Office of the Comptroller of the Currency (OCC), 

the Office of Thrift Supervision (OTS), the Federal 

Reserve Board, and the Federal Deposit Insurance 

Corporation (FDIC). The National Credit Union 

Administration is also a member of the group, but 

does not plan to adopt the policy at this time. BBR, 

10/4/99, p. 518–519. 

*Lynne Montgomery is a senior financial analyst in the FDIC’s Division 

of Research and Statistics. 

Reference sources: American Banker (AB) and BNA’s Banking Report 

(BBR). 

19 
FDIC Banking Review 

Extended Exam Cycle for Foreign Banks 

On October 22, 1999, the Federal Reserve Board, 

the OCC, and the FDIC adopted a final rule to 

expand the examination frequency cycle for certain 

U.S. branches and agencies of foreign banks. The 

rule finalizes an interim rule, which was effective 

August 28, 1998, that made healthy, smaller U.S. 

branches and agencies of foreign banks eligible for 

exams every 18 months, instead of every 12 months. 

U.S. banks were given the opportunity to have exams 

every 18 months in a 1991 law, but foreign banks 

were not afforded the same treatment at that time. 

The extended exam cycle applies to U.S. branches or 

agencies of a foreign bank that have total assets of 

$250 million or less and have received a supervisory 

ROCA rating of 1 or 2. (ROCA stands for risk management, operational controls, compliance, and asset 

quality.) In addition, the foreign bank branch or 

agency must meet certain specified capital requirements and must not be subject to any formal enforcement action by U.S. regulators. PR-FRB, 10/21/99; BBR, 

10/25/99, p. 649. 

Web Site Privacy Survey 

On November 9, 1999, the Federal Reserve Board, 

the OCC, the FDIC, and the OTS released a report 

on the results of a survey of Internet privacy policies 

of banking and thrift institutions. The survey examined 314 randomly selected Web sites of financial 

institutions, plus the Web sites of the 50 largest 

banks and thrifts. The agencies conducted the survey between May and July 1999, examining the Web 

sites’ collection of consumer information, interactive 

capabilities, and privacy disclosures. The purpose of 

the survey was to provide an indication of the state of 

the industry with respect to data collection and online privacy disclosures. The survey results were 

published in the Interagency Financial Institution Web 

Site Privacy Survey Report. 

Overall, 48 percent of the 364 Web sites surveyed 

posted a privacy disclosure, in the form of either a 

privacy policy or an information practice statement. 

Sites that collected personal information were three 

times as likely to post a privacy policy than sites that 

did not collect personal information. The survey also 

found that 96 percent of the nation’s 50 largest banks 

and thrifts that are on-line provided a privacy policy 

or information practice statement. The agencies 

define a privacy policy as “a comprehensive statement regarding the collection and use of consumer 

information,” and an information practice statement 

is “a statement describing a particular information 

handling practice, such as data security.” PR-66-99, 

FDIC, 11/9/99; BBR, 11/15/99, p. 774. 

Guidance on Asset Securitization Activities 

The four federal banking agencies released guidance on December 13, 1999, reminding financial 

institutions of basic risk-management practices that 

should be in place at institutions engaging in securitization activities. The agencies said that recent 

examinations have shown “significant weaknesses” 

in the asset securitization activities at certain financial institutions, and they noted that such weaknesses raise concerns about the basic level of 

understanding and controls at financial institutions 

that engage in securitization activities. The guidance 

highlights the risks associated with retained interests 

in securitizations, and points out that reported values 

for retained interests should be reasonable, conservative and supported by objective and verifiable documentation. The guidance states that institutions 

should ensure that sufficient capital is held to support the risks associated with securitization activities, 

and the institutions are expected to place concentration limits on retained interests relative to equity 

capital. In addition, the guidance states that institutions should establish and implement an adequate 

and independent audit function to oversee securitization activities effectively. The guidance, which 

was issued by the FDIC, the Federal Reserve Board, 

the OCC, and the OTS, is part of the agencies’ ongoing review of securitization activities at insured 

depository institutions. PR-80-99, FDIC, 12/13/99; BBR, 

12/20/99, p. 983. 

Federal Deposit Insurance Corporation 

Chairman Tanoue Renominated 

On January 31, 2000, President Clinton renominated FDIC Chairman Donna Tanoue to a new sixyear term. Ms. Tanoue, who joined the FDIC as 

Chairman on May 26, 1998, is currently finishing the 

term of former FDIC Chairman Ricki Helfer. Her 

term was set to expire on October 3, 2000. BBR, 2/7/00, 

p. 243. 

20 
Recent Developments 

Houseworth Nominated to Board 


of Directors
 

President Clinton nominated Richard H. 

Houseworth to the FDIC Board of Directors on 

January 31, 2000. Mr. Houseworth is the 

Superintendent of Banks for the State of Arizona. 

He has served as the U.S. Alternate Executive 

Director of the Inter-American Development Bank 

and as both a consultant to the Assistant Secretary of 

the Treasury for International Affairs and as the 

Director of the Export-Import Bank of the United 

States. Bloomberg News, 1/31/00. 

Assessment Rates Maintained 

The FDIC Board of Directors voted on November 

8, 1999, to maintain the existing insurance assessment rate schedules for both the Bank Insurance 

Fund (BIF) and the Savings Association Insurance 

Fund (SAIF) through June 2000. Since the FDIC 

applies a risk-based assessment system for insurance 

coverage, the healthiest institutions currently pay 

nothing for insurance and the weakest institutions 

pay up to 27 cents per $100 of insured deposits. 

Federal law requires the FDIC to maintain a minimum reserve ratio of 1.25 percent, or $1.25 for every 

$100 of insured deposits, in the BIF and the SAIF to 

cover the costs of bank and thrift failures. As of June 

30, 1999, the BIF reserve ratio was 1.40 percent and 

the SAIF ratio was 1.29 percent. BBR, 11/15/99, p. 771–772. 

Municipal Securities Rule Rescinded 

Effective December 19, 1999, the FDIC rescinded an agency regulation that requires insured state 

nonmember banks that are municipal securities dealers to file with the FDIC certain information about 

potential municipal securities principals. The FDIC 

says the regulation is unnecessary and duplicative, 

and the number of entities covered by the regulation 

is declining. The OCC and the Federal Reserve 

Board have already rescinded their regulations on 

this subject; thus, the FDIC’s rescission maintains 

uniformity among the banking agencies. BBR, 11/22/99, 

p. 822–823. 

Report on Underwriting Practices 

The October 1999 issue of the Report on 

Underwriting Practices reported no significant change 

in overall loan underwriting practices at FDIC-supervised banks during the six months ending September 

30, 1999, compared to the previous six-month period 

ending March 31, 1999. However, the FDIC examiners reported increased concerns about the level of 

“carryover debt” at FDIC-supervised banks actively 

making agricultural loans. Carryover debt refers to 

loans that are not paid off at the end of the growing 

season and are subsequently carried over into the 

next growing season. The survey of loan underwriting practices is aimed at providing early warnings of 

potential problems in underwriting practices at 

FDIC-supervised, state-chartered nonmember 

banks. The focus of the survey is threefold: material changes in underwriting standards for new loans, 

degree of risk in current practices, and specific 

aspects of the underwriting standards for new loans. 

The October report includes surveys from 1,227 

FDIC-supervised banks that were examined during 

the six months ending September 30, 1999. Report on 

Underwriting Practices, FDIC, October 1999. 

Real-Estate Survey—October 1999 

The October 1999 issue of the Survey of Real 

Estate Trends reported that the nation’s commercial 

and residential real-estate markets continued to show 

improvement in the late summer and early fall, but at 

a slower pace than before. The quarterly survey 

polled 297 senior examiners and asset managers from 

the FDIC, the Federal Reserve System, the OCC, 

and the OTS. Reports about residential real-estatemarket activity were notably less positive than in 

recent surveys; however, assessments of improvements in residential markets continued to outweigh 

reports of worsening market activity. Specifically, 31 

percent of the survey respondents described the general direction of their local housing market as better 

in October than three months earlier, compared to 45 

percent in July. Reports of weaker housing markets 

increased from 3 percent in July to 10 percent in 

October. As for commercial market trends, 33 percent of the respondents in October noted better conditions in local markets, down slightly from 35 

percent in July. 

The national composite index used by the FDIC 

to summarize results for both residential and commercial real-estate markets was 62, down from 69 in 

July. Index scores above 50 indicate improving conditions, while index scores below 50 indicate declining conditions. Beginning in 2000, the FDIC will 

conduct a substantially revised and expanded semiannual survey, covering the periods January to June 

and July to December. As a result, the next FDIC 

21 
FDIC Banking Review 

published real-estate report is expected to be available in August 2000. Survey of Real Estate Trends, FDIC, October 

1999. 

Financial Results for Third-Quarter 1999 

The FDIC reported that the Savings Association 

Insurance Fund (SAIF) earned income of approximately $365 million for the first nine months of 1999; 

however, the Bank Insurance Fund (BIF) experienced a comprehensive loss (net loss plus unrealized 

loss on available-for-sale securities) of $113 million 

for the first nine months of 1999. At September 30, 

1999, the BIF balance was approximately $29.5 billion, down from $29.6 billion at year-end 1998. The 

decrease in the fund balance was primarily attributable to recognizing estimated losses of $917 million 

for the resolution of bank failures in 1999 and the 

prior year. The BIF revenues totaled $1.4 billion for 

the first nine months of 1999, including $1.3 billion 

in interest on investments in U.S. Treasury obligations and $25 million in deposit insurance assessments. The SAIF closed the quarter with an 

unrestricted fund balance of $9.2 billion and $978 

million in the restricted SAIF Special Reserve. The 

Special Reserve was established on January 1, 1999, 

and contains the amount by which the SAIF exceeds 

the Designated Reserve Ratio of 1.25 percent. 

However, the Gramm-Leach-Bliley Act of 1999 eliminated the SAIF Special Reserve upon enactment on 

November 12, 1999, so the SAIF’s total fund balance 

is now unrestricted. The SAIF earned $442 million 

in revenue during the first nine months of 1999, consisting of $432 million in interest on investments in 

U.S. Treasury obligations and $10 million in deposit 

insurance assessments. 

The FSLIC Resolution Fund (FRF) returned $3.7 

billion in appropriated funds to the U.S. Treasury in 

the third quarter, pursuant to the RTC Completion 

Act. The Act required the FDIC to return any funds 

that were transferred to the Resolution Trust 

Corporation (RTC) pursuant to the Act but not needed to satisfy obligations of the RTC. FRF assets in 

liquidation were reduced to $592 million on 

September 30, 1999. The FRF was established in 

1989 to assume the remaining assets and obligations 

of the former Federal Savings and Loan Insurance 

Corporation (FSLIC). On January 1, 1996, the former Resolution Trust Corporation’s financial operations were merged into the FRF. PR-81-99, FDIC, 12/14/99. 

Bank Failures 

On November 19, 1999, the California 

Superintendent of Banks closed Pacific Thrift and 

Loan Company, Woodland Hills, California, and the 

FDIC was named receiver. Pacific Thrift and Loan 

had total assets of approximately $118 million and 

total deposits of $108 million in roughly 2,600 

accounts. Affinity Bank, Ventura, California, paid a 

premium of $350,000 to assume the failed institution’s $106 million of insured deposits and to purchase approximately $13 million of the assets. The 

FDIC will retain the remaining assets for later disposition. The FDIC estimates that this transaction will 

cost the Bank Insurance Fund (BIF) approximately 

$50 million. Pacific Thrift and Loan was the sixth 

failure of a BIF-insured institution in 1999. 

On December 10, 1999, the New York 

Superintendent of Banks closed Golden City 

Commercial Bank, New York, New York, and the 

FDIC was named receiver. Golden City was a statechartered bank with total assets of approximately $89 

million and total deposits of $82 million. Cathay 

Bank, Los Angeles, California, paid the FDIC a premium of $2.7 million to assume all the deposits and 

purchase approximately $85 million of the failed 

bank’s assets. This was the seventh failure of a BIFinsured institution in 1999; however, the FDIC anticipates that this will be a no-cost transaction for the 

BIF. 

The Iowa Superintendent of Banking closed 

Hartford-Carlisle Savings Bank, Carlisle, Iowa, on 

January 14, 2000, and the FDIC was named receiver. 

Hartford-Carlisle had approximately $114 million in 

assets and total deposits of $69 million in approximately 7,700 accounts. The FDIC approved the 

assumption of the insured deposits of HartfordCarlisle by Citizens Bank, Carlisle, Iowa. Citizens 

Bank, a newly chartered subsidiary of Spectrum 

Bancorp, Omaha, Nebraska, paid a premium of $5.5 

million to assume the insured deposits and to purchase approximately $4 million of the failed institution’s assets. The FDIC will retain the remaining 

assets for later disposition. The FDIC has identified 

apparent fraud at the failed bank and estimates that 

the losses at the bank will range between $18 million 

and $25 million. Hartford-Carlisle is the first failure 

of a BIF-insured bank in 2000. PR-71-99, FDIC, 11/22/99; 

PR-79-99, FDIC, 12/10/99; PR-4-2000, FDIC, 1/14/00. 

22 
Recent Developments 

Federal Reserve Board 

Greenspan Confirmed for Fourth Term 

On February 3, 2000, the U.S. Senate voted to 

confirm Alan Greenspan to serve a fourth, four-year 

term as chairman of the Federal Reserve Board. Mr. 

Greenspan’s current term was due to expire on June 

20, 2000. He was first appointed by President 

Reagan and took office as chairman on August 11, 

1987. President Bush named Mr. Greenspan to a second term in 1991, and President Clinton tapped him 

for his third term in February 1996. BBR, 1/13/00, p. 59; 

BBR, 2/7/00, p. 243–244. 

Senate Confirms Vice Chairman 

On September 30, 1999, the Senate confirmed the 

nomination of Roger W. Ferguson as vice chairman of 

the Board of Governors of the Federal Reserve 

System. Mr. Ferguson has been a member of the 

Board of Governors since November 1997. In August 

1999, President Clinton nominated Mr. Ferguson to 

fill the vice-chairman seat, which is a four-year 

appointment. Mr. Ferguson replaces Alice Rivlin, 

who left the Federal Reserve Board in mid-summer 

1999. BBR, 10/4/99, p. 517. 

Interest Rates 

On November 16, 1999, the Federal Open Market 

Committee (FOMC) voted to raise the targeted federal funds rate by 25 basis points, increasing the rate 

from 5.25 percent to 5.50 percent. In a related action, 

the Board of Governors approved a 25-basis-point 

increase in the discount rate, raising the rate from 

4.75 percent to 5.0 percent. The FOMC raised the 

federal funds rate an additional 25 basis points on 

February 2, 2000, increasing the rate to 5.75 percent. 

The Board of Governors also approved a 25-basispoint increase in the discount rate, raising the rate to 

5.25 percent. The federal funds rate is the fee that 

banks charge each other for overnight loans, and the 

discount rate is the fee charged to financial institutions for borrowing from their district Federal 

Reserve Banks. PR-FRB, 11/16/99; PR-FRB, 2/2/00. 

New Communications Procedures for
 

Federal Open Market Committee
 

The Federal Open Market Committee announced 

on January 19, 2000, that it approved modifications to 

its disclosure procedures in an effort to enhance communication to the public. The FOMC determined 

that a statement would be issued to the public immediately after every FOMC meeting. The previous 

procedure was to release a statement only in the 

event of a policy action or a major shift in the 

Committee’s view about prospective developments. 

The FOMC also changed its language describing its 

assessment of future developments. The prior procedure was to describe the FOMC’s view about the 

period ahead in terms of the relative chances of an 

increase or decrease in the intended federal funds 

rate. Under the new procedures, an announcement 

will indicate how the Committee assesses the risks of 

heightened inflation pressures or economic weakness 

in the foreseeable future. The modifications take 

effect as of the February 2000 FOMC meeting. PRFRB, 1/19/00. 

Regulation CC 

The Federal Reserve Board adopted a final rule 

amending Regulation CC, Availability of Funds and 

Collection of Checks, in order to give banks the 

option to experiment with nontraditional ways to 

return unpaid checks, such as by electronic means. 

However, using an electronic image for check presentment will be optional and by agreement for those 

institutions that want to participate. Institutions will 

not be required to enter into such an agreement 

involving electronic check processing. The final rule 

was effective December 15, 1999. PR-FRB, 10/28/99; BBR, 

11/8/99, p. 727. 

HMDA Reporting Exemption Threshold 

Increased 

The Federal Reserve Board announced on 

December 15, 1999, that the exemption threshold for 

depository institutions that are required to report 

data under the Home Mortgage Disclosure Act 

(HMDA) was increased from $29 million to $30 million. Beginning December 31, 1999, depository institutions with assets of $30 million or less will be 

exempt from reporting data on their housing-related 

lending activities in 2000. The final rule amends 

Regulation C, which implements the Home 

Mortgage Disclosure Act. The asset level that releases institutions from reporting data under HMDA is 

adjusted each year on the basis of changes in inflation 

as measured by the Consumer Price Index for Urban 

Wage Earners and Clerical Workers. PR-FRB, 12/15/99; 

BBR, 1/3/00, p. 10. 

23 
FDIC Banking Review 

Interim Rule for Bank Holding Companies 

and Foreign Banks with U.S. Offices 

On January 19, 2000, the Federal Reserve Board 

approved an interim rule setting forth procedures for 

bank holding companies and foreign banks with U.S. 

offices to elect to be treated as financial holding companies. Financial holding companies may engage in 

a broad range of securities, insurance, and other 

financial activities under Title I of the GrammLeach-Bliley Act. The rule becomes effective on 

March 11, 2000, which is also the effective date of the 

Gramm-Leach-Bliley Act. PR-FRB, 1/19/00. 

Office of the Comptroller of the Currency 

Hawke Confirmed by Senate 

On October 7, 1999, the Senate confirmed John D. 

Hawke, Jr. for a five-year term as Comptroller of the 

Currency. Mr. Hawke has held this office since 

December 8, 1998, after being appointed by 

President Clinton during a Congressional recess. NR 

99-92, OCC, 10/8/99. 

1999 Survey of Credit Underwriting
 

Practices
 

In its 1999 Survey of Credit Underwriting 

Practices, which was released in September 1999, the 

OCC reported that national banks tightened their 

underwriting standards for commercial loans in 1999 

for the first time in the past five years. The survey 

covered the period between March 31, 1998, and 

March 31, 1999. The OCC looked at the 67 largest 

domestic banks with assets of over $2 billion. The 

aggregate loan portfolio of the banks in the survey 

was $1.8 trillion as of December 31, 1998, which represents 90 percent of all outstanding loans at U.S. 

banks. Examiners at 25 percent of the banks surveyed reported tightened underwriting standards for 

commercial loans in 1999, compared with 4 percent 

in 1998. At the same time, examiners at 13 percent 

of the surveyed banks reported an easing of underwriting standards in 1999, compared to 44 percent in 

1998. Additionally, the survey found that international loans, syndicated and national loans, and agricultural loans experienced the most pronounced 

tightening in underwriting standards, while commercial real-estate and middle market credits experienced the most easing of underwriting standards. 

Despite the reported tightening of standards, examiners reported that the level of inherent portfolio 

credit risk continued to increase for all of the surveyed commercial and retail products. This embedded risk is the result of banks taking on higher levels 

of risk in previous years, which will take time to work 

its way through the loan portfolios. BBR, 10/4/99, p. 

513–514. 

New Handbook on Internet Banking 

The OCC issued a new handbook on October 14, 

1999, outlining procedures for examining Internet 

banking activities at national banks. The handbook, 

which is part of the Comptroller’s Handbook for 

National Bank Examiners, is the most comprehensive document on Internet banking issued by the 

OCC to date. The handbook outlines risks unique to 

Internet banking. For example, the handbook notes 

that Internet loan customers can be anywhere in the 

world which creates special challenges in authenticating identities, an important element in making 

sound credit decisions. In addition, Internet banking 

customers react quickly to changing market conditions and could create deposit volatility for banks. 

The handbook emphasizes that interest-rate and liquidity risk can exist with Internet customers, which 

might require increased monitoring of liquidity. 

Additional issues addressed in the handbook are: 

customer privacy, the anonymity of banking over the 

Internet, and the threat from intruders into bank systems. NR 99-94, OCC, 10/14/99. 

Final Rules Reduce Regulatory Burden on 

Community Banks 

On November 4, 1999, the OCC adopted final 

rules that will reduce the regulatory burden on community banks. One change to Part 7 of the OCC’s 

regulations allows banks to buy back their own stock 

more easily and to pay cash for the acquired shares. 

This increased flexibility will make it easier for community banks to meet Subchapter S status, which 

permits smaller corporations (those with fewer than 

75 shareholders) to avoid paying corporate taxes. 

Another Part 7 rule change increases the number of 

ways bank directors can hold required stock interests, 

called “qualifying shares,” in the bank they serve. 

Directors may now acquire qualifying shares under 

an agreement that would give the seller the right to 

repurchase the shares if the director ceases to serve 

on the board or seeks to transfer ownership to another. This change is designed to improve the ability of 

24 
Recent Developments 

national banks to attract qualified directors. The 

final rules also state that, because automated teller 

machines and other remote service units are excluded from the definition of a branch under federal law, 

they are not subject to state geographic restrictions, 

operational restrictions, or licensing laws. Further, 

the rules clarify that a facility that combines nonbranch functions of a loan production office, deposit 

production office, and remote service unit is not a 

branch. The final rules also clarify the scope of the 

OCC’s “visitorial” powers over national banks. This 

authority applies in the case of an examination of a 

bank, inspections of a bank’s books or records, regulation and supervision of activities permitted under 

federal banking law, and enforcement of compliance 

with any applicable federal or state laws on such 

activities. NR 99-99, OCC, 11/3/99; BBR, 11/8/99, p. 726. 

Information-Sharing Accord 

The OCC and insurance regulators in Illinois, 

Iowa, Mississippi, and Washington, D.C., have 

reached agreements to share information when consumers complain about bank insurance sales. The 

agreements are part of an ongoing effort to improve 

relations between the OCC and state insurance regulators. The agreements call for the OCC and the 

insurance departments to send copies of complaints 

to each other and also to communicate on other matters, including regulatory and policy initiatives. The 

OCC now has agreements with 23 state insurance 

regulators. The agreements enhance consumer protection and ensure compliance with appropriate 

insurance sales standards. BBR, 1/3/00, p. 9. 

Office of Thrift Supervision 

New Guidance on Directors’
 

Responsibilities
 

On October 21, 1999, the OTS unveiled a new 

agency document that is aimed at providing more 

guidance to directors of thrifts. The new guide, 

“Directors’ Responsibilities Guide,” covers such topics as selecting and retaining competent management, establishing a thrift’s objectives and strategies, 

establishing policies and procedures to achieve those 

objectives, identifying and understanding associated 

risks, monitoring and assessing the progress of operations, and ensuring the institution’s compliance with 

laws and regulations. The new guide, which is more 

comprehensive than the first guide issued by the 

OTS in 1989, was prompted by the high turnover 

among thrift directors because of mergers, new institutions, and retirements. 

The OTS issued a second document, “Directors’ 

Guide to Management Reports,” which explains various management reports commonly used by thrifts. 

This guide is also intended to help directors in exercising their oversight duties and responsibilities. OTS 

99-71, 10/21/99; BBR, 10/25/99, p. 660. 

New Compliance Guide and Handbook 

In December 1999, the OTS issued an updated 

guide that is designed to help institutions identify 

and understand the primary regulatory requirements 

and evaluate the effectiveness of their compliance 

programs. “Compliance: A Self-Assessment Guide” 

was first published in 1988 and revised once before 

this current revision. The guide emphasizes that a 

successful compliance operation requires the commitment of the institution’s directors and active 

involvement of senior management. Accompanying 

that commitment must be effective and comprehensive policies and procedures, including suitable internal review mechanisms. The guide serves as an 

internal reference source for managers, compliance 

officers and others whose duties include compliance 

matters. OTS 99-92, 12/20/99. 

In January 2000, the OTS also issued an updated 

compliance handbook that includes new interagency 

fair lending examination procedures which were 

developed by the Federal Financial Institutions 

Examination Council and implemented by the OTS. 

The fair lending procedures in the handbook provide 

extensive and detailed guidance for evaluating fair 

lending and compliance using a risk-focused 

approach. The handbook, entitled the Compliance 

Activities Handbook, also contains a section on electronic banking, providing additional guidance on 

agency guidelines and policies regarding the use of 

electronic technologies and innovative product delivery systems while maintaining compliance with consumer protection obligations. BBR, 1/24/00, p. 156. 

Federal Housing Finance Board 

Expanded Authority for Mortgage Asset 

Programs 

On October 4, 1999, the Federal Housing Finance 

Board approved a resolution allowing the 12 Federal 

25 
FDIC Banking Review 

Home Loan Banks to offer single-family Member 

Mortgage Asset programs, such as the Mortgage 

Partnership Finance program, which allow for risksplitting between the FHLBank and the member 

bank originating the mortgage loan. The Mortgage 

Partnership Finance program (MPF), which started 

as a pilot program at the Chicago FHLBank in July 

1997, allows FHLBank members to sell mortgage 

loans they originate to a FHLBank rather than to 

Fannie Mae or Freddie Mac, thus avoiding the guarantee fees paid to Fannie Mae and Freddie Mac. 

The FHLBank can then sell participation interests 

in the program to other FHLBanks. The new resolution allows for an additional risk-sharing structure 

for the existing MPF program. The resolution also 

allows for a new program, the Mortgage Partnership 

Purchase program (MPP), which was recently proposed by the FHLBanks of Cincinnati, Indianapolis, 

and Seattle. Under the MPP program, the 

FHLBanks can purchase fixed-rate, single-family 

mortgages from member financial institutions, subject to the establishment of a credit risk-sharing 

account to transfer some of the credit risk. Through 

the process, the member would provide further credit enhancements for the mortgage loans by providing 

supplemental mortgage insurance. Thrift industry 

groups have raised competition-related concerns over 

these mortgage asset programs. Several groups sued 

the Finance Board in 1997, claiming the Board had 

exceeded its authority in allowing the MPF program 

and that the Chicago FHLBank was going into direct 

mortgage lending by starting up the program. 

However, the U.S. Court of Appeals for the Fifth 

Circuit rejected the legal challenge on January 20, 

2000. BBR, 10/11/99, p. 576–577; BBR, 1/24/00, p. 159–160. 

New Rule Gives FHLBanks More
 

Authority
 

On December 14, 1999, the Federal Housing 

Finance Board voted to adopt and issue for comment 

an interim final rule that implements provisions to 

transfer corporate governance responsibilities from 

the Finance Board to the boards of the Federal 

Home Loan Banks. Under the new rule, banks will 

have final approval over: employee selection and 

compensation; budgets, bylaws, and dividend payments; and forms relating to advances, conditional 

advances, and transfers of advances and advance participations. Further, the rule sets limits that the law 

imposes on the compensation of FHLBank directors. 

Under the budget requirement in the rule, 

FHLBanks no longer have to submit to the Finance 

Board budget and financial reports. FHLBanks can 

also engage in construction transactions without the 

approval of the Finance Board. BBR, 12/20/99, p. 1000. 

National Credit Union Administration 

Operating Level on Insurance Fund 

The Board of Directors of the National Credit 

Union Administration (NCUA) approved a final rule 

on October 6, 1999, setting the normal operating 

level for the National Credit Union Share Insurance 

Fund (NCUSIF) between 1.2 and 1.5 percent equity 

level. Credit unions are required to maintain a 

deposit in the NCUSIF equal to 1 percent of their 

insured shares at the close of the preceding reporting 

period. However, the NCUA has the authority to set 

a normal operating level for the fund, and the agency 

is required to declare a dividend to credit unions 

when the available asset ratio exceeds 1 percent and 

the NCUSIF exceeds the normal operating level. 

The NCUA Board determined that no insurance premium assessment was necessary for 2000, since projections indicate that the NCUSIF’s investment 

earnings will continue to be adequate to cover all 

insurance and operating costs while maintaining at 

least a 1.3 percent equity level. The Board also 

agreed to return $88.4 million in dividends to federally insured credit unions, which is the fifth consecutive cash dividend issued by the NCUSIF. NCUA-PR, 

10/6/99; BBR, 10/11/99, p. 578–579. 

STATE LEGISLATION AND REGULATION 

California charges of any kind on a customer for accessing an 

On November 2, 1999, San Francisco and Santa ATM located within San Francisco. Supporters of 

Monica voters approved a local ordinance that pro- the bill accuse banks of “double dipping” by charghibits banks from charging noncustomers extra fees ing noncustomers fees when their home bank 

for using automated teller machines. Proposition F already assesses those customers. However, the 

prohibits financial institutions from imposing sur- California Bankers Association filed suit on 

26 
Recent Developments 

November 3, 1999, to block the Proposition, arguing Michigan 

that the ordinance will only affect state-chartered 

banks. The bankers argued that the National Bank 

Act, which sets no cap on fees by national banks, 

overrides local restrictions so that the ordinance is 

ineffective with respect to national banks. On 

November 15, 1999, the U.S. District Court for the 

Northern District of California granted a preliminary 

injunction preventing San Francisco and Santa 

Monica from enforcing Proposition F. In addition, 

the District Court issued another ruling on 

November 24, 1999, which prevents individual consumers in Santa Monica from using the new ordinance as a basis for a lawsuit against banks that 

charge the extra fees. BBR, 11/8/99, p. 752; BBR, 11/15/99, p. 

800; BBR, 11/22/99, p. 842; BBR, 12/6/99, p. 926. 

On January 5, 2000, Michigan Governor John 

Engler signed legislation that will overhaul and modernize the Michigan Banking Code. The new 

Banking Code of 1999 modernizes Michigan’s existing banking statute by removing obsolete and conflicting provisions. In addition, the legislation 

eliminates barriers to the use of technology in bank 

operations and reduces bureaucracy for both the 

banks and the state regulator. The law also extends 

the period between examinations of healthy banks to 

18 months, which will reduce the burden on banks 

and make it easier for the Michigan Financial 

Institutions Bureau to coordinate supervision with 

federal agencies. The new law becomes effective on 

March 1, 2000. BBR, 1/17/00, p. 101. 

BANK AND THRIFT PERFORMANCE
 

Third-Quarter 1999 Results for 

Commercial Banks and Savings 

Institutions 

FDIC-insured commercial banks earned $19.4 billion during the three months from July through 

September 1999, which represents the highest quarterly earnings ever reported by the industry. The 

surge in commercial banks’ earnings reflected continued strength in noninterest revenues, especially 

fee income, as well as a moderation in noninterest 

expenses. Noninterest income rose to $36.9 billion, 

from $34.5 billion in the second quarter of 1999, and 

$29.6 billion one year earlier. Banks’ annualized 

return on assets (ROA) was 1.42 percent in the third 

quarter, up from 1.25 percent in the second quarter 

and 1.15 percent a year earlier. The number of problem banks rose from 62 in the second quarter of 1999 

to 69 in the third quarter, and there were three bank 

failures during the quarter. 

FDIC BIF-insured mutual savings institutions 

reported net income of $2.8 billion in the third quarter of 1999, which is $13 million less than in the second quarter. The slight decline in industry earnings 

was caused by lower gains on sales of securities, 

which fell to $276 million in the third quarter from 

$445 million in the second quarter. The industry’s 

ROA for the third quarter was 1.00 percent, down 

from 1.03 percent in the second quarter and 1.14 percent in the third quarter of 1998. The number of 

problem thrifts declined to 11 thrifts with $3.9 billion 

in assets, down from 14 thrifts in the second quarter 

with $4.2 billion in assets. There was one thrift failure during the third quarter of 1999, which is the first 

failure of a thrift institution in almost three years. The 

FDIC Quarterly Banking Profile, Third Quarter 1999. 

RECENT ARTICLES AND STUDIES
 

An article in the October-December 1999 issue of 

the Atlanta Federal Reserve Bank’s Financial 

Update reports that insurance sales by banks should 

not have a major effect on the safety and soundness 

of well-run institutions. Senior economic analyst 

Michael Padhi argues that, as banks prepare to 

expand into the insurance market with the recent 

enactment of the financial modernization law, recent 

data suggest that insurance sales do not pose a big 

threat to well-managed bank holding companies. 

The study focused on insurance agency subsidiaries 

of bank holding companies in the Atlanta Federal 

Reserve District. BBR, 12/6/99, p. 916–917. 

Timothy J. Yeager, an economist with the Federal 

Reserve Bank of St. Louis, reports that community 

banks will continue to play an important role in the 

marketplace, despite the new challenges and pressures community banks are facing because of the 

changing U.S. financial marketplace. Community 

27 
FDIC Banking Review 

banks—those banks with less than $300 million in 

assets—will play a role in the future banking environment because they provide personal customer 

service and cater to small businesses. Mr. Yeager’s 

article, “Down, But Not Out: The Future of 

Community Banks,” appears in the October 1999 

issue of the St. Louis Federal Reserve Bank’s quarterly publication The Regional Economist. BBR, 12/13/99, 

p. 955. 

INTERNATIONAL DEVELOPMENTS
 

Information-Sharing Framework 

The OCC, the Board of Governors of the Federal 

Reserve System, and the European Commission 

signed a statement of cooperation on September 17, 

1999, and agreed upon a common framework to 

enhance information sharing among international 

bank supervisors. The framework provides a basis 

for bilateral cooperative arrangements between U.S. 

and European Union (EU) supervisors for overseeing 

banking organizations that have material operations 

in each other’s jurisdiction. The framework addresses three specific areas: sharing of supervisory information and consultation on common supervisory 

issues; on-site inspections; and confidentiality of 

shared supervisory information. The framework provides sufficient discretion and flexibility to take into 

account any factors that are particular to the supervisory authorities and banking organizations involved. 

Although the statement of cooperation is not a legal 

document, it provides a basis for subsequent, more 

detailed bilateral arrangements between U.S. supervisors and the bank supervisors in the EU member 

states. The statement of cooperation and framework 

for information sharing do not affect existing bilateral arrangements between the United States and EU 

member states. NR 99-88, OCC, 10/1/99. 

China 

The United States and China entered into an 

agreement on November 15, 1999, which would provide foreign financial institutions wider access to 

China’s markets. The deal constitutes a precondition 

for allowing China to apply for membership in the 

World Trade Organization (WTO). Foreign banks 

would be allowed to engage in local-currency transactions with Chinese companies within two years 

after China joins the WTO, and they would be permitted to handle retail-banking transactions with 

Chinese consumers within five years. U.S. and other 

foreign banks would also be allowed to engage in all 

transactions that Chinese banks currently handle. In 

addition, all restrictions or limitations on geographic 

expansion by U.S. and other foreign bank branches 

in China would be lifted within five years. Foreign 

financial institutions would also be able to acquire 33 

percent minority stakes in Chinese fund management companies, with an option to increase those 

positions to 49 percent. The pact also calls for the 

beginning of talks to allow foreign investment banks 

to acquire 33 percent stakes in ventures to underwrite domestic securities issues, including debt, 

equity, and foreign-currency-denominated securities. 

AB, 11/17/99. 

Japan 

On February 9, 2000, the Japanese government 

announced the sale of Long-Term Credit Bank of 

Japan Ltd. (LTCB) to a U.S. investor group led by 

Ripplewood Holdings. The transaction marks the 

first-ever sale of a Japanese bank to foreign ownership. To effect the transfer of LTCB to the investor 

group, the New LTCB Partners, the Japanese government will spend an estimated $34 billion in taxpayer money for the cleanup of LTCB’s delinquent 

assets. BBR, 2/14/00, p. 330. 

Mexico 

On September 22, 1999, Mexican officials published new rules that would gradually strengthen 

requirements for bank capitalization and credit classification. The new rules should help bring Mexico’s 

banking regulations in line with international standards. Among the most important changes in the 

new reforms is the gradual reduction of deferred 

taxes as basic capital on banks’ balance sheets to a 

maximum of 20 percent of the value of the tax credit. Currently, banks can treat 100 percent of deferred 

taxes as basic capital on their balance sheets. In addition, the new rules require banks to deduct from 

basic capital their investments in non-financial companies that are not publicly traded. Those investments in companies that are publicly traded must 

also be deducted from banks’ basic capital, when the 

investments exceed 15 percent of the capital. The 

new rules for classification of credit risk would permit 

financial authorities to evaluate risk for mortgages, 

28 
Recent Developments 

credit cards, and business loans, with additional 

reserve requirements determined according to risk. 

Officials of the National Banking and Securities 

Commission (Comision Nacional Bancaria y de 

Valores) will later announce the new methodologies 

for classifications of credit risk, as well as new 

accounting criteria, bases for fixed-asset valuation, 

and the evaluation of deferred tax levels in banks 

where deferred taxes form a significant part of their 

basic capital. BBR, 9/27/99, p. 498–499. 

29