Jean-Claude Trichet: Major issues related to the process of European financial
integration - the regional and global perspective
Keynote luncheon remarks by Mr Jean-Claude Trichet, President of the European Central Bank, at the
conference "Transatlantic Roundtable on Finance and Monetary Affaris", at the invitation of the
European Institute, Washington, DC, 13 April 2007.
* * *
Introduction
Ladies and gentlemen,
I would like to thank the European Institute for inviting me to share with you some thoughts on the
financial integration process, both within the euro area and between the euro area and the rest of the
world.
I will structure my remarks into two parts. In the first part, I will elaborate on the regional dimension of
European financial integration. After stressing the importance of financial integration for economic
growth in Europe, I will highlight some of the main achievements of European financial integration thus
far, as well as the challenges still facing us.
Seen from an international perspective, the European process of regional financial integration should
not be misunderstood as creating an isolated fortress, but on the contrary as a tool for European
financial markets to become better integrated with global markets. In the second part of my speech, I
will therefore provide some evidence illustrating that the financial links of the euro area with the rest of
the world are already particularly strong in comparative terms. I will also show that the advent of the
euro has given further impetus to such financial linkages, which now also increasingly include capital
flows to and from key emerging market economies.
The regional perspective
Implications of European financial integration for economic growth
Financial integration is of key importance for the European Central Bank (ECB), given its relevance for
the conduct of the single monetary policy: a well-integrated financial system enhances the smooth and
effective transmission of monetary policy impulses throughout the euro area. Today, I would like to
highlight a further implication of financial integration, namely that it raises the economy's potential for
stronger non-inflationary economic growth.
Generally speaking, financial systems serve to channel funds from those economic agents that have a
surplus of savings to those with a shortage; and to trade, hedge, diversify and pool risks. These
functions are facilitated by financial integration. As a result, there is a better sharing and diversification
of risk and a greater potential for stronger non-inflationary economic growth.
Regarding risk sharing, it is interesting to note that in the US, according to a particularly interesting
research, capital markets would smoothe out 39 % of the asymmetric shocks to gross state product
(the equivalent of our GDP), the credit channel would smoothe out 23 % of such shocks and the
federal government, through the fiscal channel, 13 %. 25 % of the shocks would not be smoothed
out.1 Hence in the United States financial markets and financial institutions would contribute 62 % to
the absorption of state idiosyncratic shocks. The effect is very substantially higher than the effect of
the federal budget. We see from the US example that the financial channel can be much more
important than the fiscal channel and that is a particularly important additional reason to speed up
financial integration in Europe.
Financial integration is also very important for stimulating economic growth in Europe via its impact on
the development of the European financial system. Financial development refers to the process of
financial innovation, and to the institutional and organisational improvements in a financial system that
reduce asymmetric information, increase the completeness of markets, add possibilities for agents to
engage in financial transaction through (explicit or implicit) contracts, reduce transaction costs and
increase competition. Progress in financial development can obviously also occur in perfectly
integrated markets.
Therefore, by speeding up the reallocation of capital from declining to evolving and promising
industries - the Schumpeterian process of "creative destruction" - both financial integration and
financial development positively influence the efficiency of a financial system, ultimately leading to a
higher potential for economic growth.
The introduction of the euro has already brought about important benefits resulting from increased
financial integration. And the process of European financial integration and development is still
ongoing: a research study by London Economics estimates the benefits of the full integration of
European bonds and equity markets to be around 1% of GDP growth over a ten-year period, or
approximately €100 billion.2
This brings me to the next point I would like to make, namely the identification of major achievements
and challenges of European financial integration.
Achievements and challenges of European financial integration
Let me first draw your attention to a new report entitled "Financial integration in Europe", which the
ECB published for the first time just three weeks ago.3 The main purpose of this report, which will
become an annual publication, is to contribute towards the advancement of European financial
integration and to raise public awareness of the role of the ECB and the Eurosystem in supporting this
process. My remarks will also draw on some of the findings of this report.
In order to better assess the state of European financial integration, the ECB has developed 42
quantitative indicators which are described in our report.4 In a nutshell, the evidence confirms that the
degree of integration varies according to the market segment, and that integration is generally more
advanced in those market segments that are closer to the single monetary policy.
With respect to the euro area money market, the unsecured money market reached a stage of
"nearperfect" integration almost immediately after the introduction of the euro, with the cross-country
standard deviation of the average overnight lending rates among euro area countries as low as one to
two basis points. This success has been sustained by the high degree of integration of the large-value
payment systems. The launch of the single technical platform, TARGET2, in November this year will
promote further financial integration, in particular through a harmonised service level, a single price
structure, and a harmonised set of cash settlement services.
It is, however, also a fact that the euro area short-term debt securities market has witnessed only a
limited degree of cross-border activity. This may partly be due to the fact that short-term debt
securities issued in the euro area have very similar risk characteristics and therefore offer little scope
for international diversification. Our indicator, which gives the share of short-term debt securities
issued by euro area residents and held by other euro area residents, shows a rising trend - from 7% in
2001 to over 12% in 2005 - but the absolute numbers are small when compared to the corresponding
indicators for the bond and equity market. In this respect, I would like to emphasise the Short-Term
European Paper (STEP) initiative. The STEP initiative promotes the development of a European
shortterm paper market through market players' voluntary compliance with a set of standards encompassed
in the STEP Market Convention. By the end of March this year, 35 STEP-compliant programmes,
amounting to €201 billion, had been launched under the STEP label.5
With respect to bond markets, euro area cross-border holdings of long-term debt securities have
increased strongly - from about 10% at the end of the 1990s to nearly 60% in 2005 - suggesting that
investors are increasingly diversifying their portfolios across the euro area and, therefore, that the euro
area government bond market has reached a very advanced stage of integration.
Finally, the quantity-based measure of euro area equity market integration also indicates a rising
degree of integration in the equity markets. Between 1997 and 2005, euro area residents doubled their
holdings of equity issued in another euro area country to reach nearly 30%. This implies that, following
the introduction of the euro, euro area investors have significantly reallocated their equity portfolio from
domestic holdings to holdings elsewhere within the euro area.
As a remaining challenge to the integration of euro area securities markets, I note that the euro area
securities clearing and settlement infrastructure is not yet sufficiently integrated, although several
initiatives are underway. Last November, for example, at the European Commission's request, the
relevant European industry associations and their members signed a "European Code of Conduct for
Clearing and Settlement", which aims to foster competition and efficiency of clearing and settlement in
the EU. The ECB welcomes this initiative and acknowledges the commitment by the industry.
In this respect, let me also mention that the Eurosystem considers developing a single platform for the
settlement of securities in central bank money - the so-called TARGET2-Securities. The scope of this
project is restricted to the settlement layer of the post-trading activity regarding securities settled in
central bank money. The next step will be the definition of user requirements which will benefit from a
public consultation.
Last but not least, I would like to mention the retail banking markets, which are less integrated than the
other euro area financial market segments. However, we also see progress in some fields.
For example, the current fragmentation of the European retail payment infrastructures is being
addressed by the so-called SEPA project that has been initiated by the European banking industry
with a view to creating a single euro payments area. The Eurosystem supports this project in a catalyst
role, by providing guidance to banks and the payments industry in setting objectives and defining
highlevel requirements. The self-regulatory approach chosen for SEPA is working well and we expect the
European banking industry to launch the first SEPA instruments on 1 January 2008.
Furthermore, a number of indicators point to increasing cross-border banking activities in the euro
area, such as the growing cross-border share in the financial holdings of banks and cross-border
mergers and acquisitions. I would like to emphasise the fact that cross-border banking is first and
foremost a market-driven process. Still, the public sector can play a significant role in providing an
adequate policy framework. According to our assessment, which we also explain in the new ECB
report, the EU supervisory arrangements have been substantially enhanced by two significant
measures: the extension of the Lamfalussy approach to the banking sector and the adoption of the
Capital Requirements Directive (CRD), which sets up the new regulatory framework in the EU for
banks' capital adequacy as agreed by the Basel Committee on Banking Supervision. Both measures
contribute to increasing cooperation and coordination between supervisors on a cross-border basis.
The CRD provides for better home-host supervisory cooperation, among other things, by enhancing
the role of the authority responsible for the consolidated supervision.
I would also like to mention that regulatory convergence is important not only within the EU but also in
a global context. The ECB supports the EU-US Financial Markets Regulatory Dialogue and believes it
can serve as a forum where solutions to important regulatory issues on both sides of the Atlantic can
be sought, such as accounting standards, the revised proposal for de-registration of foreign firms from
US markets, and the recent announcement regarding the cooperation between the United States and
the EU in audit oversight. Furthermore, the ECB supports the European Commission's objective to
deepen the financial dialogue with other countries, such as China and Japan.
The global perspective
I would now like to turn to the financial links between the euro area and the rest of the world.
Let me first recall a fact that is already well-known: namely that, in trade terms, the euro area is very
open, actually more open than the other G3 economies, the United States and Japan. Extra-euro area
exports of goods and services account for around 20% of euro area GDP, roughly the same share as
extra-euro area imports. This is substantially higher than in the United States, where exports represent
about 10% of GDP and imports 16%, as well as in Japan, where exports and imports of goods and
services amount to 15% and 13.4% of GDP, respectively.
Probably less well-known is, however, that the euro area is also more open than the United States and
Japan regarding the financial linkages. Such linkages can be measured with different indicators. As I
would like to highlight long-term trends, I will focus here mainly on stock data, given that flow data tend
to be very volatile and usually reflect cyclical patterns in the short run.
Five main observations can be derived from cross-country comparisons of international investment
positions.6
First, comparative data highlight the financial openness of the euro area, thus contradicting any notion
that this region is inward-looking when it comes to financial integration. The external assets and
liabilities of the euro area account for a large share of GDP, around 124% and 137%, respectively. By
comparison, in the United States, the corresponding numbers are substantially lower: 90% for assets
and 110% for liabilities. In Japan, foreign financial assets are likewise significantly lower than in the
euro area (94% of GDP in 2005), and the difference is even stronger for liabilities, which represent
only 60% of GDP, i.e. less than half of the corresponding figure for the euro area.
Second, it is interesting to observe that the advent of the euro seems to have significantly contributed
to the process of opening up euro area financial markets. The euro area has indeed become
progressively more open since 1999. On the assets side, stocks of euro area assets held abroad have
increased from less than 87% in 1999 to, as mentioned, over 124% in 2005. On the liabilities side, the
increase was also very substantial, from around 92% to 137%. The rise has actually been much less
pronounced for the United States during the same period: US assets grew from 80% of GDP in 1999
to 90% today, and US liabilities increased from 91% to 110% of GDP. In other words, the euro area
and the United States held roughly comparable assets and liabilities in 1999, but the euro area
witnessed a more substantial increase since the start of Economic and Monetary Union.
Third, the euro area appears to be a very important player in world financial markets. Comparing
assets and liabilities in absolute value terms, the sizeable gross financial liabilities of the United States
(USD 13.62 trillion in 2005) have received a lot of attention in recent years because this country also
runs very large net foreign liabilities: USD 2.5 trillion, against USD 1.2 trillion for the euro area. The
euro area, however, has about the same amount of gross financial liabilities as the United States
(USD 13.65 trillion). The difference between the two economies in net terms - hence their different
contribution to global imbalances - can be related to the fact that the euro area holds significantly
more assets abroad (USD 12.4 trillion) than the United States (USD 11.0 trillion). The difference
between the net positions on both sides of the Atlantic is related to the persistent current account
deficits run by the United States in recent years whereas the euro area has been running a current
account position close to balance.
Fourth, the euro area is an attractive place for foreign direct investment (FDI). A breakdown of
extraeuro area liabilities indeed reveals that inward foreign direct investment (FDI) amounts to more than
27% of euro area GDP, against 22.5% for the United States. The euro area seems to have received,
proportionally to GDP, a similar amount of FDI as China, 27.3% for both economies, according to the
IMF statistics. In net terms the euro area is close to balance as the stock of direct investment abroad is
only slightly higher than that of FDI within the euro area (30.4% against 27.3%, respectively).
Fifth, let me conclude with a few remarks on the bilateral FDI linkages of the euro area. In this regard,
one should keep in mind that the geographical breakdown of FDI flows and stocks is clearly subject to
some caveats, as a substantial share of FDI is channelled through offshore centres, which makes it
sometimes difficult to establish their true geographical origin and destination.
Based on available data, it is worth noting that the stock of euro area FDI abroad is mostly held with
mature economies: nearly 21% in the United States, 24% in the United Kingdom, 9% in Switzerland,
and between 2.5% and 3% in Sweden, Canada and Japan. Likewise, on the liabilities side, the United
Kingdom and the United States account for an even larger share than on the assets side (nearly 40%
and 23.5%, respectively).
At the same time, I should also stress that the amount of euro area FDI in emerging market economies
rose quickly. Between 1999 and 2005, outward FDI from the euro area to the so-called BRIC group -
which includes Brazil, Russia, India and China - increased markedly. Over this period, the stock of
outward FDI in the BRIC group rose from €63 billion to €133 billion (or by 111%). In comparison, the
stock of euro area FDI in the United States increased by 55%, from € 360 billion to €558 billion, during
the same period. While the overwhelming share of outward FDI to the BRIC group was directed to
Brazil, euro area companies have raised considerably their FDI stocks in Russia, China and India in
recent years.
Even more interestingly, the euro area has also become attractive as a destination for FDI from the
BRIC countries: between 1999 and 2005, FDI stocks from the BRIC group in the euro area tripled,
from €4 billion to €12 billion, while still remaining low in comparative terms (for instance, the figures for
US FDI stocks in the euro area rose from €322 billion to €560 billion over the same period). The
Brazilian and Russian firms account for the bulk of the BRIC countries' FDI surge in the euro area, but
Chinese and Indian FDI has picked up in most recent years, as frequently reported in the media.
On the whole, this evidence suggests that the euro area is financially integrated not only with mature
economies but increasingly also with the most sizeable emerging economies.
Concluding remarks
Ladies and gentlemen,
This brings me to the end of my remarks in which I have highlighted some major issues related to the
process of European financial integration, a process that should not be seen in isolation but rather as
an important contribution to global financial integration. I very much appreciate the transatlantic
dialogue on the lessons we can learn from each other. This round table today contributes a great deal
to increasing our awareness of these issues.
Thank you very much for your attention.