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EU accession – challenges for retail banking

Sirkka Hämäläinen, Member of the Executive Board, Conference on "Retail Financial Services in the New Europe"European Financial Management and Marketing Association,Warsaw, 28 and 29 April 2003.

Ladies and gentlemen,

It is a great pleasure for me to have the opportunity to be at this conference organised by the European Financial Management and Marketing Association today and to discuss the challenges for the retail banking sector in the accession countries.

Given that I have the benefit of being the first speaker and that I am the only central banker speaking at this conference, allow me to take the freedom to address the issue from a rather wide and policy-oriented perspective. I would like to speak about the challenges to retail banking stemming from the changing environment and the European integration process. These challenges are connected with macroeconomic conditions, changes in regulatory frameworks and strengthening market forces.


Let me start my remarks by briefly outlining the overall roadmap to EU accession and beyond for the countries expected to join the EU in 2004, which are known as the acceding countries. All these new Member States of the EU are also aiming to eventually adopt the euro, upon fulfilment of the convergence criteria concerning inflation, the exchange rate, interest rates and public finance.

When they join the EU, the new members will participate in the procedures for multilateral economic policy surveillance as set out in the Maastricht Treaty. In the area of monetary policy this implies that the new members should treat their exchange rate policy as a matter of common interest and should aim at achieving and maintaining price stability. The regime choice as such will continue to be the responsibility of the respective countries. In the area of fiscal policy the public sector deficit and debt ratios must be restricted in a sustainable way to meet the Treaty conditions.

As economic conditions among the ten countries differ considerably in nominal, real and structural terms, the situation and strategy need to be assessed, and this will be done individually for each country. After adequate convergence, the new Member States can participate in the multilateral exchange rate mechanism, ERM II, which will further strengthen stability and convergence. ERM II is a multilateral arrangement with fixed but adjustable central rates vis-à-vis the euro and with a fluctuation band of +/-15%. Decisions concerning central rates and fluctuation bands are taken by mutual agreement of the participating members including the ECB. In principle, the ECB and the central banks of the ERM II member countries commit themselves to provide automatic and unlimited defence of the exchange rate at the margins of the band. However, both the ECB and the non-euro area central banks concerned may suspend interventions if these conflict with their primary price stability objectives, and they have the right to initiate a procedure aimed at reconsidering the central rates.

Participation in ERM II is one of the well-known Maastricht criteria that allow countries to introduce the euro. Countries have to participate in the ERM II mechanism for a period of two years without severe tensions and without devaluation on a country's own initiative. It thereby forms a testing phase for the central rate as well as for the sustainability of the overall convergence process.

The convergence process and the need for sustainability pose considerable challenges for the economic policies and the behaviour of the economic agents in the acceding countries. Discipline is needed in monetary and fiscal policies as well as in the markets. Market discipline and adjustments in market behaviour depend crucially on market expectations and on the credibility of policy decisions. The process is not necessarily an easy one and it affects all areas of the economy, including retail banking.


1) Challenges for the banking sector stemming from market forces

In addition to the overall macroeconomic challenges, there are specific market pressures on the banking sector stemming from integration. In fact, banks in the acceding countries have already been facing quite similar challenges to EU banks. Over the past decade the acceding countries have undergone a successful transformation to market economies with largely privatised bank-focused financial systems. Today, these banks are confronted with increased competition, high investment needs and changing customer demands. The responses of the banks are very similar to those in the EU, namely mergers and acquisitions, modifications of business strategies and product innovation. Moreover, the EU and the acceding countries are highly interrelated from an institutional perspective. Some of the largest EU banks hold majority stakes in many acceding country financial institutions and have brought in their managerial expertise and funding from the parent institution.

However, banks in the acceding countries continue to operate in a somewhat distinct environment. Capital markets and the insurance industry are far less developed and competition from these sectors is much less intense. The trend towards securitisation witnessed in the EU has not yet spread to the acceding countries. In these areas there will certainly be changes after EU accession as at least the larger corporations gain access to the EU capital markets. Legislative and regulatory changes are also likely to affect the savings behaviour of households over time and give rise to new forms of savings such as pension funds.

Due to the fact that financial intermediation in general terms still remains relatively low in acceding countries, the banks in these countries continue to have a stronger potential for growth compared with their EU counterparts. The prevailing strong bank orientation of the financial systems keeps these institutions in the forefront in pooling savings and risk and in providing credit to households as well as the private corporate sector.

In the recent past, retail banking in acceding countries has experienced a veritable rush of attention as tight competition in wholesale activities has narrowed margins and profitability. Challenges certainly differ, and will continue to differ, across countries and regions due to a divergent degree of sophistication. In some rural areas where bank relationships are not very common banks face competition from loan co-operative and credit unions that are not subject to the same regulatory framework as banks. Internet and telephone banking are on the agenda of many banks, but the technical infrastructure is not necessarily always in place.

Substantial benefits in access to and the quality of financial services can be expected from this shift of interest towards households. Moreover, the ongoing and strengthening integration of retail services across the enlarged EU is likely to significantly enhance economic growth potentials. This development should boost public support for further convergence and integration.

2) Challenges for the banking sector stemming from regulation

The accession process has had, and will continue to have, a significant impact on the framework in which banks operate. Also in this area, substantial progress has already been achieved. All acceding countries have closed Chapter 3, "The freedom to provide services", and Chapter 4, "The free movement of capital", the chapters of the acquis communautaire that are most closely linked to banking. They have thus achieved a minimum degree of harmonisation with the EU regulations that will enable them to successfully operate in the single European market.

However, most countries have also agreed on transitional periods in some areas, particularly in the area of deposit and investor protection. These safety nets are particularly relevant in retail banking, where they aim to protect unsophisticated savers and investors. Divergent safety net coverage in different institutions may distort competition and/or cause confusion among clients. As many banks in the acceding countries are part of an EU banking group, support from parent institutions is generally expected. However, the subsidiaries – as well as locally owned banks – differ from the branches of EU financial institutions and will be covered by different protection schemes.

The accession date will by no means represent a kind of finishing line in the adjustment process; rather, it marks the start of participation in a higher league. From next year, the financial markets of the acceding countries will be part of the single European financial market and will thus have the freedom to provide services under a single passport. The EU financial markets are not only widening, as evidenced by the accession process, but also deepening, as reflected in the moves towards further integration. The new members will be part of this deepening process in the same way as the current members.

A flagship of the deepening process is a series of measures included in the Financial Services Action Plan. These measures also cover retail financial services. With the removal of the remaining barriers to the cross-border provision of retail financial services, competition can be expected to increase more rapidly in this segment. Timely preparation by both the private sector and the supervisory authorities for these changes, as well as the sound transposition, implementation and enforcement of the changes, will be crucial for both the short and the long-term success of these measures.

The ongoing global-level reform of the regulatory framework for banking supervision, known as "Basel II", deserves particular attention when assessing the future challenges for EU banks. The new framework will apply from end-2006 to all banks on an individual level as well as on a consolidated level in the EU, irrespective of their size and scope of activity. The framework will put very high demands on banks' risk management capacities as well as on the resources of the supervisory authorities in what will then be an enlarged EU. There is a need to start collecting data immediately so that more advanced approaches can be used as soon as the new regulatory framework enters into force. This is crucial from the point of view of a level playing-field, since the planned incentive structure within Basel II allows for a slightly lower capital requirement for a given exposure if a more sophisticated risk management approach is adopted.

The preservation of financial stability and consumer confidence, the objective of Basel II, is fundamental for effective financial intermediation in all banking activities, including retail banking. Supervisory authorities and those national central banks which are responsible for supervision have already been working in close co-operation within the EU. The acceding countries will be included in this co-operation now that they have obtained observer status in all the different EU and ECB bodies.


The transmission of customer payments is one of the central activities in the banking sector which is significantly affected by integration. Payment systems are naturally linked to currencies rather than countries, and the introduction of the single currency means that it is no longer warranted to have such a large number of different systems. One of the statutory tasks of the Eurosystem, according to the Treaty, is to ensure the smooth operation of payment systems, and that is why I find it important to specifically reflect on these issues for retail banks. (When I refer to the Eurosystem, I mean the ECB and the national central banks of those EU Member States that have already adopted the euro.)

When fulfilling its tasks in the area of payment and settlement systems, the Eurosystem acts as an overseer setting safety and efficiency standards, as a catalyst for change, and as an operator of payment systems. Its role is different in the fields of large-value payment services, retail payments and securities settlement services.

In the area of large-value payments, where systemic risk is important, the Eurosystem has an important oversight function with regard to all systems and an operational function in running its own payment system, the Trans-European Automated Real-time Gross settlement Express Transfer system, or TARGET. Retail payment systems have a lower potential to generate systemic risk or to build up a threat to the financial soundness of their participants, but they may have implications in terms of confidence in the payment instruments, systems and, ultimately, the currency in general. That is why the Eurosystem also has an interest in retail payment systems and payment instruments, but here it acts mainly as a catalyst – or rather, a facilitator – for their enhancement, particularly with regard to safety and efficiency. This catalyst role is performed via co-operation with other authorities and the markets, and in particular through the Eurosystem's contacts and relationships with the banks.

1) Challenges for payment systems stemming from regulatory requirements

Despite the fact that the euro was introduced for cashless payments in January 1999 and the Eurosystem has strongly encouraged integration in the retail payments area, initial progress was very slow. This led the European Parliament and the Council to issue a Regulation on cross-border payments in euro in December 2001. The Regulation lays down rules to ensure that charges for cross-border payments in euro are the same as those for domestic payments in euro. The Eurosystem did not support using a regulation as a tool to improve the efficiency of payments, but it shares the basic objectives of integration behind the Regulation.

The Regulation concerning payments in euro is directly applicable to all EU Member States and it will immediately affect acceding countries once they have joined the EU. There is therefore a need for these countries to implement some of the basic requirements of the Regulation as soon as possible.

Within the EU, the banking industry is now actively moving towards integrated systems with a higher degree of efficiency. The banking community has committed itself to the creation of a Single Euro Payments Area (SEPA) and has set up the European Payments Council to govern this project. The purpose of the SEPA initiative is to make all euro payments "domestic", and to make cross-border payments within the euro area as safe and efficient as national payments today. The ultimate goal of the SEPA is the establishment of a pan-European payment infrastructure for the safe and efficient processing and settlement of all euro payments, irrespective of whether the originator and the beneficiary are from the same EU country or not.

For its part, the Eurosystem promotes the SEPA project vis-à-vis all stakeholders, namely the banking industry, the European Commission, EU and national legislators, standard-setting bodies, and users of payment infrastructures and instruments. In order to ensure a level playing-field, the Eurosystem is also developing a harmonised oversight framework, which aims in particular to establish a high minimum common security level for retail payments. At the same time, it closely monitors and investigates innovations that will change the way in which retail payments are made, for instance electronic and mobile payments.

In principle, if the markets failed to deliver a safe integrated system, the Eurosystem would also have the possibility of getting involved in retail payments at the operational level. However, there are currently no plans to do so.

The role of the Eurosystem in the retail payments area thus clearly differs from that in the area of large-value payments. This is natural for two main reasons. First, secure and efficient wholesale systems are a major precondition for the stability of the banking system and the financial system as a whole. Second, the single monetary policy that has been operating since the beginning of 1999 was only possible because the Eurosystem organised and guaranteed the infrastructure for the real-time wholesale money market in the euro area as a whole.

Through the definition and enforcement of their oversight policies, the ECB and the EU national central banks have managed to contain the systemic risks inherent in large-value payment systems. The TARGET system provides a tool for the quick and safe transfer of euro funds throughout the euro area and the EU. Indeed, TARGET has facilitated the implementation of the ECB's monetary policy and the development of a well integrated single euro money market.

Participation in TARGET will only become necessary for the central bank of an acceding country when that country adopts the euro. Nevertheless, the Governing Council of the ECB has decided that the acceding country central banks will have the same possibility – but not the obligation – as the current non-euro area central banks to connect to the existing TARGET system once they have joined the EU. When they join the euro area, the acceding countries will not only need to be connected to TARGET for the transfer of central bank money. They will also need efficient and integrated securities clearing and settlement infrastructures for transferring the collateral needed in monetary policy operations. This is a real challenge for the acceding countries.

The current TARGET system is a decentralised one, but the Governing Council of the ECB has already made a strategic decision on the next generation of the TARGET system, TARGET2, which will be based on the principle of "less platforms than central banks". It will include a "shared Eurosystem component", i.e. an IT platform used jointly by a (gradually increasing) number of EU central banks willing to give up their own platform. These decisions will have major implications for the future of the acceding countries, and the participation of these countries as observers in the preparatory work of the Eurosystem is thus very important.

2) Challenges for payment systems stemming from market forces

In general, the national payment and securities clearing and settlement infrastructures in the acceding countries seem to be largely adequate to their membership of the EU. However, substantial work remains to be done in these areas before joining the euro area, and there are many challenges stemming not only from the needs of monetary policy but also from market forces. In principle, information and telecommunication technologies as well as the internet allow the entire payment process to be fully automated. The migration towards fully electronic and highly automated payment services – electronification – which has been the trend over the past decades will strengthen further.

In line with its statutory responsibility to promote the smooth operation of payment systems, the ECB also has a role in the field of the electronification of payments. The main aim is to promote the efficiency and security of these instruments and related systems. Here, the ECB again facilitates co-operation between the stakeholders and provides analyses and statistics to support integration. The electronic Payment Systems Observatory (, which was transferred some time ago from the Commission to the ECB, will form the channel for communication to all interested parties in the e-payments area. Once the use of electronic payments has moved beyond early development, the ECB's oversight function might become more important than its facilitator role in this area too. – Let me take the opportunity here to recommend to you an article on the "Electronification of payments in Europe", to be published in the May issue of the ECB's Monthly Bulletin.

The range of payment instruments available in acceding countries on the whole seems to be increasing. Cash is still heavily used in retail transactions, and credit transfers are the most frequently used cashless instrument. In most acceding countries cheques play only a marginal role. Payment cards are also frequently used, although mainly for cash withdrawals at automated teller machines. The number of point of sale terminals is still rather limited, but steadily growing. Direct debit schemes are still clearly underdeveloped.

While in the existing EU countries each inhabitant has on average at least 1.5 bank accounts, in some acceding countries only a small share of the population is able to make payments from an account held with a bank. The fact that salaries, pensions, social benefits and payments to public utilities are still frequently paid in cash does not encourage efficiency in the economy. I am certain that banks and the relevant authorities will find a way to change this situation.

The ECB has assessed the payments infrastructure in the acceding countries and found it sufficiently robust to ensure that it will not generate systemic risks in the enlarged EU. The systems in place for the settlement of payments in the domestic currency seem to a large extent to be compliant with EU/Eurosystem safety standards, or to be being brought into line with these standards. But there is certainly room for improvement and determined efforts should be made to standardise rules and procedures to the largest possible extent. In view of entry into the EU and, at a later stage, EMU, international standards and message formats should be promoted and implemented as quickly as possible, in order to allow for the fully automated straight-through processing and interoperability of systems. The urgent challenge for banks is to create incentives for their clients to submit payment orders electronically and to minimise the processing costs as much as possible.


The accession process has for several years already involved the Eurosystem on the one hand and the central banks and financial market counterparties of the acceding countries on the other. An in-depth policy dialogue and technical assistance activities were initiated at a very early stage, and continue to be maintained by the Eurosystem. We naturally stand ready to further intensify this co-operation in all areas where it is seen to be useful.

The integration process and changing environment mean that financial industries as well as the central banks of Europe will face considerable challenges in the near future. Banks in the acceding countries will have to catch a moving train when joining the European Union and, at a later stage, the euro area. Each new member has tailored and will continue to develop its own strategy. Here, I would like to underline two specific issues: first, the necessity to see that the development of the payment and securities clearing and settlement infrastructure is given enough weight in the strategy of integration into the EU and the euro area, and second, the need for banks in the acceding countries to closely participate in the development of the banking industry's Single Euro Payments Area initiative. The pursuit of close co-operation in all areas is strongly encouraged.

In spite of the large challenges involved, I personally am optimistic about the success of the present enlargement. This optimism is also based on past EU experience with the previous four rounds of enlargement, although the dimension of this most recent round is unprecedented.


European Central Bank

Directorate General Communications

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