Financial integration, modernisation and competitiveness in Europe: achievements and challenges
Speech by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECBat the High-Level Panel Discussion“One market, one currency: Do we use the euro to its full potential”Brussels Representative Office of the OeNBBrussels, 7 May 2007
Ladies and gentlemen,
It is a great pleasure for me to be here this evening. I still remember the time, now almost 20 years ago, when the Brussels Representative Office of the OeNB was established. Although Austria was not yet an EU member, we were already impressed by the strength of the shared aspirations of the EU countries in the run-up to the Maastricht Treaty to make a single market and a single currency in Europe a reality. In the meantime, it is now more than 12 years that Austria has been part of and has actively contributed to the joint efforts to exploit the full benefits of European Economic and Monetary Union. The introduction of the euro, coupled with the ambitious programme of structural reform pursued under the Lisbon agenda, was a major milestone in this regard. However, in my view, we are still far from realising the full potential of the single currency and the single market for economic growth and competitiveness. In particular, I believe that we could and should do more to foster financial sector performance, notably by stepping up our efforts to foster financial integration and modernisation in Europe.
Financial performance in Europe
[Slide 2] Before elaborating on the specific policy priorities for Europe, allow me to briefly recall the key importance of financial sector efficiency for overall economic performance, which stems from the crucial role of the financial system in channelling financial funds to their most productive use. In particular, as Schumpeter and Bagehot have argued, a well-functioning financial system facilitates the process of “creative destruction” in the economy by reallocating capital from declining industries to those with good growth prospects. The overall ease with which capital is reallocated among industries can therefore be considered one way of measuring the efficiency of a financial system.
On the basis of econometric analysis, we have computed estimates of the speed of capital reallocation for a number of developed countries. The results show that, over the past 40 years, financial systems of other developed countries have been more efficient than the financial system of the average euro area country [Slide 3]. Against this background, it is important to understand the respective bottlenecks and to identify adequate actions to address them.
[Slide 4]A useful starting-point for this work is to assess where further improvements can be made in the integration and modernisation of the euro area financial sector, given the fundamental role of these two processes in enhancing financial sector performance. In particular, both financial integration and financial modernisation foster the size, depth and liquidity of financial markets. Our research suggests that overall capital market size – the aggregate size of stock, bond and loan markets in proportion to GDP – is a key determinant of the ability of a financial system to reallocate capital efficiently within the economy. It also shows that the average euro area country is lagging behind other industrialised countries in this respect [Slide 5].
[Slide 6] With a view to enhancing financial sector performance, we should therefore intensify our efforts to enhance financial market integration in Europe, notably in those market segments where the integration process is comparatively less advanced. At the same time, we should launch targeted work to foster modernisation, especially of those financial system fundamentals which are expected to positively influence capital market size.
Enhancing financial integration
[Slide 7] Fostering financial integration is a major objective for the ECB, given the important role of financial integration for the performance of its core tasks, notably the conduct of the single monetary policy. Against this background, the ECB contributes very actively to furthering financial integration. An updated presentation of our findings regarding the state of financial integration in the euro area, an in-depth assessment of selected key issues in the integration process, and an overview of the Eurosystem activities to spur financial integration are provided in the new ECB annual report on “Financial integration in Europe”, which we published for the first time at the end of March this year.
[Slide 8] The report underscores the fact that the progress achieved in the euro area has been uneven across financial market segments and the underlying market infrastructures. Substantial advances can be observed especially in those areas which are closer to the single monetary policy, notably the euro area money market, the large-value payment systems and the government bond market. The introduction of the single currency also provided impetus to the integration of euro area corporate bond and equity markets, but the remaining fragmentation of securities clearing and settlement systems still acts as a barrier to more rapid progress in these fields. Similarly, banking markets, particularly in the important retail segment, are still rather fragmented, as is the underlying infrastructure for retail payments. Against this background, measures to spur the integration process in banking markets, retail payment systems and securities clearing and settlement systems will be key priorities in the coming years.
[Slide 9] As far as banking markets are concerned, several important initiatives are under way at the EU level, in particular to reduce potential obstacles to the evolution of cross-border banking, given the important role of cross-border banks in fostering the integration process. These measures aim to address fiscal, legal and prudential factors which may act as impediments to the open market access of cross-border banks – especially in the conduct of cross-border M&A operations – and to their efficient operation on an ongoing basis.
The EU framework for prudential supervision is a key component of an adequate policy framework for cross-border banks. It should in particular deliver a high degree of supervisory convergence and cooperation with a view to reducing the prudential compliance costs which may stem from overlapping or diverging national requirements and the need to interact with various authorities. With the introduction of the Lamfalussy approach and the adoption of a strengthened framework for interaction between home and host supervisors under the Capital Requirements Directive, a lot has been done in recent years to streamline the supervisory set-up. Work is currently under way to exploit the full potential of this enhanced framework. The progress made is subject to close scrutiny by all stakeholders. In particular, a wide-ranging review of the present institutional framework by the Inter-Institutional Monitoring Group, the European Commission and several EU committees and fora, to be concluded by the end of this year, will yield useful insights into the various accomplishments and the possible need for further action.
[Slide 10] Allow me also to briefly mention the efforts under way to improve market infrastructures. First, the successful and timely conclusion of the project to create a Single Euro Payments Area (SEPA) will be crucial to establish an effective pan-European framework for retail payments. The ECB actively supports this market-led initiative by playing a catalytic role, providing conceptual as well as practical assistance to the banking industry, and facilitating the effective interaction among stakeholders. The SEPA project is currently in the implementation phase, and momentum has to be built up for the launch of SEPA in January 2008. Tomorrow I will address representatives of the public sector and financial industry at a conference on SEPA organised by the European Commission . I will emphasise that the support of public administrations and other stakeholders should complement the efforts undertaken by the banks and that there is a need for “concerted action” to foster integration and innovation in the payments field.
Second, the ECB is currently assessing, in close consultation with all stakeholders, the establishment of a new facility to provide settlement services in central bank money for securities transactions in euro. With TARGET2-Securities, or T2S, the settlement of cross-border securities transactions can be as efficient as domestic settlement, eliminating the cost disadvantages that have hitherto impeded the development of a single financial market, especially when compared with that of the United States. This will be achieved by bringing together the securities accounts of multiple central securities depositories (CSDs) on a single platform. At the same time, by maintaining CSDs’ current role in relation to intermediaries, investors and issuers, T2S will ensure that there is choice and competition in the provision of services.
Fostering financial modernisation
[Slide 11] I would now like to turn to some major issues in the field of financial modernisation. To recall, financial modernisation – or financial development – refers to the process of financial innovation and organisational improvements that reduces asymmetric information, increases the completeness of markets, adds possibilities for agents to engage in financial transactions through (explicit or implicit) contracts, reduces transaction costs and increases competition. Financial modernisation is obviously closely related to the financial integration process, given that a financial system which is not integrated will surely not be the most developed one. On the other hand, however, the two processes are also distinct. In particular, financial modernisation can help to overcome frictions in the process of financial intermediation which can persist even after financial integration has been completed.
Compared with the research and policy analysis regarding financial integration, the work on the role of financial modernisation is less advanced. Against this background, the ECB has carried out substantial conceptual and empirical research in this field. In particular, keeping in mind the important link between market size and financial efficiency, the ECB has worked to identify the main channels through which financial modernisation improves capital market size and financial efficiency, and, ultimately, economic performance. While this is still very much work in progress, we have already been able to identify a number of specific areas in which further progress in financial modernisation would seem particularly useful, and where therefore either policy actions or further research would seem warranted. Let me give you a few examples.
[Slide 12] First, great care should be taken to ensure the effective protection of minority shareholders against expropriation by corporate insiders, for example via excessive executive remuneration, inadequate transfer pricing, company loans to insiders or outright theft. One important issue in this regard is protection against self-dealing transactions between company insiders and third parties. Let me recall in this context the 2003 Parmalat scandal, which highlighted the possible damage of such transactions for minority shareholders and other company stakeholders in a drastic manner. The figure presents with the “anti-self-dealing index” a proxy for the protection of minority shareholders against self-dealing transactions, based on 2003 data. It shows that the euro area average was about half of the score for the United States and about one-third of that for the United Kingdom. Of course, substantial action has been taken in recent years to strengthen corporate governance arrangements in the EU, which will also improve the protection of minority shareholders against self-dealing transactions and other forms of expropriation by majority shareholders. However, the implementation of the EU measures at the national level should be carefully monitored, not least because several of them are either non-binding or leave considerable scope for discretion.
[Slide 13] Second, the efficiency of the legal system in resolving financial conflicts should be further enhanced, given the inter-temporal nature of financial contracts and the corresponding importance of a high degree of confidence in their enforcement. The chart illustrates the time that courts take to resolve a standard financial conflict, which indicates that improvements should be made in a number of European countries.
[Slide 14] Third, enhancing banking competition will be crucial not only for enhancing banking efficiency, but also for financial modernisation and performance more broadly. This underscores again the importance of the ongoing initiatives to support a market-led process of cross-border banking, which I mentioned earlier. Moreover, the follow-up action to the Commission’s sector inquiry in retail banking – forming part of the recently issued Commission Green Paper on retail financial services – is key in this field.
[Slide 15] Fourth, further analysis would seem beneficial as regards the functioning of risk capital markets in Europe in view of the important role of financial innovation in fostering market completeness. In particular, data show that the markets for both venture capital and securitisation in the euro area are considerably smaller than in the United States. However, before drawing strong policy conclusions, further research on the main reasons for this comparative weakness would seem warranted. Moreover, as regards securitisation, there also some issues as to whether all securitisation activities are unambiguously beneficial and whether they could also pose risks to financial stability. Overall, the benefits and the risks of securitisation need to be better understood.
[Slide 16] Fifth, the information-processing capacity of European stock markets should be subjected to closer scrutiny. The efficiency of stock markets in providing reliable information about real investment opportunities is greater if stock prices adequately reflect relevant firm-specific information. A high degree of co-movement among stock prices within a market indicates a lower content of company-specific information in prices. The chart shows the average proportion of stock price returns which is explained by common factors as a measure of stock price co-movements. While the overall informational efficiency of the euro area is comparable with the United Kingdom and the United States, some countries in Europe have a relatively high degree of co-movement among stocks. Further research would seem useful to detect the underlying reasons.
[Slide 17] In conclusion, let me underscore the importance of continuing our efforts to foster financial integration and modernisation in Europe. A lot of work is under way to enhance our knowledge in these fields and to devise and take adequate policy action. A strong commitment to this important area of work will be decisive in furthering the efficiency of European financial markets and, ultimately, in fostering the performance and competitiveness of the European economy.
As regards financial integration, I consider in particular the ongoing measures to further enhance the EU supervisory framework, the SEPA initiative and the T2S project as key priorities for the coming period. While an agenda for financial modernisation is yet to be developed, the results of ECB research in this field point to the importance of measures to ensure the effectiveness of EU corporate governance arrangements in protecting minority shareholders, the efficiency of the legal system in resolving financial conflicts, and effective banking competition. Moreover, further research as regards the functioning of European risk capital markets and the information-processing capacity of European stock markets would seem warranted.
A number of major initiatives are underway, but we need to keep up the momentum in order to seize the full potential of the single market and the single currency. I am confident that tonight’s discussion will demonstrate that national governments, central banks, the European Commission and the European Parliament broadly share this common objective. Let us therefore join forces in further accelerating the integration and modernization of Europe’s financial sector.
Thank your for your attention!
 “SEPA: an opportunity for Europe - the role of the public sector", 8 May 2007, Brussels.
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