Svante Öberg: Increased financial integration - future challenges
Speech by Mr Svante Öberg, Deputy Governor of the Sveriges Riksbank, at the Conference "Bank &
Finance Outlook" (Affärsvärlden), Stockholm, 19 April 2007.
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Introduction
To begin with I would like to thank you for the opportunity to come here and speak about financial
integration and the challenges this entails.
My main message today is that financial integration is increasing rapidly in Europe, and that this leads
to better conditions for economic growth, but that it also means that regulations, supervision and
arrangements for crisis management must become more international.
I have divided my speech into four parts. I shall begin with a brief description of financial integration in
Europe in recent years. After that I shall discuss the advantages of greater integration. Then I will go
on to talk about the challenges we face as a result of integration and conclude with some possible
solutions to the problems.
It is a broad subject and we have very little time, so I will limit myself to the banking sector.
Financial integration
Traditionally, most countries' bank markets have been almost exclusively national. When banks have
conducted operations abroad, these have primarily focused on large corporations and securities
markets. Smaller companies and consumers have in principle been obliged to use the services offered
by the domestic banks.
However, in recent years the bank markets have undergone major changes. Several European banks
now offer their services outside of their national borders. More than 40 European bank groups have a
substantial part of their operations in more than three European countries. Names such as Unicredit,
Barclays, Fortis and ING are all examples of banks in the forefront of this development. The
internationally-active banks are moreover increasingly offering services to households and smaller
companies.
The integration process has been particularly evident in our own neighbourhood. Nordea and Danske
Bank have substantial market shares outside of their respective home countries. With the exception of
Iceland, it is in Nordea's case a question of market shares of more than 10 per cent in all of the Nordic
countries. Swedbank and SEB are dominant actors in the Baltic region.
But financial integration is now also increasing rapidly in other parts of Europe. The timing of my
speech could hardly be more appropriate. Only in recent weeks the media has reported on
farreaching plans for a merger between British Barclays and Dutch ABN Amro, two banks which together
would become one of the world's largest players in this sector.
Parallel to this cross-border integration process there is also another type of integration within the
banks. It is becoming increasingly common for these groups to organise themselves so that they in
practice function as one bank instead of a number of independent bank companies. What drives the
banks to change their organisation is the efficiency gains obtained through greater centralisation and
specialisation. At the same time, the operations are woven together in a way that means that the
different parts of the group become more dependent on one another.
Advantages
Increased financial integration in Europe involves economic advantages. Integration leads to
increased competition. This in turn leads to companies and consumers being able to choose between
a greater variety of products and to prices and interest rates being lower. More products make it easier
to manage and diversify risks. Lower interest rates mean lower costs for borrowing, which is beneficial
for both companies and households. Integration thereby means better conditions for economic growth.
The list of gains that integration brings could be made longer. But the advantages are well known to
this assembly and I don't believe I need to go into this in more detail.
It is enough to emphasise that we at the Riksbank welcome increased financial integration.
Challenges
I will now move on to the challenges we face due to financial integration.
As the increased integration means that countries' financial markets become increasingly woven
together, the risk increases that problems will spread between different countries. To counter this, new
and greater demands are made to find joint solutions and to cooperate across national borders. Those
days are gone when we could work on the basis of a purely national perspective for financial market
issues. Now it is a question of finding ways to manage both our interests and those of other countries
in a good way. This includes how we should conduct supervision, how we formulate regulations and
how we organise ourselves to be able to manage financial crises, if these should arise.
In Europe, the EU cooperation gives us a joint forum for tackling this challenge. The EU's Financial
Services Action Plan was launched in 1999. It has been a driving force behind the development I
described earlier. The measures proposed in the action plan have now largely been implemented.
However, much remains to be done. This is evident when one looks more closely at the EC
regulations that form the basis for the national frameworks for supervision and crisis management.
The regulations we have in the EU at present and the way we organise ourselves is not adapted to the
new conditions prevailing due to the increased integration.
One problem is that the responsibility for supervision is not adapted to banks with cross-border
operations.
Within the EU the supervisory responsibility for banks is governed by the principle which in practice
imbues all EC regulations in the financial field, namely the home country principle. This means, in
brief, that the responsibility for supervision lies with the country where the bank is legally domiciled.
To illustrate how this works, we can imagine a bank with branch offices abroad. The bank and its
branch offices are regarded as one single legal entity. They are therefore governed by the regulation
and supervision that apply in their home country. How the operations are actually divided up between
the different countries in principle has no relevance.
Danske bank is an example of a bank that has chosen to organise its operations in this way. The
relatively extensive operations conducted by the bank in Sweden are largely under Danish regulations
and supervision.
If a bank instead chooses the form of subsidiaries for its foreign operations, then its subsidiaries - as
they are regarded as independent entities - will be covered by the regulations and supervision that
apply in the respective countries in which they are domiciled. In this case, there are in a formal sense
several "home countries".
Nordea's operations in Sweden, Finland, Norway and Denmark are organised in this type of subsidiary
structure, which means that the group is covered by four different systems of regulation and
supervision.
In both of these cases there is reason to ask whether a pure "home country principle" is the best basis
for supervision of banks with considerable operations in several countries.
In the case of Danske bank, where the foreign operations are conducted in the form of branch offices,
the most important question is whether it is reasonable and appropriate that the responsibility for
supervision is concentrated to one single country. This question becomes particularly relevant if the
bank is a large actor outside of the home country and in these countries plays a decisive role in the
stability of the financial system. In the case of Danske bank's Swedish operations, one perhaps cannot
say that this is currently the case. However, it is not inconceivable that this situation might arise in the
future. The situation would be even more critical if the bank was at the same time a relatively small
actor in its own country. In this type of situation the supervisory authority in the home country - which
in this case is the one that decides - would probably consider that the need for supervision was not as
great as the other countries might consider it to be. There is an evident risk of a conflict of interests
between the countries.
There are elements of similar problems in the Nordea case, too. However, here the problem is rather
the opposite - namely that the bank group's different companies (parent and subsidiaries) would be
covered by supervision in several countries. The fact that each cross-border bank group has to obey
and report to several supervisory authorities leads to additional costs and administrative duties for the
bank. This is an obstacle to continued integration and to the competitiveness of the European bank
market.
Another problem is that there are no common arrangements for crisis management within the EU.
Basically the only EC regulations defining how responsibility should be divided between the countries
in the event of a cross-border crisis are regulations for compensating depositors in the case of bank
failures. However, these regulations are not primarily intended to ensure efficient crisis management.
They should rather be seen as protection for consumers.
The fact that the allocation of responsibility between countries in the event of cross-border crises is in
principle unregulated leads to at least two serious problems.
Firstly, it lays the foundation for the conflict of interests I just described. Even if the responsibility for
crisis management is formally unregulated, it will unavoidably fall to the country whose economy is to
a large degree dependent on the bank that is in distress. This country is not necessarily the same
country that has the responsibility for supervision of the bank. One consequence could thus be that a
country which is substantially influenced by foreign banks could be forced to pay the bill for
unsatisfactory supervision exercised by another country. The lack of a formal link between
responsibility for supervision and crisis management is in this case an evident problem.
Secondly, the unregulated allocation of responsibility for crisis management means that each country
that is involved in a cross-border crisis is thrown upon its own national crisis management and on the
goodwill of the other affected countries in contributing to efficient crisis management. It is far from
certain that this will lead to the optimal solutions. Without uniform regulations, forms for cooperation or
mechanisms for joint decision-making, there is a considerable risk that we will find ourselves in
"gamelike situations" where the countries involved act in various ways to avoid paying the crisis "bill". In this
type of situation there is a clear risk that all parties involved will be the losers.
This is a problem that affects not only the governments and authorities in the countries suffering
crises. The arrangements for crisis management, like the supervision, affect the business conditions
the banks work under. An efficiently-functioning safety net comprises a form of "quality label" on the
bank system. This in turn has significance for the banks' ability to attract customers and financiers. If
legislators and authorities cannot supply this, the domestic market will lose out in competitiveness
compared with other markets. The fact that there is currently a lack of joint regulations for crisis
management within the EU is therefore a problem, also from the banks' perspective.
Possible solutions
I have now come to the fourth and final part of my speech, the part about possible solutions to the
problems.
Regulations, supervision and crisis management need to be developed so they can function even
when banks have cross-border operations. The aim is to form a framework that can supply the need
for financial stability, both nationally and internationally. It is equally important to ensure that
regulations and institutional arrangements are designed so that the financial integration process can
continue and the competitiveness of the European bank sector can thereby be strengthened.
Considerable thought is being put into these issues at EU level right now. Some measures have
already been taken. For instance, the need for a more efficient and uniform supervision of banks with
cross-border operations has partly been met by giving the supervisory authority in the group's home
country strengthened powers and increased responsibility for coordination. To improve the exchange
of information and the cooperation between the authorities in different countries, special agreements
have been signed between the EU member states. In addition, various work is being done to ensure
that the member states implement and apply relevant EC regulations in a uniform manner.
All of this is good, of course, and is aimed at managing the problems and challenges I have taken up
here today. But it is far from sufficient. I do not intend to go into any detailed suggestions of how the
various problems should be resolved. Instead, I would just like to convey - as a contribution to
continued discussions on this subject - some general thoughts on how we can proceed.
In the short term, we should make improvements primarily in three areas:
Firstly, we in the EU should develop joint regulations for crisis management, which link together the
responsibility for supervision and crisis management in a good way. The ultimate driving force to
achieving efficient and appropriate supervision is, after all, the knowledge that one has to bear the
consequences of deficiencies in supervision.
Secondly, we should improve and deepen the exchange of information, cooperation and coordination
between the authorities in the different countries. At present there is, for instance, no common model
as to how supervisory authorities can work together. Such a model is necessary to maintain high
quality and efficiency in the supervision of complex banks with operations in several countries. An
expanded cooperation can hopefully also contribute to harmonisation of the supervision that goes
further than what can be achieved merely through joint regulations.
The agreements that I have mentioned earlier are aimed at achieving this. But it is doubtful how well
these voluntary agreements will function in an acute crisis situation. To ensure efficient supervision
and crisis management the content of the agreements needs to be formalised. An important part in
this is finding methods of resolving differences of opinion between authorities.
Thirdly, we also need to work to reduce the introduction of national special regulations in the EU's
member states. Of course, there must still continue to be scope for countries to formulate regulations
on the basis of their domestic conditions. However, this impairs the prospects of bringing about a true
harmonisation. It is therefore important to constantly question the need for national solutions in the
regulatory work within the EU. The aim should be to reduce national deviations as far as possible.
In the long term, more in-depth structural changes will be necessary. This primarily concerns
establishing joint institutions for supervision and crisis management at EU level. It may mean creating
a supervisory authority for the 40 or so banks that currently conduct extensive operations in several
European countries. It may also be a question of acting to create a joint European deposit guarantee
scheme for cross-border banks. Such a system would have several advantages. Above all, it would
mean that individual countries were not forced to pay large compensation amounts to depositors in
other countries.
I am aware that this type of suggestion is far-reaching and controversial. It would mean a transfer of
power from the member states to the EU. But the suggested arrangements would only apply to the
banks conducting cross-border operations of sufficiently large scope to warrant EU-wide measures.
The main advantage of such a "supranational" arrangement is that the public frameworks for
regulation, supervision and crisis management can correspond to the actual structure of the financial
market. When supervision and crisis management are centralised, this also creates the conditions for
reducing the administrative burdens on the banks and at the same time managing the risks where they
actually arise. Both the banks and the individual countries would be the winners in such a system.
Conclusion
My main message today has been that financial integration is increasing rapidly in Europe, and that
this leads to better conditions for economic growth, but that it also means that regulations, supervision
and arrangements for crisis management must become more international. Financial integration
provides us with a number of new challenges and we must work together to find solutions to the
problems that arise.
Thank you!