"European Banking: past, present and future"
Second ECB Central Banking Conference, 24 and 25 October 2002, Frankfurt am Main
The transformation of the European financial system
Press summary - First session
Jean Dermine, INSEAD, Fontainebleau
Jean Dermine's empirical work reveals an important pattern in the corporate structures of European banking markets. Banks expanding across borders in Europe generally choose to set up holding structures with foreign subsidiaries rather than to operate with branches abroad. This is an important observation, since it indicates that the single banking licence in Europe – introduced in 1989 with the Second Banking Directive – is not used very much. Therefore, an important condition for the full integration of European banking markets does not seem to be fulfilled.
Dermine's paper identifies a number of explanations for this pattern. On the side of corporate management, debt holders are better protected against inefficient risk shifting between the entities of a large bank, in particular if there is less information about the behaviour of some entities (e.g. those located in foreign countries). Also, subsidiaries can be managed more flexibly and are therefore more acceptable to local managers and shareholders. On the policy side, national corporate taxes may make subsidiaries more attractive. Moreover, the transformation of subsidiaries into branches may be hindered by corporate taxes and deposit insurance systems, whose application would be transferred from the host country to the home country. Since some of these factors are of a permanent nature, Dermine expects the situation to persist.
Corporate subsidiary structures in European banking have important policy implications, according to the author. First, their complex character may render supervisory monitoring more difficult. Second, unwinding a failed international bank with a cross-border subsidiary structure is very complex and risky, as it spans different legal systems. Third, whereas such companies tend to be relatively well diversified at the level of the holding, the respective national subsidiaries may encounter greater failure risk due to a more pronounced local orientation.
While reviewing the transformation of European banking from the signing of the Rome Treaty in 1957 until the present day, Professor Dermine also addresses a number of other banking policy issues. First, in contrast to wholesale corporate and investment banking services, bank retail markets are not well integrated in the European Union, partly because of information problems for small depositors and the costs of switching banks. Most local banks have preserved their retail market shares. Therefore, the author sees a need for more legislative work to harmonise consumer protection laws and national supervisory practices. Second, in the area of competition policy, a reduction of intermediation margins in retail markets, in all likelihood related to interest rate reductions during the EMU convergence process, contrasts with increased local concentration in several EU countries. The author believes that this situation calls for strict monitoring of the degree of competition in the loan and deposit markets for small and medium-sized enterprises to avoid any impediment to growth in this sector, which is very important for employment. Finally, the bank consolidation process is likely to continue and ultimately develop a stronger cross-border dimension, leading to more very large banks. This also raises the issue of potential cross-border spillovers from large bank failures. Dermine sees a need for bank crisis management to be centralised or at least co-ordinated across Europe. He suggests that both the European Central Bank and the ECOFIN Council should be involved in large cases. In order to avoid liquidity squeezes, bankruptcy procedures and deposit insurance mechanisms need to allow for quick reimbursements of depositors in the event of a winding-up.
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