pavel racocha : joining the eu - impact on the financial sector of new member states speech by mr pavel racocha, member of the board of the czech national bank, delivered at the conference entitled " the single market for financial services in the eu and its impact on globalization ", sydney, 3 november 2003. * * * on may 1st, 2004, ten countries will join the european union. will the transition proceed smoothly? the main concern related to new countries joining the eu, from the point of view of the financial sector, is what impact the enlargement will have on the functioning of financial markets in new member states. will competition in financial services increase and place a strain on institutions in accession countries or in the eu as well? will there be visible impact at all? the new member states consist of eight former transition economies and of malta and cyprus. i will focus on developments in the transition countries, and especially in the czech republic, which i know best. i will also try to make reference to other accession countries to show that the results of developments over the last thirteen years, at least in the financial sector, are not so different. this brief presentation cannot do more than deliver only a basic description of the past development of financial markets in the transition countries and of their current standing. hopefully the data from this presentation can serve as background information for those interested in further studies. the financial sectors of the new accession countries have undergone huge and substantial reforms over last 13 years. when communism collapsed, there were no traces of a market economy, no free and legal entrepreneurial economic activity, and no institutions necessary for the functioning of a market economy. if we look at the transition economies - which represent 8 out of 10 acceding countries - today, we see a completely different picture. the basic institutions are in place and running ( though sometimes slowly and not always predictably ). the private part of the economy flourishes and is the symbol of a new and well functioning economy. how did this happen? and what happened to the financial sector? and what will be the impact of the accession to the eu on the financial sector, which in the accession countries is synonymous with the banking sector. in 1990, the average starting point for reforms in the former socialist countries, the situation in the financial sector was bleak. there were no services aside from basic banking and insurance functions. the banking sector was comprised of few specialized institutions, each of them a monopoly in its own area [ one institution had monopoly

a mere attempt to disguise the fact that the euro area countries do not currently have enough resources for a credible rescue plan for italy and spain. if they did want to create such resources, they would be putting their own debt arithmetic at risk, because under eurostat methodology the guarantees for the efsf ’ s bonds are included in the guarantors ’ gross government debt. if the facility is to provide effective assistance in stabilising the larger european economies, it will need more funding. each of the concepts poses a serious threat to the reputation and credibility of the facility. a. excessive leverage is now regarded as one of the causes of the financial crisis. b. the proposals for protection and a first loss tranche of 20 % of the nominal debt are also laden with problems. the example of greece demonstrates that the losses may run to 60 %. there is great uncertainty about who would pay for the difference between the insured loss and the actual loss if the greek bis central bankers ’ speeches scenario was to be repeated in other countries. likewise, it is not clear how freely tradable protection certificates would be traded, priced, settled and, in the event of default, enforced if they were to be introduced. such certificates would de facto be quasi cds instruments underwritten by the official institution of a community of countries that are simultaneously waging a campaign against credit derivatives because they regard them as one of the causes of the crisis. c. the signs of a gradual shift towards short - term funding of the efsf are a worrying signal. the risk arising from financing assets that are by definition long - term and illiquid ( primarily rescue loans ) through a programme of shortterm debt instruments ( liability rollover risk ) is more than clear. this alm model proved to be extremely risky during the financial crisis when the commercial paper market dried up. 4. another uncertainty is related to the project of purchasing bonds in the secondary market. to fund these purchases, private capital will be needed ( e. g. in the form of senior tranches of spv debt ). therefore, this project lacks the firm official commitment which similar central bank ( boe, fed ) programmes not reliant on private investor participation have. 5. the latest uncertainty is the adjustment of the entire efsf project to the loss of france ’ s ( and austria ’ s ) aaa rating from s & p, followed by the downgrading of the efsf ’ s own rating from aaa