Global Financial Markets 2015: looking ahead - Ten theses - Liechtenstein Dialogue, Liechtenstein

Speech by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECB
Liechtenstein, 28 October 2005

Ladies and Gentlemen,

It is a great pleasure for me to participate in this conference. Let me start with a personal remark: when I stay in Vienna my address is Liechtensteinstrasse – it leads directly to the beautifully restored Palais Liechtenstein, the baroque museum to which part of the Liechtenstein art collection has returned. Although this is, of course, simply a nice coincidence, it nevertheless illustrates the presence of Liechtenstein far beyond the confines of the beautiful principality.

However, it is not a coincidence that this interesting conference on the dynamics of global financial markets is taking place here in Liechtenstein. Liechtenstein’s prospects as an attractive financial centre are closely linked to trends and developments in global financial markets. I am glad that I can combine discussions on this very relevant topic with the pleasure of visiting Vaduz.

In my presentation, I would like to provide you with my views on the development of the financial markets in Europe. I will offer you – in form of ten theses – tentative ideas on how the financial sector will look in 2015 and on what has to be achieved in order to realise the sector’s full growth potential. My overall messages will be that:

  • the financial sector will gain significantly in size and relevance on a global level and will be subject to strong competitive forces;

  • Europe is well placed in this competitive process, due to the introduction of the euro and the ongoing process of European financial integration;

  • further integration will be necessary, however, if Europe is to excel in the global competitive game.

Let me now start with my first thesis.

1) The size and relevance of the financial sector will grow significantly.

The ECB does not produce forecasts for the financial sector – therefore, I will rely on rough scenario analyses by the consultancy Mercer Oliver Wyman[1] and the McKinsey Global Institute[2].

The prospects for the financial sector are good. Its growth rates are expected to be above GDP growth. That means the financial sector will become even more relevant for economic performance: its share in global GDP could grow from 6% to 10% in 2020. Moreover, as early as 2010 the global financial stock is expected to exceed the $200 trillion mark, compared with around $118 trillion at present.

When we look at the different elements of the growth in financial stock, the rapid expansion of debt becomes apparent. In particular, private debt securities are the largest component of the global financial stock and the fastest growing.

In terms of the geographical composition of the global financial stock, Europe is catching up. Its financial stock increased by 9.9% over the past ten years, a growth rate, which exceeds that of the USA and the world (8.6% and 8.4% respectively). The depth of Europe’s financial stock has also increased considerably, from 84% of GDP in 1980 to 306% in 2003; although this falls short of the US figure of 397%.

As regards the revenue developments for financial services, it is predicted that total industry revenues will almost triple in real terms between 2002 and 2020, rising from around USD 2 trillion to USD 6 trillion. The general trend governing demand for financial services is that a country’s consumption of financial services grows as its relative wealth increases. There is still scope for considerable growth in most national markets, including those whose financial sectors are usually considered to already be “developed”.

In this context, the differences across segments and products are interesting. In addition to health insurance, mutual funds and occupational pensions, it is the retail segment, in particular retail mortgages and retail credit cards, that is expected to grow the most: well over 4% annually between 2002 and 2020.

These figures for the development of the retail sector match our own recent assessment, as detailed in the October 2005 report entitled “EU Banking Structures”[3]. First, the EU mortgage markets have been growing fast. The value of outstanding residential mortgages rose by over 8% annually in nominal terms over the period 1998 to 2004, and there is a clear catching-up process in the Member States which joined in 2004. Second, credit card transactions have risen significantly over the last few years. Credit card payments have transformed consumer lending, by providing consumers with greater flexibility and autonomy over their purchasing and borrowing decisions.

2) Macroeconomic factors and institutional factors, as well as the structure and strategies of the financial industry, are drivers of financial sector dynamics.

What drives financial sector dynamics?

First and foremost:

  • macroeconomic factors such as demography and economic growth;

  • institutional factors such as the financing of health care, education and in particular pensions and privatisations;

  • the role of the capital markets compared with that of financial intermediation via banks; and

  • the ability of the financial industry to take advantage of the opportunities provided by the lending and mortgage markets, and to supply financial services to issuers and investors from other regions of the world.

These are all important drivers of financial sector dynamics. Regulation plays a role, but does not prevent growth. The process of financial innovation is certainly also of key relevance for determining the large potential of the financial sector.

3) Financial innovation will become increasingly important for the financial industry.

Innovation will become increasingly important for the financial industry as the structure of the sector is likely to change and intensified competition may erode existing margins. We will continue to see the creation and development of new financial instruments and services. While retail banking will capture value that has so far gone untapped in specialist segments, value from the “average consumer” segment may become marginalised in terms of revenue and commoditised in terms of the transaction process. Clients will demand and receive highly differentiated solutions. There will be greater risk appetite, and the industry will offer their customers innovative new products. Solutions for retirement funding and insurance needs are particularly likely to meet demand.

The market for credit risk transfer instruments is a particularly good example of financial innovation. This market is based on the trading of credit derivatives and asset-backed securities. It has been developing at a very fast pace and already provides significant benefits for market participants such as banks or institutional investors.

I think that credit risk transfer is a particularly interesting and relevant area, because it shows how market participants solved an important problem without any intervention by public sector authorities.

Despite considerable structural change, the risk profiles of banks are still dominated by the development of their credit exposures – i.e. by credit risk. As you know, credit risk is not only acquired by means of the issuance of loans, it also takes the form of positions in corporate bonds or transactions in over-the-counter markets, which involve the risk of a counterparty defaulting.

In the past, the transfer of credit risk used to be very difficult and costly. The introduction of credit derivatives has allowed the risk inherent in a loan to be repackaged into two or three tradable components. Given that risks which were formerly inseparable can now be divided up, they can be sold separately to those wanting to buy them. Hence these instruments help to create the optimal allocation of risks in the financial system, because they allow the risks to be transferred to those most willing to take them.

The first transactions took place at the beginning of the 1990s, but we have observed strong activity only during the last five years. From a central bank’s perspective, it has to be pointed out that these new instruments require prudent risk management practices, as they may entail significant risks in particular for non-sophisticated market participants. Banks seem to be managing their risks better than seven to ten years ago. But is this the case for other market participants?

4) European financial integration will proceed at various speeds across the different segments but will continue to intensify.

Less than a month ago the ECB published, for the first time, a series of indicators regarding the state of integration of the euro area financial and banking markets[4]. Let me summarise our findings.

While the euro has undoubtedly acted as a catalyst for financial integration in general, it is true that the degree of integration differs from market segment to market segment, with integration being more advanced in those segments that are closer to the single monetary policy, notably the money market. There we have achieved almost complete integration, thanks to, among other things, the establishment of the necessary pan-European payment infrastructure, the TARGET system.

Bond market integration has also progressed significantly. Government bond yields have converged considerably and are now driven mainly by euro area-wide shocks and news. The euro area corporate bond market has grown considerably in recent years and is also fairly integrated, in the sense that the country of issuance is only of marginal importance in explaining yield differentials.

The integration of equity markets in Europe is a slow and more laborious process of overcoming fragmentation. That said, there are encouraging signs of an increasing degree of integration, such as the substantial decrease in the “home bias” in the equity holdings of investment and pension funds, and a more homogeneous reaction of equity prices across the euro area to monetary policy signals.

The pace of integration in the banking sector has been uneven. Integration is well advanced in wholesale and capital-related activities, while it is lagging behind in the retail markets. This partly reflects differences in the nature of competition in these segments. Proximity to clients, bank-customer relationships and access to information play a key role in retail banking, while they are less crucial for investment banking and for corporate banking aimed at large companies. However, lack of integration stems also from differing national regulatory arrangements, practices and product characteristics. Given the increasing importance of retail services, I expect further integration in this market segment in particular.

5) Financial integration – as a European and a global phenomenon – is essential for tapping financial sector dynamics.

Capital market integration also continues at a global level, as attested by cross-border activity, increased flows, and indications of price convergence. Since 1989 cross-border equity flows have grown nearly tenfold, at 18% per annum. It is clear national borders are losing their relevance for the financial markets.

What about regional dynamics in the financial sector? The financial sector in the EU has reached a size making it comparable to the United States, first in terms of the ratio of loans to GDP and second with regard to capital market indicators such as equities, bonds and related business. Europe has also been catching up in derivatives markets.

Does it matter? It matters because it means an efficient market for customers, it fosters innovation and competition. The United States, Europe and other regions are all strengthening their ability to raise and invest capital. The Chinese market is expected to reach the size of the German market by 2010 and the EU market by 2020.

This means that while there are many opportunities to use expertise on new markets, there are also huge opportunities in the European market. There are 450 million people in the EU alone, not to mention issuers and investors in other economic areas such neighbouring countries, the Middle East and Asia.

6) Financial centres will remain relevant but will need to continue reinforcing their competitive advantages.

There will be competition among financial centres – what makes a financial centre?

A stable currency, expertise and infrastructure, and a reliable legal and tax regime and good supervisory practices. “Soft” factors such as language, living conditions and the general notion of trust and reliability. These qualities will remain essential for financial centres in an increasingly competitive market.

7) The institutional arrangements at the European and the international level are by and large adequate but further steps towards an integrated regulatory framework are desirable.

As regards the development of institutional arrangements in the EU context: when the Economic and Monetary Union was created, a clear framework was developed to set up the ECB, organise its interlinkage with the national central banks and define the scope of harmonisation of policies.

This clear framework is missing for financial integration: the concept of the Single Market exists in the context of the financial market, but is more difficult to implement it there than on other markets. We have achieved a lot – look at the success of the euro, look at the money market and the capital markets.

But more has to be done, especially in the following areas:

  • consolidation of infrastructure (such as payments, and clearing and settlement)

  • integration of retail markets

  • creation of an integrated market for mortgages

  • cross-border consolidation of banks.

It might be necessary to have additional regulatory action, for instance in the fields of clearing and settlement or payment systems: the principles of access to the infrastructure, transparency of pricing and the unbundling of services might have to be implemented via regulatory action.

The integration of the new EU Member States into the European financial system is progressing well. Cooperation among supervisors and the sharing of information are being further reinforced.

The more fiscal authorities are concerned with financing growing public expenditure in an environment where wages are under competition, consumers are seeking lowest prices and firms are optimising tax obligations, more pressure will arise at the European and at the international level to close tax loopholes.

Internationally, the IMF, the World Bank and the OECD (for example, the Financial Action Task Force on Money Laundering) will continue to play an important role.

8) The ECB will continue to contribute to financial integration through four types of activity: service provision, helping private sector initiatives, shaping regulation and raising awareness.

Let me turn to the specific contribution the ECB makes to financial integration. We generally distinguish between four types of intervention.

  • First, the ECB and the Eurosystem provide central services. The specific features of these services can be designed in a way which supports financial integration. A good example here is the already mentioned TARGET system.

  • Second, we can act as a helping hand, or catalyst, for private-sector activities by facilitating collective action among market participants and assisting them with possible coordination problems. This is illustrated, for example, by our activities towards the creation of a Single Euro Payments Area.

  • Third, we give advice on shaping the legislative and regulatory framework for the financial system.

  • And finally we try to enhance knowledge and raise awareness of issues relating to financial integration, such as the financial indicators I have been talking about today.

9) The financial industry needs to embrace the opportunities that integration offers.

As I already mentioned, further financial integration will have positive effects on the financial industry. This is because:

  • Integration widens business opportunities.

  • Efficiency gains can result from higher risk diversification.

  • Increasing markets through geographical diversification can lead to efficiency gains via the realisation of economies of scale and scope.

However, if the financial sector is to reap these growth benefits, it is essential that it embraces the opportunities that integration offers. More than ever, individual success will depend on anticipating possible scenarios and taking action when and where appropriate. What is important is value chain restructuring and cross-border consolidation. A “wait and see” approach will not be sufficient. In a moderate growth environment, domestically-focused market players will experience pressure on their income and at the same time relatively fixed costs. Their underlying lack of growth opportunities will become exposed and depress their market valuation to the level where an acquisition becomes attractive to cross-border players with the scale, operational sophistication and technology platform to create value. It is clear that those who move first are likely to be the best positioned for the years to come.

10) The EU will continue to be the source of stability and prosperity.

While there is need for further public and private action – in terms of regulatory harmonisation and convergence, structural reforms und market initiatives – we also have to be fully aware of the very positive impact that the European Union has, not only on the financial sector but also on Europe’s stability and prosperity in general.

The EU’s openness towards new members and its acceptance of the coexistence of different degrees of integration or different layers of political identity certainly figure among its advantages. The stability that the EU generates and the close cooperation that it offers to neighbouring countries and regions benefits them greatly. Yet it is my conviction that within the EU, the formation of common positions should be intensified in order to influence the global dialogue as much as possible.

Coping with complexity has become a strength of the EU. However, efforts are needed to standardise products and harmonise rules further, as well as even further intensify cooperation between regulatory supervisors and market participants.


Ladies and gentlemen,

In my concluding remarks, I would like to return to my perspective on the financial markets in 2015. Let me summarise the main factors which will determine our success in promoting the development of the EU financial system.

There is still an important role to be played by public authorities. Given the efforts undertaken so far, one can argue that a large degree of harmonisation has been achieved in the EU regarding the main elements of financial regulation. A priority for the future is to pursue a consistent implementation and application of the EU-wide rules at the national level. This is a major task of and challenge for national supervisors. The success of their cooperation efforts will depend on their ability to deliver supervisory convergence. If there is no success in this field, pressure to modify the current institutional set-up will mount. It should be recognised that other factors not relating to financial regulation (such fiscal treatment) can play also an important role in affecting the degree of financial integation.

The time has probably come for the private sector to play its role. The closer public authorities come to removing obstacles to financial integration, the more pressing is the need for the financial industry to exploit the opportunities offered by the new environment. In this context, the European banking industry should enhance its efforts to improve levels of efficiency and so reap the benefits of further integration. To that end, innovation and creativity will be required to obtain adequate returns and high customer satisfaction as well as to compete successfully at the global level.

Given Liechtenstein’s membership in the European Economic Area, I hope that my tour d’horizon of EU financial developments has provided input for our discussion without provoking too much – because this is not the role of the ECB.

Thank you very much for your attention.

[1] Mercer Oliver Wyman (2005): Future Industry Scenarios.

[2] McKinsey Global Institute (2005): $118 Trillion and Counting: Taking Stock of the World’s Capital Markets.

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