Preliminary Findings of the Retail Banking Sector Inquiry
Speech by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECBat the European Commission’s Public HearingBrussels, 17 July 2006
Ladies and gentlemen,
It is my pleasure to be here today and have the opportunity to explain the effect that financial integration in the field of payments will have on competition conditions in the euro area. In doing so, I will concentrate on the project of creating a Single Euro Payment Area – a SEPA. This is a project that has been initiated by the banks and which is strongly supported by both the Commission and the European Central Bank.
In short, the main argument of my speech is that the introduction of the euro brought to an end the coexistence of different national currencies in one single market: we can now pay with the same coins and banknotes from Lapland to Sicily. However, cashless payments are still very much structured along national systems and borders. Economic and Monetary Union will only be completed when cashless payments are also fully integrated. Just imagine if we all spoke the same language but still used twelve different alphabets. This is the current situation in the field of payments. I am convinced that the introduction of common practices and standards for cashless payments across the euro area is key to opening up nationally fragmented retail banking markets. It induces competition among banks, increases customer choice and provides the opportunity for cost savings and consolidation.
Before I take a closer look at the area of payments, I would like to briefly refer to the broader topic of where we stand in terms of the integration of retail financial markets in Europe.
In September last year the ECB undertook the publication of its regular assessment of the state of integration in the various financial segments of the euro area. For this, we use quantitative indicators which provide the advantage of being able to assess both the current level of financial integration and its evolution over time, i.e. whether integration is progressing, stable, or even regressing.
At present, we are working on our next assessment, which is due for publication in September. I can report that the general finding remains that the integration of retail financial markets in Europe is lagging. The cross-country dispersion of the same types of interest rates for retail banking products – for example loans to households for consumer credit or for house purchase – remains relatively high among euro area countries and the respective cross-border banking activity is rather low. Furthermore, we are going to add indicators related to the financial markets infrastructures, such as indicators on the consolidation of retail payment systems. One indicator, for example, reveals that in 2005 there were still 15 retail payment systems, compared with the 19 existing in 1998. This is very different to the development of the wholesale payment systems, where we are left today with two large-value payment systems, compared with the 18 in 1998. This sharp decline was due to the launch of TARGET, the Trans-European Automated Real-time Gross settlement Express Transfer system that links the national real-time gross settlement systems of the then 15 EU Member States and the ECB’s payments mechanism into a single system. Of the four remaining systems, the TARGET system and the private net settlement system EURO1 process most of the traffic, with TARGET being the larger of the two.
But we know that financial integration is not an end in itself. Of particular importance for me as a central banker is that financial integration: (i) is essential for the implementation of our monetary policy, as it enhances the smooth and effective transmission of monetary policy impulses throughout the euro area; (ii) is relevant for the stability of the financial system and our task of helping to safeguard it; and (iii) is important for the smooth operation of financial infrastructures, covering large-value and retail payment systems and securities clearing and settlement systems.
In addition, financial integration is a key factor in the further development and modernisation of the financial system, which in turn increases the potential for greater and more sustainable non-inflationary economic growth. For example, a research study estimates the benefits from the integration of European bond and equity markets to be around 1% of GDP growth over a ten-year period, or approximately €100 billion. For retail financial markets, it was estimated that full integration of European mortgage markets would raise the European Union’s GDP by 0.7% and private consumption by 0.5% in 2015, i.e. ten years from now.
Similar lessons can be drawn from the comparison with the results of bank sector deregulation in the United States: Between 1970 and 1994, 38 US states removed restrictions on branching, and between 1978 and 1992, almost all states removed restrictions on intrastate bank ownership. Studies that quantify the growth and productivity effects of banking deregulation in the United States in the period 1970 to 1995 show that annual average state gross product increased after the reforms by approximately 1 percentage point (Strahan 2003). The evidence suggests that the growth gains stemmed from enhanced productivity rather than from increased investment. This work is particularly relevant for the ongoing banking and financial system integration that is taking place in the EU and should encourage us to go further in the integration of the banking sector.
These economic benefits are also expected from the SEPA project that inter alia exploits the new possibilities offered by progress in information technology, thereby contributing to the modernisation of the European payments industry and the further integration and development of the European financial system. Today, when referring to the euro area retail payments industry, one automatically thinks of the sum of national markets. National fragmentation is a reality, which the SEPA project aims to eliminate. At the same time, there will be a substantial effect on competition conditions due to several competition-enhancing elements which are intrinsic to the building of SEPA.
The SEPA project is inspired by the vision of the Eurosystem and the European Commission and is driven by the European Payments Council. It aims to establish domestic payments throughout the euro area, i.e. that the current distinction between national and cross-border payments no longer exists. On 4 May this year the European Commission and the ECB issued a joint statement calling for “the removal of all technical, legal and commercial barriers between the current national payment markets”. The elimination of these three types of barriers, which is the essence of the SEPA project, will stimulate competition for the reasons I will now explain.
1) Legal barriers
Let me start with the elimination of legal barriers. First of all, regulatory differences across the euro area, which create legal uncertainty and function currently as barriers, will be removed as a result of the Payment Services Directive. It goes without saying that a single market should be regulated by a single set of rules and the Payment Services Directive will cover the current void. Banks, card schemes, service providers and other stakeholders have been emphasising the need for a clear and homogenous legal background in order to develop their business proposals. This Directive will cover this requirement and will provide the necessary legal certainty to expand operations across the euro area. Titles III and IV of the proposed Directive on payment services in the internal market will in particular greatly facilitate SEPA implementation. An early adoption of these Titles in national legislation will be key. I would like to mention that the ECB is looking forward to the timely completion of this procedure – although I would add that I believe that the introduction of SEPA instruments in January 2008 can go ahead even if the Directive is not yet fully incorporated into national laws. A different issue relates to Title II of the Directive, namely payment institutions and their competition with banks. Here we have some concerns: how are banks and payment institutions going to coexist in the same business segment, while being subject to different supervision requirements?
2) Technical barriers
I would now like to talk about technical barriers. Several technical standards, characterised by national fragmentation, are in practice technical barriers; they are actually major stumbling blocks in the building of SEPA as they prevent integration and competition, as also identified in the sector inquiry into the payment cards industry. The fragmentation of standards is an inheritance of the past. Within SEPA, however, banks need to realise that they cannot compete on technical standards, which is a reality that the telecommunications’ sector has already accepted.
The technical standardisation work has now taken off in the EPC; the Eurosystem’s expectation is that by end-2007 at the latest, pan-European standards will be in place and adopted by all stakeholders. The intention of the EPC to involve all stakeholders is particularly welcome. Areas of priority are, in our view, not only credit transfers, direct debits and card payments, but also cash, infrastructures, account identifiers and security and also the governance of all standards. Uniform standards will create a technical level playing field for the whole of the euro area. It is nevertheless important that all stakeholders participate in the definition of standards, which should be neutral and not nationally biased, so as to guarantee universal adoption and to avoid that a particular card, terminal or software vendor is better positioned than another.
What does this mean in concrete terms? When card and terminal standards are harmonised, providers will no longer be limited to or protected by national markets and issuers and acquirers will have a choice of providers, which will be in direct competition with each other, located anywhere in the euro area. This will certainly not leave the price levels, service and technology offered unaffected. The possibility of settling card payments in ACHs, together with other payment instruments – provided of course that there is no compromise of the security level of card payments – will oblige providers to make better offers. Standardisation will lead to competition, which up to now has been limited to within national borders. Competition will in turn encourage efficiency, innovation and better services.
At this point, it is worth noting that the Eurosystem has been insisting that SEPA should be future-oriented. Banks should realise that preserving the status quo means that Europe will drift backwards, which is at odds with the objectives of the Lisbon Agenda. Since standardisation work is taking place, it should be ambitious enough to stimulate the competitiveness of European banking and to incorporate the most efficient and innovative techniques. As such we are considering e-invoicing, for example, which the EPC began studying at the request of corporate treasurers. E-invoicing has a considerable savings potential; we expect banks, together with corporates, to seize the opportunity and show their dynamism and ambition.
3) Commercial barriers
Intrinsic to the building of SEPA is also the elimination of commercial barriers. Diverging national commercial practices would obstruct the development of SEPA-wide business proposals. The EPC addressed this problem by agreeing on a SEPA direct debit scheme, a SEPA credit transfer and a SEPA Cards Framework, which are currently being enhanced or complemented. The use of these SEPA instruments will enhance competition, by empowering operations at a pan-European scale.
Let me illustrate this by a few examples. The SEPA Cards Framework requires the separation of brand and processing services. This brings an end to vertical integration and means that independent processors can position themselves on the market and claim market shares. It also requires scheme participation on the basis of transparent and non-discriminatory criteria; therefore, banks cannot be obstructed in their efforts to join a scheme by a lack of transparency. Any bank can apply for membership of any card scheme in the euro area and, by doing so, can offer its clients – cardholders and merchants – the possibility to use this specific card brand. The SEPA direct debit will also increase competition between banks to attract big corporate clients which can shop around for the best offer in the euro area. It will be possible to make efficient and convenient cross-border payments using SEPA direct debits and credit transfers in the place of cheques. The SEPA instruments will cover the current void and can actually be of great help for customer-to-business payments on a cross-border basis, including internet transactions. ACHs will be able to operate on a pan-European scale, on the basis of uniform business practices and standards.
I hope that I have been able to explain to you convincingly why the above changes, which are intrinsic to the building of SEPA, promote competition. Furthermore, under the right market conditions – let me repeat: no legal, technical and commercial barriers – new entrants are expected to see the business potential of entering an enlarged market. The Eurosystem therefore believes that the SEPA project will pave the way for an integrated and more competitive market which will foster innovation, better products, better service and finally better prices.
However, migration to SEPA could also potentially negatively affect competition conditions, leading to too much concentration. Thus, it is a test on how “competition-minded” SEPA drivers are. I have already noted that standardisation work should be carried out with all stakeholders participating, otherwise the end-result could be sub-optimal. Another example is the card schemes.
The SEPA Cards Framework offers three SEPA compliance options. These are the replacement of the national card scheme by an international card scheme, co-branding with an international scheme or evolvement through alliances, expansion, etc. The Eurosystem is neutral to all three, but believes that both the market as a whole and the specific market initiatives taken individually would benefit better if transition to SEPA did not translate solely into a single scenario meaning that the market would end up in the long term with only two major players. Decision-makers are invited to take a close look at all options.
It is also important that potential synergies among schemes are exploited; no scheme should take advantage of its established position to isolate other initiatives. Furthermore, national markets should open to international schemes. Finally, some dubious competition practices have been reported by market participants; we would like to reassure the market that authorities will certainly take a close look at these and take any necessary action.
However, SEPA is not the solution to all potential competition problems and, once migration has been completed, the possibility of anti-competitive behaviour cannot be excluded. SEPA, as currently defined, does not encompass some crucial elements from a competition point of view. I would also like to underline that an environment conducive to competition should go hand in hand with transparency. My vision of retail banking in the future is one where prices for payment services are cost-based and transparent for the customer. Another major issue left out of the definition of SEPA is interchange fees. Although the Eurosystem asked the EPC to define some interchange fee principles, our understanding is that EPC would rather leave this to competition authorities. I would not like to expand on the current interchange fee situation; I would only like to note that we see the sector inquiry into the payment cards industry as a first step towards the clarification of the interchange fee situation, so that card schemes and banks can proceed with their SEPA decisions and elaborate their business models against a stable background. Of course, we do not accept the current uncertainty as an argument to delay decisions and SEPA progress, but a more precise framework would greatly facilitate the process.
Summing up, the Eurosystem has an optimistic view on the evolvement of competition conditions in the euro area. Migration to SEPA calls for a uniform legal, technical and commercial framework, which will enable euro area-wide competition and make the euro area market more dynamic, flexible and attractive to new entrants. This enhanced competition will allow for better products, services and prices and stimulate innovation. At the same time, it is recognised that SEPA is not the answer to all competition issues; competition authorities will carefully follow the migration process to ensure that the end result meets expectations.
I would like to conclude with the old proverb “competition is the whetstone of talent”. I am convinced that the introduction of common practices and standards for cashless payments across the euro area is key to opening up nationally fragmented retail banking markets. It induces competition among banks, increases customer choice and provides the opportunity for cost savings and consolidation. I believe that banks have realised this and many of them see SEPA not only as a challenge but also as a great opportunity to strengthen their competitiveness in an increasingly more globalised financial system.
Thank you for your attention.
 See the ECB’s website at http://www.ecb.europa.eu/pub/pdf/other/indicatorsfinancialintegration200509en.pdf.
 London Economics (2002), “Quantification of the macro-economic impact of integration of EU financial markets”, Report to the European Commission.
 London Economics, “The Costs and Benefits of Integration of EU Mortgage Markets, Report for European Commission, DG Internal Market and Services”, August 2005.
 Strahan, Philipp E, “The Real Effects of US Banking Deregulation”, the Federal Reserve Bank of St. Louis Review, July/August 2003, 85(4), pp. 111-128.