General Impact Of Emu On Banking And Financial Markets

The arrival of Euroland represents a watershed in EU (and global) banking. This is not only because of EMU itself, but also because of the positioning in time of EMU and concurrent market developments. The latter 'positioning' reflects the apparently successful launch of EMU closely on the heels of another major and related regulatory initiative, the SMP. EMU has helped to consolidate EU bankers' expectations towards more sustained deregulation and intensifying competition. Contemporaneous market developments embrace trends like globalization, the rise of a shareholder value culture in banking, a related drive to be more efficient, intensifying competition, needed pension reforms throughout much of Europe and, of course, technology. In this context, EMU has a potentially significant and complementary impact on an already strongly integrating and more intensely competitive banking market.

Like its predecessor the SMP, the strategic impact of EMU on banking in the new Euroland is rather complex and with varying time dimensions attached to different possible effects. As explained earlier, disentangling the specific effects of any single bank strategic driver like a major regulatory initiative is also not easy when so many important changes are happening and intensifying at the same time. With these caveats in mind, the strategic impact of EMU is already proving (as expected) to be major.

Broughton et al. (1999, p. 1) point out that in 1998 and 1999 there is strong evidence that the divergence of performance of European bank sectors is narrowing. This phenomenon appears to be associated with a sharp narrowing in divergence of key macroeconomic variables within the EU. The aforementioned authors believe that GDP growth is now the key determinant of performance among EU bank sectors.

EMU is expected to strengthen pressures to reduce excess capacity in banking, bank profits will come under more strain, geographic and market (functional) diversification (both within and outside of EMU) will become more attractive in some segments of banking, and bank M&A activity can be expected to grow. Generally, banking competition is likely to intensify in most sectors. As securities markets become deeper and more liquid, present securitization trends are also likely to be sustained and accelerated.

The immediate and most transparent impact of EMU is on financial markets and on the traditional wholesale banking businesses of foreign exchange, corporate banking and government bond trading. EMU has reduced currency risk and lowered the transactions costs of international trade. Bond and equity markets are expected to become deeper and more liquid; portfolio allocations will become more internationally diversified. Financial services in many countries will become liberalized and more open to foreign competition. EMU and the concurrent rise of internet and direct banking should also help the progression towards a more globalized retail banking market within the EU.

The cost of government debt issues is likely to be lower under EMU. With the removal of currency risk, attention will focus more on the evaluation of credit risk when pricing different EMU countries' debt. The credit-worthiness of individual states will be left to the markets. Rating of government debt will become a more important issue; local market underwriting skills will also be increasingly emphasized.

Although fiscal consolidation within EMU is likely to reduce the volume of government debt securities, the market in private securities (bonds and equities) could grow significantly with, for example, more investors and issuers coming to the market in a larger EMU bloc. EMU could boost the corporate bond market; the costs of new bond and commercial paper issues will be lower because of more competitive underwriting and hedging in a market that is no longer segmented by currency. In this new environment, companies are more likely to issue debt than borrow from banks. Some commentators have suggested that up to one-third of EU banks' present corporate lending business could shift into capital markets. Increasing diversification by euro asset managers will correspondingly increase the number of investment portfolios to which these new securities could be marketed. This movement towards increased portfolio diversification will also be stimulated through the needed reform of EU pensions and the resultant boost to asset management along US lines.

However, it seems overly simplistic to assume that Euroland will become 'overnight' a US-style capital market. There are (and will remain) many differences between Euroland and the US. Gros and Lannoo (1999, p. 61), for example, emphasize two such differences. Regional differences are especially important in the EU and these arise from deeply rooted structural and institutional features. A second important difference is that EU banks play a much more important role than market-based forms of financing of investment compared with the US. EMU, however, will certainly facilitate a considerable EU movement along the US-style capital market path in the longer run. This is already apparent in trends like equity market link-ups, the emergence of US-style government bond markets (with a primary focus on credit-risk differentials) and increasing securitization. Also, the movement towards a US style of investment banking is likely to be a more pressing need in some market segments.

As with the SMP, the stronger macroeconomic environment flowing from EMU is expected to increase opportunities for banks. As Spavanta (1999, p. 59) emphasizes, the stimulus to the growth and deepening of financial markets should itself boost EU economies because of the well-documented link between economic growth and financial development. As companies restructure and expand, there should be growing business for banks. The more positive economic environment leading to greater stability and more sustainable higher rates of GDP growth should help to boost bank profits. Although in the shorter term banks appear to face more threats through trends like securitization and the growth of US-style asset management, there are also corresponding increased opportunities for various banks.

Another feature worth emphasizing is that the banking implications of Euroland strictly defined (to include member countries only) clearly extend beyond the Euroland banks themselves. For one thing, other EU and foreign banks compete strongly in the wholesale markets most immediately affected by the EMU initiative. Another strategic feature is that banks in those countries yet to join full EMU need to be prepared strategically. In this general respect it is interesting to note that domestic M&A activity and protecting existing home markets appears to be given a high and more immediate strategic priority by some banks.

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