## Mr Duisenberg outlines the future development of the financial sector in the euro area
Speech by Willem F Duisenberg, President of the European Central Bank, at the XXIVth IO Annual Conference in Lisbon on 25 May 1999.
## Introduction
The euro area constitutes a large economy, of a size comparable to that of the United S fact alone places the euro and the euro area financial system firmly 'centre stage' in economy. Consequently, it is essential for the euro area financial system to be stable a not only for the benefit of the euro area economy itself, but also for the world economy
The introduction of the euro on 1 January 1999 had a profound impact on financial syste within and outside the euro area. Part of this impact was immediately evident in integration of money markets and the replacement of national currencies by the euro i exchange markets. The fact that the changeover to the euro progressed smoothly is a re indication that the euro area financial system is able to remain stable during times change.
However, a further part of the impact on financial systems - most likely the greater pa experienced over a longer period of time. The euro is likely to become one of the maj reshaping both the domestic financial system of the euro area and the global financi This process should lead to a more efficient allocation of finance within the global ec it will also call for the ability to adjust to structural changes in order for stable to be maintained.
Today, I should like to outline the likely future development of the financial sector financial markets in the euro area as envisaged by the European Central Bank (ECB). To t I shall first briefly discuss the impact of the introduction of the euro on domestic mo I shall then turn my attention to likely developments in the financial markets and in system, before concluding with some remarks on how these likely developments might affe stability and efficiency of the financial system in the euro area.
## Impact of the introduction of the euro on money markets
Until the end of 1998 the various money markets of the euro area still displayed a cert of distinctive features. However, following the changeover to the euro they were i swiftly and smoothly at the beginning of January 1999.
A highly competitive single money market has already emerged in the euro area, as bank well prepared for the changeover to the euro and the TARGET system has provided an eff means of making cross-border payments. In particular, transaction volumes in money ma rapidly reached high levels while typical bid/ask spreads decreased almost immediately low levels. This indicates the depth and high degree of liquidity that the euro money already achieved. A feature of the current stage of the development of the euro money which is particularly worthy of note, is that differences in overnight interest rate s reflect differences in the credit standing of banks rather than that of the country transaction takes place.
These structural developments are, of course, positive. For the Eurosystem (i.e. the ECB an national central banks of the 11 countries participating in the euro area) the existence o and liquid money market enhances the efficiency of monetary policy operations. In this respe should like to draw your attention to the 'market friendliness' of the framework applied b Eurosystem to the conduct of monetary policy operations. By this I mean that the framework based on tenders in which markets decide who receives the liquidity. The standing facilitie open and recourse to the marginal lending facility is not subject to scrutiny. In addition, eligible collateral is extensive.
## Prospects for the development of financial markets in the euro area
Looking now at the financial markets from a broader perspective, it is important to remember the financial markets of the euro area began the process of integration before the start o Three of Economic and Monetary Union. An indication of the pace of integration before Januar 1999 is provided in particular by the evolution of spreads between yields on the bonds issu the various central governments of the euro area. These spreads narrowed continuously from mi 1995 onwards and their volatility was also noticeably reduced during this period. Fac contributing to this favourable pattern included increased convergence towards low rates inflation across the euro area during Stage Two, the gradual reduction and finally disappearance of exchange rate risks, the commitment of governments towards improving the sustainability of public finances, and the increase in the depth and liquidity of governmen markets.
As I have already said on a previous occasion, I believe that the interest rate markets of area will increasingly provide an accurate reflection of the differences in credit quality various issuers as well as differences in liquidity between bonds, while divergences purely r to the location of market participants within the euro area will become less and less relevan
It seems highly likely that the capital markets of the euro area will become even deeper and liquid over time, and hence more efficient. The number of market participants is likely to in as the cost of financial market transactions is lowered, and the sophistication of positio activities is likely to increase further as market participants equip themselves with more methods of adjusting their portfolio exposures.
One particular area of the capital market in which the markets in euro area countries traditionally been a lot less active than in the United States is the corporate bond and com paper market. However, there are good reasons to expect that corporate bond and commercia paper issuance in the euro area will gather pace in the future. During the first few months year we have already seen a fair amount of activity in this field.
For large companies in particular, it makes sense from the point of view of efficiency to h the methods of financing at their disposal, namely bond and paper financing, bank loans equity financing. Indeed, since the credit ratings of many large companies are better tha credit ratings of most banks, this should lead to savings on the cost of capital for the c sector. The introduction of the euro should provide sufficient depth and liquidity for the co debt market that would guarantee competitive pricing.
On the demand side, the reduced borrowing of the public sector will leave more room for t private sector to issue debt securities. As you know, the amount of public debt in the euro still high, and we trust that governments will keep their commitment to bring it down to sustainable levels as agreed in the Stability and Growth Pact. In addition, the euro area has
in order to be able to take care of its future pension payments, and a part of these sa to be invested in corporate debt securities. An increase in global demand for euro-de debt securities is also expected as the euro becomes a major reserve currency. Moreo demand for higher-risk euro-denominated debt securities is likely to increase, particu current low level of sovereign yields increases incentives to search for higher yields.
Turning to equity markets, and first to the institutional set-up of stock exchanges, towards more integration and greater market efficiency is already apparent. As conso within the financial services sector has increased the size and geographical intermediaries and fund management institutions, they seem to be pressing for market-p become more concentrated in order both to reduce costs and to enhance liquidity. In some companies have recently announced that they are reviewing their listing practices aim of reducing costs by cutting back on the number of exchanges in which they are liste
However, this development towards greater concentration does not necessarily mean that is concentrated only in a few exchanges. A possible pattern of development could als different stock exchanges to concentrate on specific types of companies ('blue-chips', s industries, small companies and new companies, for example). In any case, the physical of stock exchanges is becoming less relevant as screen-based trading with remote a becoming more widely used.
With regard to investor behaviour, an increasing number of equity market investors appear to be taking positions on the equity market of the euro area from a sectoral ra national perspective. Area-wide equity indices have been made available by various participants, thus providing investors with opportunities to monitor area-wide equity p well as, in some instances, positions in area-wide industrial sectors.
The fact that the euro area (and EU) equity markets are becoming more integrated, mor and deeper is good for market efficiency, and a more efficient allocation of capital s that equity financing becomes more readily available for companies.
I should also like to mention that a prudent, harmonised regulatory framework, on the and harmonised market practices, on the other, are key factors guaranteeing a favourable for these structural changes. In these areas a lot of work is under way, and much has achieved in order to pave the way for truly integrated financial markets. Harmonisati example, repurchase agreements, national company laws including bankruptcy laws, and aspects of the legal and regulatory framework, would enhance legal clarity and certa thereby improve the efficiency and stability of the financial markets.
Indeed, the European Commission recently published an Action Plan containing prioriti timetables for measures aimed at improving the single market for financial services. In Plan, measures are proposed to advance the harmonisation of the legal framework and information, as well as to facilitate investors' operations throughout the single market
In this respect, I should also like to pay tribute to the International Organization Commissions (IOSCO) for its efforts. Although I have focused mainly on the financial sy the euro area, we can clearly see that the euro area financial system is an integral global financial system. With this in mind, I should like to express my support for t IOSCO to promote high standards of regulation in order to maintain just, efficient a markets.
## Prospects for the development of banking systems in the euro area
Turning now to likely developments in the banking system, it is important to note that the area financial systems in general and the banking sector in particular have, until now, relatively national and fragmented with little cross-border retail activity. However, it is that the euro will add weight to a number of fundamental factors that are increasing the pr for structural change. With these structural changes I mean not only consolidation, which s inevitable, but also increased cross-border co-operation and mergers. In short, the euro banking sector is expected in the future to look and behave more like the banking sector single economy.
In addition to and reinforced by the introduction of the euro, other factors that are le changes in the financial landscape include technological development, globalisation and chan in what consumers and firms expect from the financial system and financial service provide These factors are reshaping the business of banking as well as the financial system as a w Economies of scale and scope may have been changing in different areas of banking and eve taking different directions. For example, the rapid development of information technology made the collection and processing of information considerably cheaper, but at the same t technological investments are taking a larger share of banks' resources. Therefore, economie scale in some aspects of the collection of information may have been reduced, but at the sam time investments in more sophisticated technology have increased economies of scale and sco in some areas of banking. While I do not wish to go into detail on this matter, the general that emerges is that the banking industry has to be in a position to adjust to a new situa take these factors into consideration.
Indeed, in the course of the last few months, a number of bank mergers in the euro area, incl mergers between relatively large institutions, have been announced or are being contemplat Such 'high-profile' mergers are likely to contribute to an acceleration of the pace of bo consolidation and integration of the banking systems of the euro area.
However, it should be remembered that the recent pattern of consolidation represents part longer-term trend in the European banking industry, as is highlighted by the large decline number of credit institutions in the euro area countries over the past decade or so. In t 1980s there were more than 11,000 credit institutions in the euro area countries; today number around 8,000. This sharp decline in the number of credit institutions is mainly the of mergers among savings and co-operative banks, which epitomise what one may call 'consolidating' or 'defensive' mergers - mainly aimed at cutting costs and diversifying risk also at reaching a size of own funds compatible with a regulation that has been agreed at t level.
So far, this consolidation process has taken place mainly within national boundaries, wit possible exception of the Benelux and Nordic countries. The preference for domestic mergers opposed to cross-border mergers) may be explained by the fact that the relevant market for services remains national rather than pan-European. Furthermore, the scope for cost-cutt appears to be larger if the merging institutions have overlapping operations. The fact that 'proximity', notably in the corporate style of governance and management, is traditionally as a key factor in the success of mergers may also have played a role. However, from my o professional experience of running a truly pan-European bank, I could add that professio identity is a much stronger force for unity than national identity is a force for separation.
## Conclusion
I have outlined the likely pattern of evolution that we envisage for the euro area fina Summing up the various elements, we see a pattern which leads towards a financial syst should perform its functions more efficiently using the advantages available to the system of a large economy. A large financial system can be more readily versatile, i. investors and those in need of financing with a full range of options to choose from a their requirements.
What does all of this mean for financial stability in the euro area?
First of all, I should like to remind you that the financial system of the euro area s degree of stability during last year's period of financial turbulence as well as duri dramatic structural shift connected to the changeover to the euro. In the former case, there was a significant spillover effect for the euro area markets, but they recovered without suffering any lasting damage. There was no disruption to any of the basic functi financial system, and public confidence in it remained strong throughout.
Second, the foreseen structural changes require, as I mentioned earlier, the need for a be taken seriously by all participants in the financial system. This adjustment appea intensified recently: there has been an increase in merger activity, an establishment and an introduction of new products and services, often based on modern information tech The process of structural change contains risks, but if these risks are identified earl carefully, they do not present a threat to financial stability. After all, we are decision-making and planning by people who are dealing with risks every day at the professional level. In this regard, the smooth changeover of the financial system t demonstrates the virtues of efficient and careful forward planning.
Third, I do not view efficiency and stability of the financial system as being contr many ways these qualities actually support each other by laying a firm foundation financial system. An inefficient financial system, in addition to being costly to soc more vulnerable to shocks.
At the ECB, we play our part in the evolution of the euro area financial system by pr with stable monetary conditions. By creating an environment of price stability, we all sector agents to focus their attention on the questions that are most relevant to their to take advantage of the benefits of this stable environment, such as the lengtheni planning horizons.