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European
Economic Perspectives 22
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Alone?
European
banks are consolidating rapidly. So far, most mergers have taken place
within national boundaries. A new CEPR Report examines the challenges
for national competition policy and whether we need a Europe-wide
financial regulator.
Banking
is in turmoil. The bank as an institution is changing; the industry is
changing. Advances in information and financial technologies are
transforming banking practices at the same time as regulatory changes
have transformed banking markets. This is true in the United States,
with the Riegle-Neal Act of 1994 and the gradual repeal of the 1933
Glass-Steagall Act. It is even more so in Europe, where the ultimate
regulatory change has been the adoption of a single currency.
These
changes have been accompanied by an unprecedented wave of mergers and
acquisitions. A handful of huge global institutions seem prepared to
dominate the scene. At the same time, the Asian crisis and its aftermath
have left deep wounds. Banks, European banks in particular, appear to be
vulnerable to economic accidents like Asia and Russia. In some respects,
they are more fragile than ever before, as the near-collapse of Long
Term Capital Management illustrates.
There
seems little doubt that within the monetary union, European banks will
continue to consolidate. But is this desirable, particularly if mergers
happen predominantly within rather than across national borders? What
are the implications for competition? And how should governments manage
bank supervision as systemic risk grows? These are some of the key
questions addressed in a new CEPR Report, The Future of European
Banking.
The
evidence suggests that although the European banking industry has
experienced a significant increase in competition, national markets
remain segmented and there is certainly room for a further
intensification of competitive pressures. In part because of the current
lack of regulatory harmonization, but also due to past heritage,
competitive conditions have not yet provided a powerful impetus for
change. Non-regulatory barriers, taxation and corporate law in
particular, are also likely to remain important for the foreseeable
future in maintaining nationally segmented markets.
The
existence of different currencies has been an important factor in
European segmentation. Alone, however, the euro will not be enough to
create a true single European financial market. This is because
diversification possibilities in Europe are almost as good within
countries as they are across countries. This contrasts with the United
States, where states are more homogeneous and diversification benefits
must be sought across state borders. In Europe, the benefits from
consolidation that have driven US banks to merge across states can be
obtained by merging within a country.It is clear why a European bank’s
first bids for growth by acquisitions would naturally be made
nationally. Mergers are easier within the same culture and regulatory
environment and they may also bring local market power – a welcome
relief from increasing global competitive pressures. But there will be
losers from such increases in market power, notably small businesses,
which will not be big enough to access the new euro financial markets
directly and consumers, at least until direct banking becomes more
widespread.Reduced competition is not the only reason why this tendency
for national consolidation is unhealthy. Because national banking market
structures and lending practices differ widely across Europe, the same
change in interest rates by the European Central Bank (ECB) will affect
economies differently. This could be a serious hindrance to the
operation of a single monetary policy.National consolidations should be
discouraged, the Report concludes, and regulatory and political barriers
to cross-border mergers should be dismantled. Cross-border mergers
permit the emergence of efficient producers without prejudice to
competitive conditions. They also help homogenize banking practices,
promoting the desirable convergence of the mechanisms by which a single
monetary policy will be transmitted to the real side of European
economies. It is time to favour the emergence of European competitors
rather than national champions. In this endeavour, the main players will
be the national competition authorities. If they or the European
Commission limit the domestic consolidation of the banking industry,
national banks will learn to go against their natural tendencies and
start consolidating internationally. At the same time, the role of
European competition policy will remain important, particularly in
checking that state aids do not derail the necessary restructuring of
inefficient banks that are regarded as national champions. Banking
supervision is another delicate and urgent issue. As banks take on more
market risk, their ability to withstand sudden fluctuations in market
prices depends in part on the readiness of the central bank to provide
liquidity to the financial system and to banks in particular. In this
respect, the ECB is a very different institution from the Fed – more
concerned with and more constrained by the risks it may take onto its
own books and thus likely to be less ready to provide liquidity to
banks. The implication is that ex ante regulation and supervision are
correspondingly more important in the European monetary union than they
are in the United States.
There
are a number of worrying risks associated with the current decentralized
supervisory system for European banking, the Report argues. The advent
of cross-border banking, the likely emergence of pan-European universal
banks and, more generally, the new competitive climate of European
banking, confront national supervisors with delicate coordination
issues. In the face of these challenges, it is unlikely that the
informal coordination among independent national authorities – as
provided for by the Second Banking Directive – will be a safe
arrangement.
Past
European experience with national supervision has not always been
satisfactory, with domestic supervisors sometimes being too close to the
institutions that they regulate, thus risking being captured. The
natural distance that a supra-national regulator keeps would thus appear
to be particularly healthy. But it is ironic that while the
international financial community is studying the possibility of setting
up a ‘world financial regulator’, petty national jealousies appear
to be preventing this from happening at the European level, putting the
stability of European financial markets at risk.
Building
a centralized supervisory body is a possibility already foreseen in the
Maastricht Treaty, but it appears only to allow centralization of
supervisory responsibilities within the ECB. While a clear improvement
on decentralized supervision, this may not be the optimal arrangement as
the ECB is already being perceived as accumulating too much power and
issues of accountability have been raised. An independent European-wide
regulatory agency, distinct from the ECB, may generate fewer concerns in
this respect while at the same time facilitating accountability.
This
article summarizes ‘The Future of
European Banking: Monitoring European Integration 9’ by
Jean-Pierre Danthine, Francesco Giavazzi, Xavier Vives and Ernst-Ludwig
von Thadden (CEPR, 1999).
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