The ECB, the euro and the integration of financial and mortgage markets
Speech delivered by Ms Sirkka Hämäläinen, Member of the Executive Board of the European Central Bank, at the 14th Annual Convention of the European Finance Convention Foundation, Paris, 23 November 2000
I should like to thank the organisers for inviting me here to the 14th Annual Convention of the European Finance Convention Foundation. It is a great pleasure and an honour for me to have this opportunity to speak to you about the euro and its implications for the integration of the European financial markets.
The introduction of the euro is a project of a structural nature and its effects will become visible only gradually. Therefore, it will only be possible to assess fully the main benefits and the degree of success of the single currency in the longer term. Bearing this in mind, I shall discuss various aspects of financial market integration and the implications of the euro and the single monetary policy. In this respect, I intend to focus in particular on mortgage markets.
1. The impact of the euro and the single monetary policy
The introduction of the euro in the context of a stability-oriented monetary policy was expected to have major benefits for the financial landscape of the euro area. It should be acknowledged, though, that the rapid change in the European financial markets is not only a consequence of the euro, but also reflects the global trends towards liberalisation and deregulation, as well as the new possibilities brought about by technological development and financial innovation.
Economies of scale, the disappearance of exchange rate risk and increased homogeneity, underpinned by increased cross-border competition and consolidation, have helped to promote deeper and more liquid markets in the euro area. These developments have already led to overall efficiency gains in terms of reduced transaction costs, increased transparency and better allocation of financial resources. Nonetheless, the process of change has only just begun.
A pre-condition for the positive developments which we have witnessed so far is the firmly established "stability culture" of the euro area economy. The process of convergence which preceded the single currency was instrumental in fostering this stability culture. So was the institutional set-up of the Eurosystem, as laid down in the Treaty on European Union. The primary objective of price stability and the principle of central bank independence contribute to ensuring a high degree of credibility for the monetary policy.
The credibility for the price stability objective has been - and continues to be - an important factor in enhancing developments in financial markets, particularly for the longest-term market segments, such as the mortgage sector. The markets for longer-term financial instruments play a very important role in ensuring a timely and homogeneous transmission of monetary policy impulses to the real sector of the economy. This is one reason why the development of financial markets, and their integration across the euro area, are essential from the viewpoint of the Eurosystem.
The shorter end of the market is also important for monetary policy. Deep, integrated money markets are essential to achieve an even distribution of central bank liquidity and the same level of short-term interest rates across the euro area. It is at the short end of the market where we have seen the most rapid development. The national markets were successfully integrated into an efficient euro area market practically immediately upon the introduction of the single currency. Other segments of the financial markets are also making progress towards integration, although at a slower pace.
The use of different currencies was only one of many factors behind the national segmentation of the European financial markets. Removing the currency barrier was an important step towards integration. But this alone is not enough. Many other measures must be taken, by private institutions as well as business associations, Community institutions and national authorities, in order to remove the remaining barriers, such as differences in legal frameworks, practices, traditions and technical infrastructure. Work is under way in most of these areas, in part driven by market forces and in part by policy makers.
At the policy level, I would particularly like to highlight the importance of the Financial Services Action Plan endorsed by the EU Council last year. This Action Plan aims at removing barriers, particularly with regard to the legal environment. The cross-border provision of financial services, improved conditions for raising capital on an EU-wide basis, and a level and transparent playing-field for all financial market participants are crucial for the deepening and widening of the euro area markets. The Action Plan is expected to be fully implemented by 2005.
Another important initiative is the so called "Committee of Wise Men on the Regulation of European Securities Markets". Its main mandate is to identify whether existing institutional arrangements can be adapted in order to ensure a faster and more efficient implementation of the regulatory reforms in the field of securities markets.
The initial report by the Committee of Wise Men, which was published recently, highlights the need to achieve greater efficiency when adopting the necessary legal reforms, by ensuring that the chosen procedures are as rapid as possible, are easy to implement and ensure a high degree of flexibility. They also give guidance on ways to achieve a more homogeneous approach, throughout the EU, when implementing regulations at the national level. In the report, the "Wise Men" suggest priorities and put forward a proposal to speed up the implementation of the Action Plan.
One trend in the European financial markets apparent already before the single currency has been the gradual increase in the relative importance of non-bank financing and securitisation. Traditionally, bank financing has been the dominant source of financing in continental Europe and direct financing from the capital markets was considerably less popular than in the United States, for example. The outstanding amount of debt securities issued by non-financial US corporations was more than ten times the corresponding amount of securities issued by euro area corporations at the end of 1998. Nevertheless, the securitisation process is gradually gaining momentum in the euro area with the ratio of outstanding bonds as compared to bank loans for non-financial corporations increasing from 10% in 1998 to 11½% in the first half of this year.
The relatively modest development in this area reflects that these practices are influenced by traditions and long-standing business relationships. It takes time, especially for smaller companies, to build up the expertise and structures needed to obtain financing directly from the market. For example, credit rating is a basic requirement for issuing bonds. In Europe, the proportion of small and medium-sized companies which are rated is comparatively low, and the rating industry itself is not yet as developed as it is in the United States.
Nonetheless, some progress is already evident. At the beginning of 1999, the share of bond issues by non-financial corporations with a rating below "A" was around 10% of the total bond issues for the euro area. One year later, this ratio has more than doubled to reach approximately 25%.
Overall, the corporate bond market in the euro area has already increased in size by 24% since the introduction of the euro. If we refer only to bonds issued by non-financial corporations, the increase is even greater, at 32%.
For bond issuers, the euro market has opened up a much wider circle of investors than the small national markets could offer. There is broad agreement on the view that the recent intense merger and acquisition activity, as well as the heavy investment in the telecommunications industry, would have been much more difficult to finance without the broader euro area market.
However, the changes are not only volume-related. Qualitative developments are also important for improving market liquidity. Several of the euro area governments have reformed their issuance programmes with a view to making their bonds more "investor friendly", for example by increasing the volume of the issues and adopting more regular and transparent issuance calendars. The improved liquidity achieved through qualitative improvements relates to a number of private issues too, most notably the Jumbo Pfandbriefe.
Qualitative improvement is particularly evident in the field of derivatives, where some euro-denominated products have, in fact, taken the lead globally. The Bund contract is now the most active and liquid futures contract in the world. Similarly, the EONIA swap market (the euro overnight interest rate swap market) boasts a degree of liquidity which is unrivalled anywhere in the world.
Of course there are some market segments where progress has been less impressive, notably due to differences in national legislation. This is the case, for example, in the repo market, as the legal status and the definition of repos differ across the euro area.
2. Developments in the mortgage market
The general developments in the financial markets in the euro area also apply, to a large extent, to the sector of mortgages and other types of housing financing. Nonetheless there are certain factors specific to this segment of the financial markets which are worth mentioning.
First of all, the sheer size of the market for mortgage and housing financing is important from a monetary policy point of view. Lending to households currently represents almost 50% of total bank lending to the private sector in the euro area. Mortgages and other lending for house purchases, in turn, represent 63% of lending to households and this share is gradually rising. So, housing financing is important for the transmission of monetary policy through the credit channel.
From a global perspective, various developments seem to indicate the increasing importance of mortgage securities markets. Recent developments in the United States are interesting in this respect. The shrinking US Treasury securities market is providing other issuers of highly rated securities with an excellent opportunity to seek financing in the market. Mortgage-backed assets are among those securities particularly benefiting from this situation. It is not easy to transpose this experience to Europe, owing to, inter alia, different legal and regulatory regimes. However, the boom in Pfandbriefe issuance seems to partly be triggered by a decrease in issuance by euro area governments in response to improved budgetary prospects.
The greater activity in the market for mortgages and other types of housing financing seems to reflect at least two factors. First, the euro area economy is enjoying a robust cyclical situation and falling unemployment. This has been recognised by households, which now have more confidence in the future and are more willing to invest in a home.
The second factor is the stability-oriented policy of the Eurosystem which creates a confidence that the low-inflation environment will be maintained. Inflation expectations embedded in the French Treasury 30-year inflation-linked bond indicate that inflation is not expected to exceed 2% on average, which is in line with the price stability definition of the Eurosystem. Low inflation expectations make it easier for households to take long-term investment decisions.
An important development in the integration of the housing finance market has been the rise in the issuance of mortgage bonds in several countries. This increase is a good example of a process of emulation which is conducive to improving the standards used in the market. Before the introduction of the euro, practically only Germany had a sophisticated legal framework for the issuance of mortgage bonds. It should be noted that the development of the mortgage lending sector in Germany benefited from a long period of low inflation and low inflation expectations.
Following the introduction of the euro, several other countries, for example France, Luxembourg and Spain, have introduced legal frameworks inspired by the German example and in some respects even improving on the pioneering German model. Investors and consumers will only benefit from these developments.
The development of the mortgage bond market is also contributing to a better allocation of the resources devoted to the housing financing sector. The fact that a very large part of the financing of the housing sector in the euro area still is on the balance sheet of the banks makes it costly for banks in terms of regulatory capital. Developing the market segments for mortgage bonds and mortgage-backed securities, and the longer-term capital market in general, may be instrumental in improving the asset-liability management of banks. This should help reducing costs and could, at least to a certain extent, lead to more favourable mortgage conditions for households.
Even though the cross-border competition among mortgage providers is still rather limited, the interest rate differences on mortgage lending across the euro area have narrowed considerably since the introduction of the euro. Despite the progress made so far in the housing financing sector, much however remains to be done.
3. Concluding remarks
I should like to conclude by summarising the main messages of my presentation. First, the Eurosystem's monetary policy delivers price stability, thereby minimising uncertainty among investors and consumers. This is an essential contribution to the efficient functioning of the euro area financial markets.
Second, the current achievements as regards the integration of the financial markets have been important, and have in some fields exceeded expectations. But we should not forget that further improvement is still needed in many areas. Here, it is worth underlining that the introduction of the euro is not yet complete. Only when the euro banknotes and coins are introduced in the beginning of 2002 will the benefits of the single currency, such as being able to compare prices easily across the euro area countries, become apparent to the general public. This will provide a further boost for the integration of the financial sector, at the retail level.
Third, with regard to the mortgage sector in the euro area, the overall integration of financial markets, low inflation expectations and favourable cyclical conditions are contributing to the growth of this market segment. The trend towards securitisation, improved legal frameworks and emerging cross-border competition are likely to continue reshaping this sector to the benefit of both investors and consumers.
Finally, these developments are contributing to improving and harmonising the transmission mechanism for the single monetary policy throughout the whole of the euro area. At the same time, they produce more stability, certainty and security for households in their housing financing. There is absolutely no conflict between improved efficiency of monetary policy and an increased level of well-being for households. Instead, they go hand-in-hand.