EU Banking Sector: Current Environment and Future Directions

Abstract

Within the current European economic landscape, plagued by financial, economic and national debt crises, a vivid debate has been sparked in the academic and professional environment regarding the way in which the European banking sector can contribute to the achievement of a long term sustainable economic growth. The debate is even more entailed since the financial crisis started in the banking sector and the main contagion happened through banks operating regionally and globally. Within this context, our paper aims at providing an overview of the main characteristics of the European banking sector and of the challenges that it will face in the post-crisis period. This represents a first necessary step in our opinion, for the better understanding of the way in which the European banking sector can contribute to the achievement of a long term sustainable economic growth. In order to achieve this we used a qualitative analysis combined with a series of empirical data and a series of own calculated indicators that underline some of the characteristics of the EU member states banking systems. [PUBLICATION ABSTRACT]

Headnote

Abstract:

Within the current European economic landscape, plagued by financial, economic and national debt crises, a vivid debate has been sparked in the academic and professional environment regarding the way in which the European banking sector can contribute to the achievement of a long term sustainable economic growth. The debate is even more entailed since the financial crisis started in the banking sector and the main contagion happened through banks operating regionally and globally. Within this context, our paper aims at providing an overview of the main characteristics of the European banking sector and of the challenges that it will face in the post-crisis period. This represents a first necessary step in our opinion, for the better understanding of the way in which the European banking sector can contribute to the achievement of a long term sustainable economic growth. In order to achieve this we used a qualitative analysis combined with a series of empirical data and a series of own calculated indicators that underline some of the characteristics of the EU member states banking systems.

Keywords: European banking sector, economic landscape, challenges

Introduction

The banking system represents the main channel through which the European Union economy is financed. It also represents one of the hardest affected economic sectors by the global financial and economic crisis. Although, banks failure have been avoided through public capitalizations and nationalisation (see Bradford & Bingley, Glitnir Bank, Royal Bank of Scotland, Northern Rock, Dexia, Max Bank, Proton Bank or Fortis) or mergers and acquisitions, the huge budgetary effort was needed in order to ensure the stability of the system. This determined a vivid debate at the policy makers level and in the academic environment. The need for a system of checking and balancing that will prevent future derails of the European banking system has become more obvious now than ever. Within this context, we believe that a first necessary step in order to develop a suitable answer to such a complex problem is represented by the understanding of the current status of the European banking system, its characteristics and dynamics.

Thus, the aim of our paper is to provide an overview of the main characteristics of the European banking sector and of the challenges that it will face in the post-crisis period. In order to achieve this we have used a qualitative analysis, employing also a series of empirical indicators in order to underline the main characteristics of the banking sectors of the EU member countries.

The other part of the paper is organized as follows: the second part of our research highlights some common features of the EU banking systems and also the main achievements made in the last years; the third part of our research aims to underline the challenges faced by the EU banking systems in the post-crisis period; while part four provides the concluding remarks of the research.

1. Characteristics of the EU Banking Sector

Taking into account the main characteristics of the banking system of the EU member states we can distinguish between two relatively homogenous groups: the EU-15 member countries and the new EU member states.

Regarding the new member states of the European Union (except for Malta and Cyprus), they have developed during the last two decades a comprehensive process of structural and institutional reforms, that have aimed the transformation of these economies based on a centralized model in fully functioning market economies. Comparing the evolution of the main macroeconomic indicators from these countries with the ones from the EU-15 countries, it is highlighted the further existence of significant differences between these groups of countries.

If we take into account the size of the GDP per capita, we will observe that the new member states of the European Union tend to record a relatively lower level then the one registered by the EU-15 countries (see Fig. 1.). If we focus our analysis on the period prior to the financial crisis, we observe that at the end of 2008 the EU-15 countries' GDP per capita was of 32.233 euro while the new member states recorded a value of 10.942 euro. After three years of financial and economic crisis, at the end of 2010, the EU-15 countries' GDP per capita was of 30.137 euro while the new member countries were recording a value of 9.325 euro. Thus, taking into consideration this indicator, we observe that the EU-15 countries managed to maintain their advantage over the new member states, despite the financial and economic crisis that they have crossed.

Regarding the growth rates of the GDP we note the fact that on average the new member countries have recorded a much higher increase compared with the countries from the UE-15 during the period previous to the financial and economic crisis (2000-2008). These developments enabled the new EU member states to recover relatively quickly a large part of the existing gap to the EU-15 countries, thereby reaching about 63% of the purchasing power recorded by these countries. However, this positive evolution hasn't been recorded by all the new member states in the period prior to the crisis. Thus, the Czech Republic has experienced a severe financial crisis in 2004 triggered due to the high number of non-performing loans [4]. This fact prompted a lower growth rate for this state in the period prior to the crisis. Although we are dealing with a negative evolution, the example of the Czech Republic reinforces the idea that the economic growth is directly influenced by the development of the financial system of a country. Starting from this premise, we believe that the development through the adoption of financial innovations and the integration of the EU member states financial systems is a good step towards achieving a sustainable long term economic growth. Regarding strictly the European Union financial system, the EU-15 member countries have a more sophisticated and developed financial system, this being obvious also when comparing their assets. Thus, in 2010, the financial systems assets belonging to the EU-15 countries have a value of approximately 512,5% of the GDP compared with just 149,4% in the case of the new member states, this fact being also highlighted in Figure no. 2.

As we can notice from Figure no. 2., the banking institutions represent the main financial ones at the European Union level, the share of the assets held by them in GDP being of 364.24% for EU-15 and of 112.63% for the new member states. Taking this into account we can state that the European financial system is dominated by the banking sector, while the capital market represents the second main component of the system (this is true except for some countries like the Great Britain where the capital market has a long standing tradition, Finland, Sweden and Netherlands). It can also be noticed that although in the case of the EU-15 countries there are a series of other financial intermediaries that hold significant shares, none of them exceeding the position currently held by the banking institutions. In the case of the new EU member states, even if in the last years the assets held by the insurance companies, the investments funds and the pension funds recorded an increase, their level remains low compared to the assets held by banking institutions, this being due to the fact that these intermediaries tend to provide only basic products, strictly related to their field of activity. Given this background, we can state that banks, alongside capital markets, are the main components of the EU financial system.

At the European Union level there are a series of significant differences regarding the members ' states financial systems structure. Thus, according to Figure no. 3., in 2010 the EU-15 countries have recorded a ratio of banking assets in GDP of 364,24%, while the ratio of firms capitalisation in GDP was only 60,2%. In the case of the new member states these ratios have recorded a value of 112,63% for banking assets and of just 18,48% for listed firms. This fact however, highlights the huge potential of development that the new member states have regarding their financial sectors.

According to the study conducted by [15], in the '80 has occurred a significant shift in the European financial system, which went from a financial system strongly dominated by the banking sector to a more dynamic one, in which the capital market began to play an increasingly important role. The results of this study indicated that the European Union financial and monetary integration process represented the catalyst factor for these mutations.

Instead, the financial systems of the new European Union member states are dominated by the banking sector. Thus, according to Table 1, the banking assets from these countries came to be 1059.35 billion euros at the end of 2010, an increase of 327.70% from the value recorded at the end of 2001, of only 347.15 billion euros.

Taking into account these differences the latent potential that the banking systems in the new member states have it is emphasised again. This explains the motivation of foreign banks, especially of those located in the EU-15 countries to expand their activities within these markets [5, 57-106]. Nevertheless, the European Central Bank data [8] highlight that the deposits and the loans from the European banking system have recorded almost a doubling in the last decade at the European Union level. However, there are several countries where these developments have not been equally positive. Thus, in the case of Czech Republic and Slovakia, the banks recorded a much slower development of their activity mainly due to the delays that occurred in the restructuring of nonperforming loan portfolios that these banks had accumulated as a result of the banking crisis from the mid 90s.

The diminishing of the number of banks from the new European Union member states took place in the context of the transition process to the market economy and especially as a result of the deepening of the European integration process. Despite a number of bank failures within these countries, the number of banks decreased mainly due to the large number of mergers and acquisitions that took place in the last decade, both at domestic and cross border level. The most active in such transactions have been mainly the banks located in the EU-15 countries, this aspect being emphasized also by their share in the new member states total baking assets which is on average around 80% and in some cases reaches even 95%. In the case of the EU-15 countries the share held by the foreign banks is much smaller, which can be attributed to the fact that these markets are far more mature, and the possibility for a foreign bank to gain a market share that would enable it to support its activity is relatively low.

To assess concentration at the European Union level the European supervisory authorities rely on two main indicators: CR-5 and the Herfindahl index [2]. Hence, according to Table 2, regarding the concentration of the European Union banking markets, it can be noted an increase during the analysed period. More exactly, in the case of the new member states the value of the indicator CR-5 varies between 43,9% and 80,5%, while the EU-15 countries record a value of this indicator between 25% and 93%. With respect to the Herfindahl index, its value has also recorded an increase during the period analyzed, particularly for the EU-15 countries. Instead, in the case of the new member states banking systems, after a period in which the Herfindahl index has decreased, as a result of increasing competition, lately it has recorded an increase due to the strengthening of several banks position within these banking systems and due to the financial and economic crisis that led to the departure of several smaller banks from these markets. In the case of the EU-15 countries, the number of banking institution is much higher, this leading to a more reduced banking market concentration than in the new member states case, despite the banking activity consolidation trend recorded at the European Union level. Nevertheless, we must underline that the smaller countries tend to register the highest degree of market concentration.

To sum up, we can state that the European financial system is based mainly on the banking system, existing however a series of significant differences between the banking activities conducted within each member state. That is why the innovation and integration of the European banking system represent the most important elements of the process of European financial development, the fulfilment of these objectives facilitating the achievement at EU level of a stable and sustainable economic growth.

2. Future Directions of the EU Banking Sector in the Post Crisis Period

The impact of the financial and economic crisis has been tremendous on the European Union economy. As the need for bank capitalisation and the sustainability of the national debt grows even stronger, European authorities are developing regulations which aim at preventing the accumulation of such risks in the future. Thus a strong case has been made in the European Parliament for the introduction of a Financial Activity Tax (FAT) that should be applied to all banking institutions that operate in the European Union. The aim of this tax is to provide the necessary resources for a systemic bail-out fund, so that European tax payers will not be obliged to contribute in the event of macroeconomic disorders like the ones from 2008-2009. Even if there are several researches in the academic literature that underline the benefits of such a tax ([13]; [19, 153-159]; [18, 101-115]; [6, 162-172]; [1, 248-287]; [17]; [14, 527-558]; [12]; [16]) there is no final decision on its introduction by the European Union yet. Still, there is the need for the diminishing of the high liquidity that characterised the EU banking system before the start of the global crisis by any means necessary, even through the introduction of a tax on financial activities.

It is also the result of the global crisis that the European Union has set-up a new integrated supervision framework, the European System of Financial Supervisors that will allow for a better management of pan-European crisis situations. In the case of the banking sector, the European Banking Authority that inherited all of the tasks and responsibilities of the Committee of European Banking Supervisors is tasked with regularly performing stress tests in order to ensure the soundness of the European banking system and to detect any potential hazardous situation that could have systemic implications. EBA has already carried out several stress tests and made also some recommendations to the banks that failed them in order to enhance their capital ratio. This forms part of a broader set of EU measures agreed in order to restore confidence in the banking sector [3]. Thus, it is expected in the future that banks with pan-European branch networks will come under intense scrutiny from EBA in order to prevent any negative implication like the Icesave scandal.

The future adoption of the European Fiscal Compact will have also a direct impact on the European banking system. Thus, as governments are restricted on the level of budgetary deficit that they may have, the big European banks will have to find other lucrative and safe investments to replace their governmental bonds operations. It is to be expected a shift toward SMEs financing, as this sector can provide high yields. Banks could be persuaded to grant extensive funding to the SME sector also by the incentives that the European Union has prepared in its Europe 2020 strategy.

In the post-crisis environment a key element in the strategy of every bank will be represented by the reduction of the operating costs. Thus, banks will be more prone to adopt into practice new technological innovations that will allow them to better reach their clients and provide customised services at low costs. The development of display cards, the increase of the smart phone usage and the extension of the internet coverage will contribute to the development of new and innovative way through which banks will be able to distribute their products and services at reduce costs. It is to be expected a shift in the distribution channel, from large branch networks with a numerous staff to self banking, internet banking services and call centre support.

Furthermore, it is expected that European banks will get more involved in cross-border transactions, especially for the retail segment, as all member states will fully adopt the TARGET2 and SEPA. The transition to these two funds transfer system, will seriously affect the banks margins from this type of operations. Thus European banks will try to compensate this decrease in income through an increasing transactional volume and through the cross selling of these services.

It thus becomes obvious that the European banking system will be focused on the internet related products and services, with emphasise on the funds transfer and payment services for both, retail and corporate customers. This is underlined also by the European Commission which has adopted in 2011 the "Green Paper - Towards an integrated European market for card, internet and mobile payments" [11], a document that emphasise the need for a further integration of the card, internet and mobile payments infrastructure. It is thus expected that banks will be stimulated to develop and implement new services and products in this area that will facilitate cross-border operation and the extension of access to banking products and services to even a greater number of EU citizens.

As an overall idea the European banking system will undergo some major changes within the next period, as banks are recuperating from the global crisis and trying to harmonise their operations to the new, more strict regulatory framework, that aims at preventing the reappearance of turbulences similar to the ones registered during the last global financial and economic crisis.

Conclusions

The obtained results underline the existence of two types of banking systems in the European Union. Thus, on the one hand these are banking systems of the EU-15 countries, that have benefited from a long period of capitalism and free market, and thus have achieve a high level of development and sophistication. On the other hand, are the banking systems from the new European Union member countries that have gone through a process of transition to market economy prior to the European integration process. These banking systems are still having a huge dormant potential that is unexplored.

The current financial crisis deep implications on the EU baking sector have determined an unprecedented reaction from the national and international authorities, materialised in the adoption of measures, rules and reform projects which aimed to prevent the collapse of the banking systems, restore the thrust and re-launch of the bank's lending activities. However, the more rigid banking supervision and regulatory framework of the European Union that is being developed as a result of the global financial and economic crisis could have a negative impact on the development of the banking sectors of the new EU member states. Still the fact that the bancarisation level of these countries is still low presents a great opportunity for the implementation of the latest technologies here where their impact could be exponential in contrast with the EU-15 banking sectors were many of these technologies represent just upgrades of the existent ones.

Thus, taking into account the characteristics of the banking sectors from the EU member states and the changes that will occur as a result of the global financial and economic crisis, it is to be expected a shift in the European bank strategy. A reorientation toward more traditional activities is very likely, but through new and innovative distribution channels, as operations with financial derivative products and government bond become more heavily regulated.

References

References

[1] Arestis, P., Sawyer, M., (1998), The Tobin Financial Transactions Tax: Its Potential and Feasibility, in Arestis, P., Sawyer, M., (eds.), The Political, Economy of Economic Policies, Macmillan Press, London, pp. 248-287

[2] Ayadi, R. and Pujáis G. (2004), Banking consolidation in the EU: overview and prospects, CEPS: Brussels.

[3] Bank of International Settlements (2012), BIS Quarterly Review - International banking and financial market developments

[4] Bonin, J. P. et Wachtel P. (2004), Dealing with financial fragility in transition economies, BOFIT Discussion Paper 22, Bank of Finland

[5] Dermine, J. (2006), European banking integration: Don't put the cart before the horse, Financial Institutions, Markets and Money, 15, pp. 57-106

[6] Eichengreen, B., Tobin, J., Wyplosz, C. (1995), Two Cases for Sand in the Wheels of International Finance, The Economic Journal, 105(428), pp. 162-172

[7] European Banking Federation (2011), EU Banking Sector: The world's largest banking system in the world's largest economic space. Facts and Figures 2011/2012, Brussels

[8] European Central Bank (2010), Structural indicators for the EU banking sector, ECB, Frankfurt

[9] European Central Bank (2011), Structural indicators for the EU banking sector, ECB, Frankfurt

[10] European Commission (2009), European financial supervision, Brussels, 27.5.2009, COM(2009) 252 final.

[11] European Commission (2011), Green Paper - Towards an integrated European market for card, internet and mobile payments, COM/2011/0941

[12] Jetin, B., Denys, L. (2005), Ready for implementation - Technical and legal aspects of a currency transaction tax and its implementation in the EU, World Economy, Ecology and Development (WEED), Berlin

[13] Keynes, J. M. (1936), The General of Employment, Interest and Money, MacMillan, London.

[14] Pollin, R., Baker, D., Schaberg, M. (2003), Securities transaction taxes for U.S. financial markets, Eastern Economic Journal, 29(4), pp. 527-558

[15] Rajan, R.G. et Zingales, L. (2003), Banks and markets: The changing character of European finance, in: Gaspar, V.; Hartmann, P.; Sleijpen, O. (Eds.), Proceedings of the 2nd ECB Central Banking Conference on the Transformation of the European Financial System, European Central Bank, Frankfurt

[16] Schulmeister, St., Schratzenstaller, M., Picek, O. (2008), A General Financial Transaction Tax Motives, Revenues, Feasibility and Effects, Research Study by the Austrian Institute of Economic Research commissioned by Ecosocial Forum Europe, co-financed by Federal Ministry of Finance and Federal Ministry of Economics and Labour

[17] Spahn, P. B. (2002), On the feasibility of a tax on foreign exchange transactions. Report to the Federal Ministry for Economic Cooperation and Development, Bonn

[18] Stiglitz, J. E. (1989), Using tax policy to curb short-term trading, Journal of Financial Service Research, 3, pp. 101-115

[19] Tobin, J. (1978), Proposal for International Monetary Reform, Eastern Economic Journal, 4, pp. 153-159

[20] World Bank (2011 ), The Little Data Book 2011