Process and Progress of EU Economic Integration:

the Financial Sector

Christoph Walkner DG ECFIN, E1

Outline

• EU instruments for economic policy

• The case of the financial sector

EU economic integration: Instrument Mix

National policies Co-operation, co-ordination EU legislation, Treaty changes

National actors’ responsibility

Employment policy Taxes Amount and composition spending Pensions

plus some co-ordination, co-operation

Rationale for co-operation, co-ordination

Direct cross-border policy spillovers of national policies

Indirect cross-border policy spillovers, via national policy affecting inflation rate, inducing ECB to change interest rates

Avoiding free rider behaviour

The instruments of co-operation, co-ordination

Information exchanges Best practices Policy dialogue Peer reviews Common rules, objectives and actions

Specific co-ordination, co-operation Instruments in economic policy

BEPG (general guidance)– Cardiff process (Product and Capital markets)– Luxembourg process (Employment)– Cologne process (Macroeconomic dialogue)– Stability and Growth Pact (budgetary policies)

Lisbon objectives (March 2000)– Strategic goal: EU most competitive economy– Spring Report (economic, social, environmental

issues)– Open method of co-ordination (peer reviews)

The rationale for EU legislation:

Multiple Nash-Equilibria Prisoners dilemma, enforcement Level playing field Easier to deal with outside world

The instruments of EU legislation:

Non-binding Recommendations (Commission)

Regulations, Directives (Council, Parliament)

Treaty changes (exceptional)

Example: Financial Integration

Rationale Legal instruments and progress The way ahead

Rationale

Financial integration raises growth, as – Allocation of capital is improved– Higher efficiency of financial intermediation– More opportunities for risk-diversification– More consumer choice

This lowers capital costs

and improves productivity

Legal instruments: Maastricht Treaty

Euro introduction– Common currency for more than 360 million

persons– Single monetary policy: ECB, Eurosystem

EU legislation: Banking

Banking financing still dominant in EU Single Licence (1993)

– Opens EU market for all banks– Mutual recognition of home supervisory

practices– Home country control plus co-operation

between supervisory authorities– Harmonisation of laws and practices for

banking (capital requirements etc.)

Banking integration

Still spreads between national interest rates (mortgages, consumer credit)

Two tier structure for bank liquidity:– Large banks cross-border– Smaller banks domestic

Asset management more EU oriented– Portfolios of insurance, pension funds

Consolidation, mainly along national lines

Cross-border M&As are lagging

Depository Institutions M&As in numbers: domestic vs. cross-border

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10

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1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

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cross borderdomestic

FSAP, 1999

42 legislative and non-legislative measures:

takeover directive market abuse directive prospectus directive ISD transparency directive (financial reporting)

Lamfallussy framework

Problems of implementation lead to Lamfallussy four level framework:

Level 1: adoption Level 2: implementing legislation Level 3: consistent transposition Level 4: consistent enforcement

Extension of Lamfallussy framework to banking, insurance

Money and Financial Markets I

Highly integrated: – unsecured money market (interbank lending)– Fixed income

• convergence sovereign yields• Higher issuances (public, corporates)• New products: euro denominated ABS/pan-

European Pfandbriefe• Rising outside euro area interest in market

Money and Financial Markets II

– Derivatives• interest rate swaps• euribor based future contracts• European index trading

– Equity Markets• Investor level, less on issuers• Increasing correlation among national markets• Higher standard deviation on national markets than

euro wide

Money and Financial Markets III

Less integrated: collateral– Foreign listing of equity, bonds– Cross-border trading of equity bonds– secured money market (repos, CP)

• Due to national regulations, contract laws and technical barriers

Equity market consolidation

Euronext (Amsterdam, Brussels, Paris, Lisbon) plus LIFFE (London)

NOREX (Stockholm, Helsinki, Copenhagen, Oslo, Iceland)

Deutsche Bourse (Clearstream)

Technical barriers

Clearing and Settlement (Giovannini) Payments Systems

– Target– Retail Payment systems

• Regulation on cross-border payments in euro• Banking initiative (PE-ACH)

Next Phase

Corporate Governance Audit Reform Common Accounting Standards (IAS) Cross-border supervision Retail banking integration?

Conclusion

• Instrument mix for economic processes

• Financial sector integration progressing, still unfinished business

• Coming policy initiatives