Mr Duisenberg outlines the future development of the financial sector in the euro area
Speech by Willem F Duisenberg, President of the European Central Bank, at the XXIVth IOSCO
Annual Conference in Lisbon on 25 May 1999.
Introduction
The euro area constitutes a large economy, of a size comparable to that of the United States. That
fact alone places the euro and the euro area financial system firmly "centre stage" in the global
economy. Consequently, it is essential for the euro area financial system to be stable and efficient,
not only for the benefit of the euro area economy itself, but also for the world economy.
The introduction of the euro on 1 January 1999 had a profound impact on financial systems both
within and outside the euro area. Part of this impact was immediately evident in the rapid
integration of money markets and the replacement of national currencies by the euro in foreign
exchange markets. The fact that the changeover to the euro progressed smoothly is a reassuring
indication that the euro area financial system is able to remain stable during times of structural
change.
However, a further part of the impact on financial systems - most likely the greater part - will be
experienced over a longer period of time. The euro is likely to become one of the major factors
reshaping both the domestic financial system of the euro area and the global financial system.
This process should lead to a more efficient allocation of finance within the global economy, but
it will also call for the ability to adjust to structural changes in order for stable financial systems
to be maintained.
Today, I should like to outline the likely future development of the financial sector and of the
financial markets in the euro area as envisaged by the European Central Bank (ECB). To this end,
I shall first briefly discuss the impact of the introduction of the euro on domestic money markets.
I shall then turn my attention to likely developments in the financial markets and in the banking
system, before concluding with some remarks on how these likely developments might affect the
stability and efficiency of the financial system in the euro area.
Impact of the introduction of the euro on money markets
Until the end of 1998 the various money markets of the euro area still displayed a certain number
of distinctive features. However, following the changeover to the euro they were integrated
swiftly and smoothly at the beginning of January 1999.
A highly competitive single money market has already emerged in the euro area, as banks were
well prepared for the changeover to the euro and the TARGET system has provided an efficient
means of making cross-border payments. In particular, transaction volumes in money markets
rapidly reached high levels while typical bid/ask spreads decreased almost immediately to very
low levels. This indicates the depth and high degree of liquidity that the euro money market has
already achieved. A feature of the current stage of the development of the euro money market,
which is particularly worthy of note, is that differences in overnight interest rate spreads mainly
reflect differences in the credit standing of banks rather than that of the country in which the
transaction takes place.
These structural developments are, of course, positive. For the Eurosystem (i.e. the ECB and the
national central banks of the 11 countries participating in the euro area) the existence of a deep
and liquid money market enhances the efficiency of monetary policy operations. In this respect, I
should like to draw your attention to the "market friendliness" of the framework applied by the
Eurosystem to the conduct of monetary policy operations. By this I mean that the framework is
based on tenders in which markets decide who receives the liquidity. The standing facilities are
open and recourse to the marginal lending facility is not subject to scrutiny. In addition, the list of
eligible collateral is extensive.
Prospects for the development of financial markets in the euro area
Looking now at the financial markets from a broader perspective, it is important to remember that
the financial markets of the euro area began the process of integration before the start of Stage
Three of Economic and Monetary Union. An indication of the pace of integration before January
1999 is provided in particular by the evolution of spreads between yields on the bonds issued by
the various central governments of the euro area. These spreads narrowed continuously from
mid1995 onwards and their volatility was also noticeably reduced during this period. Factors
contributing to this favourable pattern included increased convergence towards low rates of
inflation across the euro area during Stage Two, the gradual reduction and finally the
disappearance of exchange rate risks, the commitment of governments towards improving the
sustainability of public finances, and the increase in the depth and liquidity of government bond
markets.
As I have already said on a previous occasion, I believe that the interest rate markets of the euro
area will increasingly provide an accurate reflection of the differences in credit quality between
various issuers as well as differences in liquidity between bonds, while divergences purely related
to the location of market participants within the euro area will become less and less relevant.
It seems highly likely that the capital markets of the euro area will become even deeper and more
liquid over time, and hence more efficient. The number of market participants is likely to increase
as the cost of financial market transactions is lowered, and the sophistication of position-taking
activities is likely to increase further as market participants equip themselves with more refined
methods of adjusting their portfolio exposures.
One particular area of the capital market in which the markets in euro area countries have
traditionally been a lot less active than in the United States is the corporate bond and commercial
paper market. However, there are good reasons to expect that corporate bond and commercial
paper issuance in the euro area will gather pace in the future. During the first few months of this
year we have already seen a fair amount of activity in this field.
For large companies in particular, it makes sense from the point of view of efficiency to have all
the methods of financing at their disposal, namely bond and paper financing, bank loans and
equity financing. Indeed, since the credit ratings of many large companies are better than the
credit ratings of most banks, this should lead to savings on the cost of capital for the corporate
sector. The introduction of the euro should provide sufficient depth and liquidity for the corporate
debt market that would guarantee competitive pricing.
On the demand side, the reduced borrowing of the public sector will leave more room for the
private sector to issue debt securities. As you know, the amount of public debt in the euro area is
still high, and we trust that governments will keep their commitment to bring it down to more
sustainable levels as agreed in the Stability and Growth Pact. In addition, the euro area has to save
in order to be able to take care of its future pension payments, and a part of these savings is likely
to be invested in corporate debt securities. An increase in global demand for euro-denominated
debt securities is also expected as the euro becomes a major reserve currency. Moreover, the
demand for higher-risk euro-denominated debt securities is likely to increase, particularly as the
current low level of sovereign yields increases incentives to search for higher yields.
Turning to equity markets, and first to the institutional set-up of stock exchanges, an evolution
towards more integration and greater market efficiency is already apparent. As consolidation
within the financial services sector has increased the size and geographical reach of
intermediaries and fund management institutions, they seem to be pressing for market-places to
become more concentrated in order both to reduce costs and to enhance liquidity. In addition,
some companies have recently announced that they are reviewing their listing practices with the
aim of reducing costs by cutting back on the number of exchanges in which they are listed.
However, this development towards greater concentration does not necessarily mean that trading
is concentrated only in a few exchanges. A possible pattern of development could also be for
different stock exchanges to concentrate on specific types of companies ("blue-chips", specialised
industries, small companies and new companies, for example). In any case, the physical location
of stock exchanges is becoming less relevant as screen-based trading with remote access is
becoming more widely used.
With regard to investor behaviour, an increasing number of equity market investors already
appear to be taking positions on the equity market of the euro area from a sectoral rather than a
national perspective. Area-wide equity indices have been made available by various market
participants, thus providing investors with opportunities to monitor area-wide equity positions as
well as, in some instances, positions in area-wide industrial sectors.
The fact that the euro area (and EU) equity markets are becoming more integrated, more liquid
and deeper is good for market efficiency, and a more efficient allocation of capital should mean
that equity financing becomes more readily available for companies.
I should also like to mention that a prudent, harmonised regulatory framework, on the one hand,
and harmonised market practices, on the other, are key factors guaranteeing a favourable outcome
for these structural changes. In these areas a lot of work is under way, and much has still to be
achieved in order to pave the way for truly integrated financial markets. Harmonisation in, for
example, repurchase agreements, national company laws including bankruptcy laws, and other
aspects of the legal and regulatory framework, would enhance legal clarity and certainty and
thereby improve the efficiency and stability of the financial markets.
Indeed, the European Commission recently published an Action Plan containing priorities and
timetables for measures aimed at improving the single market for financial services. In the Action
Plan, measures are proposed to advance the harmonisation of the legal framework and market
information, as well as to facilitate investors' operations throughout the single market.
In this respect, I should also like to pay tribute to the International Organization of Securities
Commissions (IOSCO) for its efforts. Although I have focused mainly on the financial system of
the euro area, we can clearly see that the euro area financial system is an integral part of the
global financial system. With this in mind, I should like to express my support for the aims of
IOSCO to promote high standards of regulation in order to maintain just, efficient and sound
markets.
Prospects for the development of banking systems in the euro area
Turning now to likely developments in the banking system, it is important to note that the euro
area financial systems in general and the banking sector in particular have, until now, been
relatively national and fragmented with little cross-border retail activity. However, it is envisaged
that the euro will add weight to a number of fundamental factors that are increasing the pressure
for structural change. With these structural changes I mean not only consolidation, which seems
inevitable, but also increased cross-border co-operation and mergers. In short, the euro area
banking sector is expected in the future to look and behave more like the banking sector of a
single economy.
In addition to and reinforced by the introduction of the euro, other factors that are leading to
changes in the financial landscape include technological development, globalisation and changes
in what consumers and firms expect from the financial system and financial service providers.
These factors are reshaping the business of banking as well as the financial system as a whole.
Economies of scale and scope may have been changing in different areas of banking and even
taking different directions. For example, the rapid development of information technology has
made the collection and processing of information considerably cheaper, but at the same time
technological investments are taking a larger share of banks' resources. Therefore, economies of
scale in some aspects of the collection of information may have been reduced, but at the same the
time investments in more sophisticated technology have increased economies of scale and scope
in some areas of banking. While I do not wish to go into detail on this matter, the general picture
that emerges is that the banking industry has to be in a position to adjust to a new situation and
take these factors into consideration.
Indeed, in the course of the last few months, a number of bank mergers in the euro area, including
mergers between relatively large institutions, have been announced or are being contemplated.
Such "high-profile" mergers are likely to contribute to an acceleration of the pace of both the
consolidation and integration of the banking systems of the euro area.
However, it should be remembered that the recent pattern of consolidation represents part of a
longer-term trend in the European banking industry, as is highlighted by the large decline in the
number of credit institutions in the euro area countries over the past decade or so. In the
mid1980s there were more than 11,000 credit institutions in the euro area countries; today they
number around 8,000. This sharp decline in the number of credit institutions is mainly the result
of mergers among savings and co-operative banks, which epitomise what one may call
"consolidating" or "defensive" mergers - mainly aimed at cutting costs and diversifying risks but
also at reaching a size of own funds compatible with a regulation that has been agreed at the EU
level.
So far, this consolidation process has taken place mainly within national boundaries, with the
possible exception of the Benelux and Nordic countries. The preference for domestic mergers (as
opposed to cross-border mergers) may be explained by the fact that the relevant market for retail
services remains national rather than pan-European. Furthermore, the scope for cost-cutting
appears to be larger if the merging institutions have overlapping operations. The fact that cultural
"proximity", notably in the corporate style of governance and management, is traditionally seen
as a key factor in the success of mergers may also have played a role. However, from my own
professional experience of running a truly pan-European bank, I could add that professional
identity is a much stronger force for unity than national identity is a force for separation.
Conclusion
I have outlined the likely pattern of evolution that we envisage for the euro area financial system.
Summing up the various elements, we see a pattern which leads towards a financial system that
should perform its functions more efficiently using the advantages available to the financial
system of a large economy. A large financial system can be more readily versatile, i.e. provide
investors and those in need of financing with a full range of options to choose from according to
their requirements.
What does all of this mean for financial stability in the euro area?
First of all, I should like to remind you that the financial system of the euro area showed a high
degree of stability during last year's period of financial turbulence as well as during the rather
dramatic structural shift connected to the changeover to the euro. In the former case, it is true that
there was a significant spillover effect for the euro area markets, but they recovered quickly and
without suffering any lasting damage. There was no disruption to any of the basic functions of the
financial system, and public confidence in it remained strong throughout.
Second, the foreseen structural changes require, as I mentioned earlier, the need for adjustment to
be taken seriously by all participants in the financial system. This adjustment appears to have
intensified recently: there has been an increase in merger activity, an establishment of alliances
and an introduction of new products and services, often based on modern information technology.
The process of structural change contains risks, but if these risks are identified early and analysed
carefully, they do not present a threat to financial stability. After all, we are talking about
decision-making and planning by people who are dealing with risks every day at the highest
professional level. In this regard, the smooth changeover of the financial system to the euro
demonstrates the virtues of efficient and careful forward planning.
Third, I do not view efficiency and stability of the financial system as being contradictory. In
many ways these qualities actually support each other by laying a firm foundation for the
financial system. An inefficient financial system, in addition to being costly to society, can be
more vulnerable to shocks.
At the ECB, we play our part in the evolution of the euro area financial system by providing it
with stable monetary conditions. By creating an environment of price stability, we allow private
sector agents to focus their attention on the questions that are most relevant to their activities and
to take advantage of the benefits of this stable environment, such as the lengthening of their
planning horizons.