Financial Integration, Competition, and Efficiency

Speech by Pentti Hakkarainen, Member of the Supervisory Board of the ECB, at the European Bank Executive Committee Forum organised by BNP Paribas, Brussels, 11 April 2018

Financial integration drives benefits through the boost it provides to competition. In an integrated market, businesses and consumers gain access to a wider range of potential providers for their banking services. This empowerment of banks’ clients leads to stronger market forces – which drive banks to innovate in a search for higher productivity and ways to provide better quality services to customers.

Competitive forces generally work well in the private economy. However, in banking there is room to cultivate them further. In nationally segmented markets, banks were protected and hidden from the beneficial pressures that the market creates. Today, the banking industry is more and more subject to the same rigour as other sectors of the economy.

In my remarks today I would like to explain my views on how the euro area and the banking union are helping to facilitate this competitive trend. I will also outline how the globalisation of regulatory standards has also played a positive role. Looking forwards, I will suggest some steps that can further reinforce value-adding financial integration – to the benefit of all Europeans.

The benefits of financial integration

Let me start by explaining some specifics on how financial integration creates benefit for businesses and retail consumers.

Looking at businesses in Europe, the benefits of financial integration stem from the way that competitive forces influence the availability of financing from one country to the next. If two entrepreneurs in two countries bring two projects to the market, each representing the same credit risk – they should face a similar chance of success and enrichment. However, this is not possible if banking markets are highly nationally fragmented – and if one country’s banking system is able to lend to domestic businesses much more cheaply than is possible in a neighbouring country.

Financial integration helps to level this playing field for companies by bringing more choice and more competitive vigour into banking markets across Europe. As I explained in a speech in Dublin last year, I believe that in a prudentially sound environment – with good regulation and supervision – banking competition is an unambiguously positive thing.[1] In internationally competitive environments the terms of borrowing available to businesses for the same risk tend to flatten across national borders. This not only implies fairness, but it also means that the way resources are allocated across the economy becomes more efficient – thereby supporting better economic growth outcomes.

Retail customers can gain in similar ways from financially integrated and competitive banking markets. In a financially integrated and competitive European banking market inefficient banks will not survive – only the best financial institutions will succeed. This Schumpetarian process of “creative destruction” leads in the end to consumers gaining access to a wider range of products to choose from, at more attractive prices, and with more reliable quality of service.

National self-interest and the global level playing field

One of the questions posed in today’s discussion is whether the goal of national self-interest clashes with the desire to operate a global level playing field in financial regulation. Personally I find it odd that this question is raised at all – as it shows that some misunderstanding of where national interests lie must somewhere exist.

An international level playing field is a necessary building block to achieve an integrated and truly competitive banking market. For the reasons that I have outlined above, building such a competitive environment is in the interests of bank customers whichever country they come from. Businesses and retail consumers – i.e. citizens, employers, and employees – benefit from enhanced service levels and pricing.

It should also be recalled that internationally integrated markets have helped certain countries under stress to survive crisis periods. The recent experience of Baltic countries during the Great Recession is an example of this. Even whilst those countries were under substantial macroeconomic stress, international banks continued to make credit available – thereby allowing continued access to finance for Baltic borrowers.

Obviously, macroeconomic problems in home countries can also potentially spill over and have negative impacts on the lending activity of home banks’ foreign operations.[2]

Nonetheless, on balance, I believe that it is supportive to the resilience of banking markets when banks’ business activities are spread across multiple countries. Diversification of revenue sources reduces the risks of over-exposure to potential concentrated macroeconomic problems in a particular geographical location. As such, I tend to believe that financial integration reduces the risks of precipitous credit crunches.

An international level playing field is also good news for efficient incumbent banks. In such an environment these institutions are thereby enabled to compete efficiently across a wider set of markets – and can potentially reach more clients. Given this assessment, it is worth to ask – which banks would be suspicious and defensive against internationally harmonised regulatory standards? I tend to think that this defensive response will be concentrated amongst inefficient banks who don’t think they are up to the job of competing on fair terms with cross-border providers. It is not in the interest of European citizens to pay attention to such parochial concerns, and so we should move forwards to provide conditions in which local monopolists are challenged, not protected.

Cross border banking in Europe – where we stand and where next

The recent history of European financial integration is generally said to have had two phases. First, following the introduction of the euro, financial integration steadily increased. Second, when the financial crisis and the associated sovereign crisis arrived – confidence in cross border financial activity dramatically dropped, leading to a large reversal of the integration achieved in the previous decade. These two trends are evident in both price and quantity indicators, as has been set out within recent ECB Financial Integration reports.[3]

However, the story does not end there. Europe is now finally emerging from its lengthy period of crisis, macroeconomic conditions are improving, and this is leading to the reintegration of the European financial sector. It is particularly notable that after considerable fragmentation observed during the crisis, a reintegration trend began in the summer of 2012. This is linked to decisions by European political leaders to establish the banking union, and by the ECB’s announcement of a new monetary policy tool – the outright monetary transactions (OMT).

More recently, over the last year, the ECB’s price-based composite indicator of financial integration has increased substantially since 2017. This reflects that the economic recovery has been spread reasonably evenly across the euro area, and that this has led to some price convergence in the cost of equity and bond finance.

Quantity-based indicators are yet to clearly show a consistent continuation of the initial reintegration pattern set in motion during the summer of 2012. This may reflect that various interbank markets are still affected by special factors, given that a full exit from unconventional monetary policy measures has yet to take place.

Focussing beyond this snapshot on the status of integration today, it is important to also recognise that the conditions for cross-border contestation of banking markets in Europe are perhaps better than they have ever been before.

On the one hand, the single European rulebook provides the highest degree of harmonisation in banking standards that has existed to date. There is still some progress to be made in closing down the remaining unnecessary options and national discretions in certain areas of legislation. Nonetheless, the largely harmonised rulebook is a valuable building block for an integrated banking market – with a high degree of cross-border contestation.

On the other hand, the private sector is itself evolving in a way that supports integration and competition.

Most crucially, technology is vitalising cross-border market forces, including in the retail sector.[4] As consumers increasingly move towards usage of digital interfaces in their communication with banks it potentially becomes easier for cross-border competitors to enter domestic markets. Bringing over a digital platform need not imply the same investment in fixed costs as is necessary to develop a physical branch-based footprint in a new country. This reduced cost of entry will help ensure competitive impulses are spread across the whole of Europe – meaning that all banks are healthily incentivised to deliver what their customers need.

It is also worth to note that banks are increasingly offering more standardised products from country to country. In the past, idiosyncratic national markets differed in major ways in terms of the way banks and payment systems functioned, for example some countries relied on cheques whilst others adopted the giro system. Now these idiosyncrasies are much less evident. Mortgages are becoming increasingly similar from one country to the next, and one observes an increasingly uniform way that banks recognise different types of collateral.

I therefore believe that the overall trend remains in the direction of further integration. It is important that we continue to build the regulatory and institutional architecture for the banking sector around this reality.

In the first instance, this means that it is urgent that Europe proceeds in implementing the third pillar of the banking union – a common deposit insurance system. While supervisory and resolution decisions are now taken at European level, deposit insurance schemes remains at the national level. This means that depositors’ protection is not uniform across Europe and may be influenced by the location of the bank. There is also a geographical misalignment of liability and control – which is not good for the incentives of decision-makers, and can create perceptions amongst investors that lead to fragmentation in the cost of borrowing across European borders.

A few Member States have been reluctant to support progress in building a single, fully-fledged European deposit insurance scheme. This is driven by concerns about such a scheme resulting in cross-subsidisation of weaker banking systems using the financial resources of stronger countries. I believe that such concerns are unfounded – as they fail to understand how limited the risks are both in terms of exposure to losses and cross-subsidisation for well-constructed deposit guarantee schemes.

An important research paper was published today by the ECB which empirically demonstrates exactly how limited these cross-subsidisation risks are, provided that banks pay appropriately designed risk-based contributions to finance the deposit insurance fund.[5] I encourage those who are sceptical of the European deposit guarantee scheme to read this. I hope that this factual analysis brings the debate back to reality – and provides reassurance on the large net benefits associated with establishing such a scheme.


In concluding, let me emphasise that much rapid progress has recently been made in providing a platform for cross-border European banking. Principally, the establishment of the European Banking Supervision at the ECB is a huge step forwards in ensuring that unnecessary impediments to cross-border activity are eliminated.

A single supervisor with a single European approach provides confidence to market participants that if an approach to compliance is acceptable in one country – it will also be acceptable in prospective new markets in other countries. A European perspective also ensures that the incentives of supervisors are correct when they seek to manage cross-border banking risks. The interests of all countries and consumers are treated equally when structures are analysed and risks are appraised.

As I have outlined, evidence is already emerging that these factors are supporting a post-crisis “reintegration” of European financial sectors, including aspects of banking markets. This is to be welcomed, as the contestation of markets will drive the innovation and productivity in the banking sector that businesses and retail consumers need. I would, however, argue that retail banking integration in particular can go much further than presently is the case.

Looking forwards, I encourage legislators, supervisors, and market participants to all accept that financial integration – particularly within the banking union – is both welcome, and is a long-term trend that is here to stay. Future plans should reflect this, and should seek to harness further the resulting competitive forces – thereby creating benefits for all sides.

[1] Enhancing the environment for banking competition, Keynote address by Pentti Hakkarainen, Member of the Supervisory Board of the ECB, at the FIBI International Banking Conference 2017, Dublin, 22 June 2017.

[2] See, for example - Popov, A., and G. Udell, 2012. “Cross-border banking, credit access, and the financial crisis.” Journal of International Economics 87, 147—161.

[4] I note that policy makers should remain vigilant that new technologies are interoperable, so that the envisaged competition benefits can materialise.

[5] ”Completing the Banking Union with a European Deposit Insurance Scheme: who is afraid of cross-subsidisation”, April 2018, ECB Occasional Paper Series, J. Carmassi, S Dobkowitz, J Evrard, L Parisi, A Silva, M Wedow.

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