Erkki Liikanen: A central bank's view on technology based efficiency and
productivity in the financial markets
Opening speech by Mr Erkki Liikanen, Governor of the Bank of Finland, in the Bank of Finland seminar
on Technology-driven Efficiencies and Risks in Financial Institutions, Helsinki, 21 November 2005.
* * *
Europe needs more growth. But we are aging. So growth cannot come from an increased labour
contribution. We therefore need higher labour productivity. We need more investment, which in turn
increases productivity. And we need better solutions, recipes, bringing a lot higher total factor
productivity. This means faster technological change.
We are happy to have with us today Professor Matti Pohjola, the renowned economist, who has
written extensively on ICT, productivity and growth.
We know that ICT can be a powerful tool in productivity growth, not only concerning ICT-investment
but above all the use of ICT in new processes and ways of organising companies and the public
sector.
In Europe, the use of IT in the services sector has not brought about the same increase in productivity
that we have seen in the United States. The reason behind this, however, is not only slightly lower
investment levels in ICT but - I believe - less competitive markets. When there is less competition,
there is less pressure to innovate, and less pressure to increase efficiency.
This is why we need to have the real Internal Market as an opener of competition. And we need to
abolish the remaining barriers to cross-border business in all areas.
Today, we have a common monetary policy but we don't have a common financial market.
We have made some progress in the financial markets, such as in the wholesale business generally
and the integration of inter-bank large value payment systems and securities markets in particular.
Both of which have proceeded well. Retail banking and securities settlement systems are where
matters are lagging most. And the co-ordination and convergence of supervision require further work.
A Europe-wide financial sector will bring better and cheaper services and lower interest rates to all
customers: to consumers, SMEs and large companies alike. Lending decisions are also decisions
about innovation in other sectors. All of which promote growth.
From the macroeconomic point of view, the integration of the financial sector is significant for Europe,
because:
- integrated and efficient financial markets would allow the dilution of risks by spreading them
among countries and regions, and
- integrated financial markets can contribute to the efficient transmission of monetary policy.
* * *
In the 1970s and 80s, Finland saw substantial investment in IT in the financial sector. But it was only
after the financial crises in the early 1990's that the sector was forced to revise their operations, and
ICT was widely used in both re-engineering the internal processes and in creating new distribution
channels.
In the ten years that followed, banks cut their operating expenses by 50%. This process was initiated
when public authorities set stark quantitative cost savings requirements as a condition to receiving
capital support. On top of which, enhanced competition, due to deregulation, has increased the need
for continuous re-engineering. Certainly, commonly created standards for customer-to-bank and
interbank communication also played a significant role in this development.
From which we can see that we need IT-investment, we need competitive pressure and we need
investment in innovating in the organisation to bring about productivity growth.
Now -and even more so in the future -tough competition in integrating markets force financial market
institutions to further improve their performance and increase their efficiency. That is also what share
holders want. And to bring these improvements about, streamlined inter-bank payment systems and
automated securities settlement systems are required in particular.
The European financial sector demonstrates, however, significant differences in efficiency, both
between institutions and between national banking sectors. This question will be further elaborated in
today's presentation by De Nederlandsche Bank's Jacob Bikker, the author of a well-known book in
this area.
Implementation of ICT has caused profound changes in many business lines, and yet there is the
potential in further renewing and streamlining the processes - it should not be about carrying out the
computerisation of old processes but rather about reinventing the processes and using the full
capacity of new technology.
Efficiency comes from savings in personnel and time, streamlined and automated process flows, from
less errors, from economies of scale and from lower processing costs per unit. Banks have created
new sources of income by offering more sophisticated products which would not have been possible
without the use of ICT. The whole banking landscape is changing. It is going to be of the utmost
interest to hear Bob DeYoung's presentation on what the implications of these changes to the industry
are, and how far this evolution can go.
A modern, networked economy also requires financial institutions to review their way of carrying out
their business with their customers in order to produce added value. This often requires being part of
their customers' business processes and doing more than was required of them earlier. An example of
this is electronic account statements, with their structured references and other information for
automated booking and reconciliation in the company's financial management. The demand for
straight-through-processing from customer to the bank, between banks and to customer is intense.
Aspect of these issues will be discussed during both Bo Harald's and David Blair's presentations in
this seminar.
* * *
From bricks and mortar to clicks and mortar is the most visible phenomenon of ICT in financial
institutions A new distribution channel, the Internet, and mobile terminals, along with sufficient ATM-
and payment card networks have made it possible to bring down the number of bank branches, giving
savings in operating costs. Take, for example, one Finnish bank which has managed to cut its
distribution costs by 25% and unit production costs for payments by 68% over a 3 year period. This
was achieved by implementing multi-channel applications.
Customers have adopted the new way of banking, paying bills, checking credit card balances or
trading in securities, independent of time or place, surprisingly fast. Coming generations will probably
have difficulty in understanding how anyone ever queued at a bank branch to pay his bills - to say
nothing of writing a cheque. Today, it is difficult to see how a bank could enter the Finnish or Nordic
markets without a well-functioning and comprehensive Internet service.
New customer generations are also more willing and capable of extensively managing their finances
using e-banking services. Housing loans, for example, are still largely negotiated in branches, but
already we have seen how people request offers from various banks via the Internet before entering
into final discussions with one bank. This reinforces the customer's negotiating power. And this
increases competition.
Development also requires sufficient security elements to create and maintain public confidence. And
here the challenges are growing. We need European level cooperation in network security. Here I
hope that ENISA, the European Network Security Agency, will make its contribution. We need efficient
cooperation among the law enforcement authorities to fight cyber crime. And we need the secure
electronic identification and protection of data privacy. Identity theft, the worst case of e-crime, must be
fought on all these fronts.
ICT implementation and exploitation often require huge investments. In many banks ICT has replaced
personnel as the largest single item of expenditure. Old legacy systems are aging, and according to a
recent survey, over 80% of ICT expenditure goes into maintenance of these systems. New investment
is required, and these are challenging projects. In Europe, it seems the banking industry is very
prudent in front of new investments. This may partly reflect caution due to over investments in the
past, as for 2 K. But it may also mirror the risks currently a deficient vision of the future. Maybe there
are not enough incentives - such as competition?
* * *
Can regulation be used to enhance competition? This was the case with the Internal Market
programme. Twelve or fifteen national regulations were replaced by a harmonized one. Active
competition policy was pursued. So a level playing field was created in a great number of sectors. And
the regulatory costs were lower than in the past.
But in general, regulation can be a double-edged sword. The first priority is that markets are dynamic
and search for growth. Sometimes, however, regulation is also required where market failure is
evident.
The EU Commission's regulation (2560) on euro payment fees was the first step towards forcing the
banking sector to do something about the intra-EU cross-border payment systems. By regulating the
fees that banks were able collect from cross-border euro-denominated payments within the EU, the
Commission - in effect - cut the banks' income and forced them to develop cost saving measures in
the processing of these payments.
The new draft on the new legal framework for payments is coming soon. This framework should have
the effect of harmonising the general terms of payment transmission throughout Europe. This means
that a payment initiated by a Finnish customer in Helsinki to an Italian bank's customer in Milan or a
Portuguese bank's customer in Lisbon to a German bank's customer in Wilhelmshaven - or wherever
in Europe - must not take longer than 3 banking days. Knowing the diverse terms of payment in use
today, this will inevitably force the banking industry to improve their operations. This development will
also benefit all companies involved with Europe-wide trade.
Banks have committed themselves to creating the single euro payments area, SEPA through their
cooperation forum the EPC (European Payments Council). This development should result in an
integrated euro payments market. Work on the definition of common payment instruments is in
progress, but the infrastructure for handling them is still obscure.
Different levels of ICT usage in Europe and different traditions cause controversies in this SEPA work.
The only option for Europe is to succeed in creating such an internal payments infrastructure that
benefits the end customer and enhances economic growth. We must not build SEPA according to the
lowest common denominator; instead it must become the momentum for the entire European financial
sector. It could provide the required push for the banking industry to find the touchstone to guide them
to a new level of competitiveness.
* * *
Why do we need a conference such as this? In their individual statutes, the euro area central banks
have been given the task to contribute to the smooth conduct of policies pursued by the various
authorities relating to the prudential supervision and the stability of the financial system. On top of
which, we are to contribute to the smooth operation of the payment and securities infrastructure. This
is the basic task of the European System of Central Banks. The Bank of Finland has even been
explicitly committed to participating in developing financial markets.
From this, you can see that the objective comes mainly from the need to boost economic growth; the
solutions however lie at the micro-level. Two thirds of the topics covered by this conference take a
micro approach. We need to interlink the forces of integration, competition, innovation and the use of
technology. Within the financial markets, technology can give us that edge.
When setting up this conference my colleagues were faced with the difficulty of placing the issue
before central bankers: the theme is partly a financial market policy issue, partly an oversight issue
and we cannot ignore the fact that central bank operations are involved, too. It falls into the area of
cooperation with supervisors, as technology changes the risk profile of financial institutions and the
market as whole.
It is essential that new technologies, new products and processes are understood not only by market
operators but also by the authorities. Contagion can take on new forms via networks and loss of public
confidence. The new multi-channel world is more transparent than the old brick and mortar world. This
understandably poses new demands on supervisory regulation - although it should not become a
barrier to development. Co-operation across borders must be ensured in the integrated markets.
I would like to wrap this issue up by promoting e-banking, which to me covers various services in
banking and securities markets while extending to the basic infrastructure that include payment
systems and instruments. We at the Bank of Finland have felt this area should constitute a strategic
focus. I believe you can share this vision.
How can we enforce such a strategy? Perhaps best through the provision of analysis and research
focusing on efficiency and productivity in the financial sector. Some of this requires the development of
methodology and we must surmount the difficulties of current research in capturing a multifaceted
reality due to a shortfall in data. Therefore the accent remains on co-operation with market
participants. After all, it is the market that will have to deliver the efficiencies.
I wish you all a lively debate.