FRBSF Economic Letter
96-12; April 5, 1996
The European Community (EC) implemented the framework for a single European
market for retail banking services in 1993. The integrated market was
expected to increase competition and financial integration in EC financial
services, much as interstate banking and branching is expected to increase
competition in many U.S. banking markets.
The EC's transition to a single market for banking has been a large and
complex undertaking. For one thing, it is part of a larger effort to create
a single market for all goods and services. For another, the effort involves
a number of countries, so that agreements on regulations are required
both at the EC level and at the member-nation level. In addition, the
integration covers a region whose population and banking assets are more
than one and a half times the size of the U.S. population and banking
This year, the EC plans to release an evaluation of the impact of the
creation of the single banking and financial markets, which could help
the EC plan for the ongoing integration of its banking markets. In anticipation
of this report, this Letterexamines the progress of the EC member
nations over the three years leading up to the target date for integration
and the fifteen months following the target date. The analysis focuses
on the twelve EC countries that were members when the single market was
implemented on January 1, 1993--Belgium, Denmark, France, Germany, Greece,
Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain, and the
United Kingdom. (See the Letter of November 25, 1994 for
a discussion of Austria, Finland, and Sweden, which became members on
January 1, 1995.)
The goals of integrating the EC's banking markets are part of the larger
effort of integrating its goods and services markets. This effort includes
eliminating impediments like tariffs, quotas, and controls on exchange,
investment, and interest rates, as well as nontariff barriers and differing
national product standards that may protect domestic industries and reduce
the trade of real goods, services, and financial services within the EC.
The EC integration process is complex and involves a series of legislative
measures. These measures start with the European Commission, which is
the executive and administrative body of the EC. The Commission proposes
EC legislation, which is then reviewed by and potentially modified by
the European Parliament, before going on to the European Council for adoption.
(Note that the Commission also is responsible for negotiating trade agreements
for the EC and for ensuring that EC rules and regulations are enforced.)
The legislative process includes use of regulations and directives, both
of which are legally binding. EC regulations
take precedence over national laws, while EC directives
generally require action on the part of the member countries to be
implemented--that is, typically the member countries are given some time,
usually two to four years, to pass legislation based on the EC standards.
This directives process leads to similar statutes across the Community,
while still allowing for some variation between countries. The European
Commission reviews the member nations' statutes to determine whether they
meet the EC requirements. If they do not, the EC automatically initiates
legal "infringement proceedings" designed to force the member
countries to take appropriate action on implementation.
Traditionally retail banking services have been provided to customers
in the country where the bank is headquartered. These are typically offered
to business and individuals, and include payments services, consumer credit,
credit cards, mortgage products, foreign exchange, and travelers checks,
as well as commercial loans and letters of credit. In contrast, wholesale
banking services already are provided to large corporations and financial
institutions in more "competitive" regional or global financial
The road to a single European retail banking market in 1993 was paved
with ten key banking directives. The First Banking Directive was made
in 1977, for implementation in 1979, but it led to little cross-border
movement by banks. It essentially set the criteria for expansion across
national boundaries within the EC by incorporating the concept of "host
country rule." Under host country rule, a foreign bank or branch
was required to gain permission from the supervisory authorities in the
hostcountry before it was allowed to operate in the host nation.
As the impetus for integration grew over the years, the Second Banking
Directive came out in 1988. It was adopted in 1989 for implementation
on January 1, 1993. It replaced the host country rule with a home
country rule, and it also adopted some other major principles designed
to create unified banking regulations and a more efficient banking sector.
Under home country rule, the host country regulators must turn over the
primary regulatory responsibility for foreign-chartered banking institutions
operating within its borders to the institutions' home country regulators.
This reform means that, for example, a Dutch-chartered bank or banking
subsidiary operating in Belgium is regulated by its "home" or
Dutch regulatory authorities, rather than by the "host" or Belgian
regulators. Moreover, the list of authorized banking activities is determined
by the bank's Dutch or "home" country standards, not by the
"host" Belgian standards.
Another principle in the Second Banking Directive was harmonization.
It created uniform safety and soundness standards and a comparable competitive
environment across the EC member countries. This means that banks operating
in more than one EC country face a set of uniform EC standards and capital
requirements, rather than a dozen different regulatory systems and capital
A third principle was mutual recognition. This is the principle of a
single banking "license" or "passport," which eliminates
the need for EC banks to obtain a local banking charter from the host
country for branches and/or bank products that are permitted by their
home country bank regulations. Essentially this allows inter-nation banking
and branching in the EC.
Eight more banking directives were adopted between 1986 and 1992 and
scheduled to be implemented before January 1, 1993. They required that
banks be examined annually at the fully consolidated banking institution
level for risk exposure and management, set minimum capital and solvency
standards, limited an institution's exposure to large borrowers, and set
standards for reporting financial and accounting data. Adoption of all
of these directives by each of the member nations was crucial to the long-run
integration of the EC banking market.
A key tenet of the EC integration effort for banking as well as other
markets is that it will increase efficiency and thereby lead to net benefits
for all member countries. Of course, not all member countries--nor all
the regions and industries within them--will benefit from all aspects
of the single market, and, indeed, some will suffer. To mitigate adverse
impacts, the EC allows for transfer payments to help member nations adjust
to more competitive markets. Still, the difficulties in making the transition
may play a role in determining just how quickly a country moves to adopt
the directives for specific goods or services, like banking services.
In the case of banking, the principle of home country rule embodied in
the Second Directive created an incentive to open up the regulatory process
in member countries that had more restrictive banking powers. Otherwise,
domestic banks in these countries would have more restricted banking powers
in their home market than would foreign banks.
Counteracting this incentive to liberalize powers for some countries
was the expectation that increased foreign competition would have a relatively
sharp negative impact on the domestic banking industry. This was based
in part on a study Price Waterhouse did for the European Commission (see
Commission 1988), which estimated an overall 21 percent reduction in the
price of EC banking services as a result of the single market. In addition,
the study examined eight of the countries individually (Belgium, France,
Germany, Italy, Luxembourg, The Netherlands, Spain, and the U.K.), and
the results suggested that Germany and Spain, and perhaps France, might
be expected to experience especially large adjustment costs, which could
make them candidates for a slower pace of adopting directives.
In a series of reports, the Commission monitored the adoption of EC directives,
including the banking directives. The results indicate that in the financial
services sector, the adoption rate has been relatively fast with respect
to laws designed to free the movement of capital and the adoption of a
single market for some types of financial services. At year-end 1993 the
twelve existing member nations were evaluated on their implementation
of the 10 key banking directives. Of the 120 possible implementations
(10 measures times 12 member nations), there were 98 cases in which the
banking directives were transposed into national statutes; by April of
1994, the number rose to 107.
Still, the progress of adopting the EC banking standards over the 1991
to 1994 period varied noticeably across countries, as the wide range of
potential price reductions found in the the Price Waterhouse study might
suggest. Of the eight countries in the study, the six countries showing
price reductions in the range of 10 to 25 percent adopted either all,
or all but one banking directive by April 1994. In contrast, Spain and
Germany, the countries where prices were estimated to fall by 34 and 33
percent, respectively, were much slower to implement the directives. Greece,
which was not covered in the Price Waterhouse study, also lagged well
behind. Because the Greek banking industry is relatively concentrated
and has a history of protection, Greece also was a likely candidate for
large adjustment costs and a slower pace of adoption.
The EC member nations have made a significant effort to adopt a single
banking market. Even though some countries delayed implementation, apparently
to postpone negative effects on their domestic banking industry, nearly
92 percent of the major banking directives had been implemented by August
1994. Of the remaining cases, most are likely to be resolved by EC and
member state efforts already underway. Thus, standards for capitalization,
solvency, risk exposure, supervision, disclosure, and money laundering
are in place in most member nations.
The EC itself describes a "profound change in cross-border competition"
as a result of the "single passport" and companion directives
that now make it possible for banks to provide retail banking services,
either through banks or branches, throughout the EC, a fundamental goal
of the single market. The EC's 1996 study, while addressing new efforts
to eliminate "residual barriers" to the single market, likely
will reflect this significant progress the EC has made towards integrating
Gary C. Zimmerman
Commission of the European Communities. Various years. The Community
______. 1988. "The Economics of 1992." European Economy
35 (March), pp. 86-95 and 171-197.
Zimmerman, Gary C. 1995. "Implementing the Single Banking Market
in Europe." Federal Reserve Bank of San Francisco Economic Review
Number 3, pp. 35-49.
On February 20 Federal Reserve Board Chairman Alan Greenspan presented
a report to the Congress on the Federal Reserve's monetary policy objectives
for 1996. The report includes a summary of the Federal Reserve's monetary
policy plans along with a review of the economic and financial developments
in 1995 and the economic outlook in 1996. Single or multiple copies of
the report can be obtained upon request from the Public Information department,
Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, CA
94102; phone (415) 974-2246 or fax (415) 974-3341.
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