Mr Wellink speaks about trends in the
European banking industry and in banking supervision
Speech held by Dr A H E M Wellink, President of De Nederlandsche Bank, at the launch of the
Netherlands Society of Investment Professionals on 6 October 1999.
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I. Introduction
Ladies and gentlemen,
It was with great pleasure that I accepted the invitation to deliver a speech on banking supervision at
this official launch of the Netherlands Society of Investment Professionals. On this occasion, I would
like to give you a broad picture of the major trends in the European banking industry. After having
discussed the key driving forces for change, I shall present the strategic responses of banks to these
forces. I will then describe the reactions of banking supervisors to these changes. At the end of my
speech, I shall share my views on the future of banking with you. You will understand that it is
impossible for me to tackle all relevant issues due to time constraints.
II. Forces for change in European banking
The European banking landscape is generally expected to undergo drastic changes over the next few
years. Perhaps the most fundamental force for change in the financial sector has been the evolution of
technology, particularly computing and telecommunications. Technological innovations affect banking
capacity by changing production costs. They also spur disintermediation, increase competition by
lowering entry and exit barriers, help the internationalisation process, and so on. Technological
developments have shaped banking business both internally and externally. Internally by means of the
reconstruction of banks' internal organisation and production processes and externally by spurring
product innovation and establishing new distribution channels. The fruits of developments in
information technology are, of course, available to non-banks as well as banks.
Another driving force behind structural changes in the European banking sector is undoubtedly the
introduction of the euro. It is assumed that the euro capital markets will be deeper, more transparent
and more liquid than the previously existing national capital markets. This could make it cheaper for
large corporations to raise money directly in these markets than to borrow from banks. The
privatisation of banks is another force for change. It is also argued that the deregulation of the
financial sector will further erode the obstacles that deny new providers of financial products access to
the market. Demographic factors are also shaping the European banking industry.
The widely held view thus appears to be that European banks are heading for turbulent times. The
driving forces just mentioned will lead to intensified competition not only among banks but also
between banks and other, new financial intermediaries. This is generally expected to increase the need
for a restructuring of the banking sector. The general tenor seems to be that banks are specialised in an
economic activity that can, to a growing extent, be performed by non-specialist players. If so, the
demand for bank loans will decline and the structure of the balance sheets of banks will alter.
This envisaged disintermediation and securitisation is expected to pose a threat to relationship
banking, which still occupies a prominent position in the banking industry. It even raises the question
of the continued viability of banks. It should, however, be realised that any shrinkage of the banking
industry as a result of market forces is not by definition cause for concern. That would be different if
the decline of the banking industry were due to excessive regulation. Excessive regulation would
prevent banks from operating more efficiently and from offering new products. This in turn would
allow other or new providers of financial services, which are subject to less stringent regulation, to
push banks out of the market. Such a situation would, of course, be highly undesirable.
III. Strategic responses of banks
As you may have guessed by now, I myself do not believe in the gloomy scenarios. The structural
trends I have just identified have obviously prompted banks to reconsider their activities and their
distribution channels. In the following, I will emphasise that the driving forces have not only posed
threats but have also offered banks new opportunities.
Consolidation in the European banking industry
The driving factors mentioned before have changed the perceptions with respect to the efficiencies to
be achieved through consolidation in the banking industry. Indeed, the number of mergers and
acquisitions has increased considerably since the mid-1980s. Mergers and acquisitions are, in turn,
partly responsible for the reduction in capacity and the slight increase in concentration in the EU
banking industry over the past decade. So far, the recent wave of consolidation has developed mainly
within national industries. Cross-border mergers or acquisitions still seem to be the exception,
although things have started to change.
Looking at simple capacity indicators like the number of banks or branches per inhabitant, it can be
expected that consolidation will continue in the French, German, and Italian banking sectors in
particular. It is questionable, though, whether this process will follow the same pattern as, for example,
in the Netherlands or Sweden, because the share of publicly owned banks has always been much larger
in France, Germany and Italy. It is also unlikely that the expected consolidation process will ultimately
lead to concentrated banking sectors such as that in the Netherlands. Indeed, the domestic markets in
France, Germany and Italy are bigger and, consequently, offer room for a greater number of viable
banks. It will also become increasingly difficult to interpret national concentration ratios in the euro
area.
Conglomeration
A second manifestation of the forces for change is conglomeration in the financial sector. Largely due
to the deregulation of previously segmented financial markets, different types of financial institutions
have entered each other's territory over the past decade. A familiar example of this is the provision of
typically traditional banking products like mortgages by pension funds and insurance companies. In
parallel with this development, banks, securities institutions, and insurance companies have merged
into financial conglomerates. In the Netherlands, 10 out of the 15 largest banks are part of a financial
conglomerate, which makes our country the undisputed leader in this field. The recent acquisition of
the Nationale Investeringsbank by the PGGM and ABP pension funds is the first major partnership
involving institutional investors and commercial banks.
New products, markets and distribution channels
The driving forces identified earlier also have major implications for the type of business conducted
by banks, and the way that business is conducted. The information technology and the deregulation of
the financial services sector have enabled banks to develop an entire range of new, complex financial
products and new distribution channels. Technological innovations have recently been instrumental in
the creation of various derivative products - including credit derivatives - and the application of credit
scoring techniques to consumer finance, credit cards and mortgages. It has also become possible to
unbundle the various risks implicit in any single financial instrument - for example market risk, credit
risk and liquidity risk - and to trade these risks separately.
As for disintermediation and securitisation, it is true that securities markets have become increasingly
important in providing funding to businesses. However, banks are closely involved in the issue of
securities by large corporations and institutions. Investment banks possess the expertise necessary to
manage issues successfully, to attract potential investors, to maintain a securities market, and to hedge
or underwrite possible risks. As regards the trade in shares, bonds, and derivatives, banks increasingly
focus their activities on executing customers' orders, speculate on market developments, and engage in
proprietary trading. Activities of this kind generate commission income for the banks.
So, how much truth is there in the pessimistic view that the position of banks in the financial
intermediation process is being gradually eroded? Indeed, one could say that the banks' role in
supplying credit has been steadily declining, as evidenced by their falling share in total financial debt.
The decreasing reliance on bank loans seems to be most pronounced among large firms with credit
ratings, which can resort to public capital markets to meet their funding needs. By accessing the public
capital markets, these firms can bypass the usual screening by banks to some extent.
However, I think that this view on banks' disintermediation must be nuanced and put into perspective.
Bank loans, savings accounts, and deposits continue to grow when expressed in terms of national
income. Therefore, I am sure banks will continue to play an important role in solving asymmetric
information problems in the financial markets. Some businesses can rely only on bank loans because
they are unable or unwilling to reveal their financial position to the outside world. If insufficient
information is disclosed, rating agencies are unable to form an accurate opinion of the financial
position of a particular company and the attendant risks. Such companies are thus only able to obtain
external funds in the form of bank loans after screening and monitoring by banks. Recent international
experience has shown that, particularly during periods of economic stress, banks perform a critical
function in providing large corporations, too, with liquidity. In other words, large firms also need to
and want to maintain relationships with banks.
Besides, conclusions with respect to the position of banks in the financial system which are based
solely on balance sheet activities are misleading. In recent years, banks have developed an extensive
range of off-balance sheet operations. By offering instruments like financial derivatives, banks have
been able to tap new sources of income. If one ignores these activities, one may wrongfully conclude
that banks are a dying breed. For Dutch banks, the credit equivalents of off-balance activities already
amount to between 15 and 20% of their on-balance sheet operations.
Even taking balance sheet and off-balance sheet operations together does not present an accurate
picture of the true position of banks in the economic system. Banks are, for example, also closely
involved in setting up, managing and marketing investment funds. In most EU countries, more than
80% of all investment funds are controlled by banks. In the Netherlands, half of all investment funds
are associated with banks. Banks have thus been successful in internalising at least part of the
supposed disintermediation on their liabilities side, which indicates their capacity to adapt to altered
market conditions.
Developments in information technology also offer potentially important commercial uses in the retail
distribution channels. In the development of, and participation in these new distribution channels,
banks are leading the way. Through alliances with supermarket chains, banks in some EU countries
are already marketing simple banking products in-store. Banks are closely involved in the
development of e-commerce, too, and have established a sound position in remote banking.
IV. Developments in banking supervision
As indicated earlier, the driving forces have enabled banks to venture into many new areas. Many
banks have seized the opportunity to diversify their activities, both geographically and in terms of their
product mix. This obviously increases the burden on regulation and supervision. Bank supervision has
always focused on the assessment of the quality of a bank's balance sheet at some point in time, and
on whether it complied with capital requirements and restrictions on portfolio composition. This
approach, however, has become less adequate in a world where banks are active players in
international capital markets and can, because of potential trading losses, be driven into financial
problems extremely rapidly. Thus, the emphasis in banking supervision has shifted toward risk control
and market discipline. Take, for example, disclosure requirements to improve transparency as well as
reliance on internal risk models that are more flexible than capital requirements.
The process of mergers and acquisitions in banking mentioned earlier raises supervisory questions
with respect to concentration and market power. It is difficult, however, to draw conclusions about the
competitive nature of banking markets on the basis of concentration ratios. The reason is that the
figures for the banking industry as a whole can mask sharply different degrees of concentration in
specific segments of the market. In wholesale markets, competition may be fiercer and a critical mass
may be required which exceeds that appropriate for national markets. In the retail markets, on the
other hand, banks still operate in fairly fragmented national markets.
It is also true that for a proper evaluation of the relationship between concentration and competition,
the volume of intermediation activities by non-banks in specific segments of the retail markets should
be taken into consideration. The high concentration index for the banking industry must be interpreted
differently if other financial institutions also have a significant market share. As you know, non-banks
also perform an important function in the intermediation process in the Netherlands.
Another supervisory issue related to mergers and acquisitions, internationalisation and conglomeration
in the financial sector is systemic stability. Here, a distinction should be made between the national
and international dimension. Nationally, the issue of systemic stability is particularly relevant for
small countries where very large banks or financial conglomerates have emerged. In the Netherlands,
systemic supervision, aimed at safeguarding overall financial stability, is the domain of the
Nederlandsche Bank, especially where banks and payment systems are concerned. Internationally, the
trends just sketched stress the increasing importance of coordination and cooperation between national
supervisory authorities and further harmonisation of regulatory rules. These elements are effected by
various sector-specific international groupings of regulators and supervisors, such as the Basel
Committee on Banking Supervision, the Joint Forum on Financial Conglomerates, the Financial
Stability Forum, and the Banking Supervision Committee of the European Central Bank. Given the
responsibility of national central banks for fostering financial stability in the eurosystem, this Banking
Supervision Committee could, in principle, develop as a forum for strengthening the multilateral mode
of supervisory cooperation within EMU.
Yet another supervisory issue is raised by the increasingly blurred distinction between different types
of financial institutions and the growing importance of financial conglomerates. These developments
have recently led to the establishment of a Council of Financial Supervisors in the Netherlands. This
Council consists of Board members of the Securities Board, the Insurance Board and the
Nederlandsche Bank. I consider the establishment of the Council as an accurate and logical reaction to
the structural developments in the financial services industry. It seals the long-standing close and
harmonious relationships between the Dutch financial supervisors.
The Council of Financial Supervisors will not execute supervisory functions itself, but leaves that to
its constituents. It deals with regulatory issues that go across boundaries of specific financial sectors.
The first issue concerns the supervision of financial sector integrity. The second field of operation
deals with the supervision of financial conglomerates. The third subject is related to customer
protection, focusing on adequate product information. In this respect, the Nederlandsche Bank has
recently established a Consumer Protection unit. This unit deals with the supply of information to
consumers on the supervisory role of the Nederlandsche Bank. The unit will also stimulate the supply
of information by institutions under supervision regarding their products, and will inform consumers
on the possible procedures and competent authorities to settle disputes.
V. Concluding remarks
Let me now briefly summarise the key insights emerging from my speech. Banks now conduct a much
wider range of business than simply taking in deposits and making loans, which is their traditional
financial intermediation business, and have become financial services firms. In many countries
off-balance sheet income of banks now exceeds income earned from their traditional activities.
Moreover, profound changes in the distribution channels for banking products and in bank-customer
relationships can be observed.
The driving forces identified in this speech may have put the industry under pressure but, more
importantly, they have also created new opportunities. One is left with the undeniable impression that
the regulation of banks has not prevented them from developing new activities and entering into new
markets. In this respect, it may be noted that banking supervision and regulation are naturally
frequently re-assessed in light of new developments. The recent suggestions for adaptations in the
regulatory framework for banks by the Basel Committee on Banking Supervision mirror the genuine
intention and proactive attitude of supervisors to ensure sound market conditions in the financial
services industry, and to safeguard the stability of the global financial system.
Having said all this, I cannot but finish with an optimistic observation. The banking industry has
shown ingenuity in coping with many challenges. This is mirrored in the diversification of its
activities. By continuously aiming at a high level of ethics and professionalism within the Dutch
investment community, the Netherlands Society of Investment Professionals will certainly contribute
to the health and integrity of the financial sector in general, and the banking industry in particular.