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Possible effects of EMU on the EU banking systems in the medium to long term

9 February 1999

In the context of the task of the Eurosystem (i.e. the European Central Bank (ECB) and the national central banks of the Member States participating in Monetary Union) to contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system, as laid down in Article 105 (5) of the Treaty establishing the European Community, the ECB will release a report of the Banking Supervision Committee entitled "Possible effects of EMU on the EU banking systems in the medium to long term".The report addresses the structural impact that Stage Three of Economic and Monetary Union (EMU) is likely to have on the EU banking systems in the medium and long term, as well as the way in which the EU banks are responding to the envisaged developments. It also provides relevant information on the features and structure of the EU banking systems.

The report has been prepared with input from the representatives of the EU banking supervisory authorities represented on the Banking Supervision Committee, chaired by Mr. Edgar Meister, who is a member of the Board of the Deutsche Bundesbank. The Committee assists the Eurosystem in promoting co-operation between the relevant authorities on issues relating to banking supervision and financial stability. The report also draws on interviews with representatives of selected banks conducted at the national level.

The main findings of the report - which can be regarded as being useful both to banks and to the public authorities responsible for maintaining financial stability - are summarised below.

First, Monetary Union is expected to have an impact on banking activities in various ways. The reduction in foreign exchange activity in the currencies replaced by the euro can be considered to be the immediate consequence. However, banks are likely to increase their money and especially securities market activities to even out lower revenues from foreign exchange trading. The introduction of the euro and the single monetary policy will favour the setting-up of deep and liquid integrated money and capital markets that will, in turn, generate growth, but also trigger further competition in this area. A reduction in government debt owing to fiscal consolidation under Monetary Union is likely to boost the spreading of other securities and, possibly, the securities activities of banks. Retail deposit business might be affected to the extent that the establishment of a low interest rate environment would induce customers to seek alternative investments to deposits. Lending business might benefit from the positive macroeconomic environment brought about by Monetary Union, but the expected further securitisation and disintermediation might operate in the reverse direction. Correspondent banking services are likely to decrease owing to the centralisation of treasury functions at large banks. All in all, Monetary Union will offer banks new business opportunities, and the ways in which these will be exploited will vary among banks, depending on their specific activities and strategic choices.

Second, Monetary Union is expected to act as a catalyst to the structural trends already under way in the EU banking systems as a result of other factors (such as financial liberalisation, disintermediation and technological change). In particular, these trends can be characterised as follows:

  • a reduction in existing excess capacity;
  • an increase in pressure on banks' profitability;
  • an increase in competition; and
  • the spread of internationalisation and geographical diversification.

In particular, Monetary Union is expected to reinforce the current tendency in the EU banking systems towards a reduction of banking capacity. Notwithstanding the measurement problems for bank capacity, there are good reasons to assume that excess capacity exists in several Member States. This can be regarded as the result of imperfect competition and/or regulation in the past. There has already been a reduction in capacity in many countries over the past few years. However, Monetary Union is expected to exert, through increased competition, further pressure towards the reduction of excess capacity. In particular, the branch network and staffing levels, given the existing marked differences across countries, are likely to be affected, thus enabling banks to achieve efficiency gains. In addition, Monetary Union is likely to speed up the process of disintermediation (reducing the share of banks in the borrowing or saving activities within an economy) which is already under way in the EU banking systems. Institutional investors are expected to continue to grow, mainly owing to demographic and social changes, but they may also benefit from the depth and liquidity of the single financial market with a single currency and broader investment opportunities.

Third, Monetary Union is likely to affect the features and magnitude of banking risks. The positive macroeconomic effects of Monetary Union are, on balance, expected to mitigate credit risk in the euro area. Market risk is set to decrease, especially with regard to foreign exchange and interest rate risk. It is likely that banks will seek to replace part of their lost foreign exchange business with new or increased involvement in non-euro area markets, which could entail the possibility of increased country risk. Liquidity risk is likely to decrease owing to deeper and more liquid markets within the euro area. Legal and operational risks may be relevant in the short term owing, respectively, to the overall new legal environment in the euro area and the necessary system adaptations for the transition to the euro, as well as the imminent year 2000 problem, but should become less relevant in the long term.

Fourth, Monetary Union requires banks to reconsider their strategies in order to be able to cope with the challenges posed by the single currency. This process is already under way throughout the EU banking systems; it gained momentum, in particular, following the decision concerning the Member States which would participate in the euro area from the start of Stage Three. Indeed, EU banks are currently responding with improvements in services and procedures, changes in the range of products supplied to customers, as well as mergers, strategic alliances and co-operation agreements. The extent to which the recent wave of mergers and acquisitions in the EU banking sector has been triggered by the advent of Monetary Union is difficult to assess, since similar activity can be observed in other markets (e.g. in the United States). Whereas most mergers and acquisitions in the European Union have so far taken place at the domestic level, the possibility cannot be ruled out that some of them were intended to provide a basis for further cross-border expansion. The comparatively low degree of concentration within the EU banking sector as a whole could provide room for further consolidation.

Fifth, in the short term the structural adaptation process could be made more difficult by the combination and possible mutual reinforcement of several factors, including the protracted financial crises in Asia and Russia, potential negative developments in Latin America and the preparations for the year 2000, as well as the revenue and cost impact of the changeover to the euro. However, in the medium and long term the adjustment process is likely to result in a stronger and fitter banking sector as a whole, owing, inter alia, to the positive effects brought about by the stable monetary environment under Monetary Union.

Against this background, it is important during the transition phase that, on the one hand, EU banks are encouraged to strengthen their strategic adaptation process and, on the other, that the authorities responsible for financial stability remain vigilant.

The report will be available on the ECB's Website ( and from the ECB's Press Division at the following address:


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