EMU and the International Monetary System
Chapter

12 The Euro and European Financial Markets

Editor(s):
Thomas Krueger, Paul Masson, and Bart Turtelboom
Published Date:
September 1997
Share
  • ShareShare
Show Summary Details
Author(s)
Robert N. McCauley and William R. White 

Many uncertainties as regards timing, scope, and other issues still surround the introduction of a single currency in Europe. Nevertheless, the event seems probable enough, imminent enough, and important enough to warrant some consideration of what the effects might be on the structure of European financial markets and the implications of such changes both within Europe and for the international financial system.

The story line in this paper is dynamic but simple. The starting point is that Europe-based financial firms are already under significant competitive pressure to restructure. Moreover, existing forces of technological change and deregulation affecting cross-border activity (the First and Second Banking Directives) must eventually cause those pressures to intensify, even if the effects to date on international competition in corporate and retail banking have been limited. However, the introduction of the euro seems likely to be a catalyst for change going well beyond the need to absorb the direct costs of transition. It seems probable that it will play an important role in stimulating the growth of a much larger and more liquid securities market in Europe (both private and public). This could be a significant new source of competitive pressure for banking firms providing traditional forms of intermediated credit in Europe. While the bond market in euros is likely to attract both more international investment and more issuance in that currency, implying an enhanced role for the euro in the international financial system, the associated profits may be rather highly concentrated. The direct influence of the euro in stimulating international competition among banks for traditional kinds of business will be a second new source of competitive pressure, but in itself likely to be of a lower order of importance. Existing legal, fiscal, regulatory, and cultural factors will continue to divide markets. Nevertheless, it is not difficult to tell a dynamic story in which increased competition among banks, aided by ongoing disintermediation, leads to increased pressure for more harmonization and in turn still more competitive pressure.

Should such a competitive environment emerge, it will be all the more important to have in place adequate incentive structures and supervisory arrangements to promote sound banking practices. Issues having to do with managing banking problems in a single currency area, should they occur, are also important but of course cannot be addressed without recognizing the complications posed by moral hazard problems. Whatever Europeans choose to do in these areas, there will also be international implications. Given the nature of integrated international financial markets, any adjustment problems that might occur could have spillover effects beyond Europe. Globally integrated financial markets also imply that the approach taken to problems of systemic risk within Europe should be coherent, with any approach adopted more globally. While this is in fact already the case, the bargaining dynamics of achieving global agreements could well be different in the future should Europe increasingly speak with a single voice.

The Euro and the Balance of Competitive Pressures in European Financial Markets1

If European banks are about to enter a period of enhanced competition, the starting position for many banks is not particularly strong. As indicated in Table 1, the rate of return on the assets of continental European banks rebounded in 1995 and, according to preliminary reports, it rose further in 1996. However, this should not overshadow two other trends. The rate of return continues to be relatively low in some countries (compared with U.S., U.K., and restructured Scandinavian banks)2 and profits seem to have been trending down since the mid-1980s (see Table 2). Net interest margins have tended to narrow, and loan-loss provisions have been high.3 Reflecting these realities, the ratio of bank share prices to general stock price indices has been falling in most European countries (see Table 3) and downgradings of continental banks by rating agencies have become more common (see Figure 1), even if credit ratings remain relatively high. In sum, there is at least a prima facie case that a significant degree of restructuring is required, leading to some withdrawal of capital from the industry and some concentration of that capital that remains.

Table 1.Profitability of Major Banks in 1994 and 1995
Return on Assets1Loan Loss ProvisionsNet Interest MarginOperating Costs
19941995199419951994199519941995
CountryNumber of Banks(As a percentage of total assets)
Denmark220.291.200.610.422.852.552.202.07
Finland32−0.69−0.161.650.601.981.572.302.21
France60.170.270.630.391.601.542.042.00
Germany20.520.560.350.231.821.572.061.98
Netherlands30.690.722.272.182.172.26
Norway41.311.810.16−0.382.962.862.823.01
Spain60.700.790.520.452.472.462.452.62
Sweden40.551.231.090.592.342.391.761.81
United Kingdom41.221.270.310.342.452.443.022.98
Memorandum items
Japan421−0.21−0.750.882.030.901.010.740.74
Switzerland30.630.520.300.331.171.072.172.18
United States121.811.870.330.313.573.353.803.49
Source: IBCA Ltd, as reported in BIS (1996a).

Pretax profit.

The portfolio of securities is marked to market.

1994 and 1995 results are not fully comparable owing to a break in series.

Combination of half-year results at an annual rate and IBCA estimates. Fiscal years.

Source: IBCA Ltd, as reported in BIS (1996a).

Pretax profit.

The portfolio of securities is marked to market.

1994 and 1995 results are not fully comparable owing to a break in series.

Combination of half-year results at an annual rate and IBCA estimates. Fiscal years.

Table 2.Long-Term Accounting Indicators of Banks’ Performance1
Pretax ProfitsNoninterest Income
1980–8221986–881990–941980–8221986–881990–94
Country(As a percentage of assets)(As a percentage of gross income)
Belgium0.40.40.3152226
Finland0.50.5−1.6495853
France0.40.4−0.1161746
Germany0.50.70.5293029
Italy0.71.00.8262926
Netherlands0.30.70.6252630
Norway0.60.00.2273029
Spain0.71.10.6182027
Sweden0.30.80.5303144
United Kingdom1.11.00.7293743
Memorandum items
Japan30.50.60.214241
Switzerland0.60.70.6474951
United States1.00.71.0243035
Source: OECD, as reported in BIS (1996a).

For Belgium, the Netherlands, and Switzerland, all banks; for other countries, commercial banks only.

For Belgium and France, 1981–82.

Fiscal years.

Source: OECD, as reported in BIS (1996a).

For Belgium, the Netherlands, and Switzerland, all banks; for other countries, commercial banks only.

For Belgium and France, 1981–82.

Fiscal years.

Table 3.Long-Term Movements in Bank Share Prices

(Ratio of bank1 index to overall index, 1980 = 100)

Country19701980–821984–861990–921993–9519951996
Belgium1109793109155166182
Finland85988447221513
Germany93948375787267
Italy1389686726765
Netherlands927756616064
Norway10110367179910
Spain561127885767270
Sweden66998468666166
United kingdom85979083118127143
Memorandum items
Japan7110315821891996194181
Switzerland64999259605549
United States142111120699296111
Source: National stock exchanges, as reported in BIS (1996a).

ForJapan (prior to 1983). Belgium, and the Netherlands. including other financial institutions.

The rise in this period is largely due to the breakdown of restrictive arrangements aimed at controlling bank share prices.

Source: National stock exchanges, as reported in BIS (1996a).

ForJapan (prior to 1983). Belgium, and the Netherlands. including other financial institutions.

The rise in this period is largely due to the breakdown of restrictive arrangements aimed at controlling bank share prices.

Figure 1.Long-Term Credit Rating of Major Banks1

Source: IBCA.

1Average of banks’ rating at the end of the year. The number of banks included are in parentheses.

There are also a number of reasons for believing that competitive pressures in the European financial industry are likely to increase significantly. Technological change is affecting the financial services industry everywhere, lowering the costs of both information and transactions. This challenges the basis of traditional relationship banking and encourages securitization as well as competition from nonbanks for corporate and retail banking business. The growing interest in many European countries in private pension schemes and other means to encourage savings on the part of a rapidly aging population will work in the same direction. Finally, the process of financial deregulation in Europe has been under way for almost 30 years, culminating in the Capital Liberalization Directive of 1988 and the Second Banking Coordination Directive, which came into effect on January 1, 1993. The explicit purpose of these Directives was to encourage a heightened level of international competition in the member countries of the EU.

What is somewhat surprising, in light of all these forces for change, is how little impact they have had to date on the structure of the European financial industry, which continues to be basically “national” in the provision of corporate and retail banking services.4 Moreover, banking products in many continental European countries are still significantly overpriced relative to those supplied by low-cost providers elsewhere in Europe.5 The reason for this is that there also exist many forces resisting change. One important consideration is that the industry has not had very many years to react to recent deregulatory initiatives, and has also had to adjust to a rather sluggish macro-economic environment. With time, these impediments to change should disappear. However, other impediments to international competition are likely to be longer lasting. There continue to be significant differences across European countries in the legal, tax, regulatory, and supervisory frameworks within which financial firms have to operate. Different accounting and reporting procedures, technical standards, labor practices, and cultural preferences further distinguish national markets. Finally, the continuing and important role of the state in the banking business in many continental European countries (see Table 4) is also a force acting to suppress international competition.

Table 4.Bank Share in Financial Intermediation in 1995
Assets of Banks as a Percentage of Assets of Banks

and Nonbank Financial Institutions
Of which
CountryTotalSavings

banks
Mutual and

cooperative banks
Share of state-

owned banks1
Finland259
France7381512
Germany7736145o
Italy811660
Netherlands252
Norway631913
Spain78263
United Kingdom5630
Memorandum items
Japan2790
Switzerland2533534
United States22410
Sources: OECD; and national data.

Partly estimated.

1994.

Of which building societies, 8 percent.

Excluding savings and regional banks, which are: partly owned by local communities. Their total share of assets is 3 percent.

Sources: OECD; and national data.

Partly estimated.

1994.

Of which building societies, 8 percent.

Excluding savings and regional banks, which are: partly owned by local communities. Their total share of assets is 3 percent.

In the rest of this paper, we speculate on how the introduction of a single currency in Europe might tilt the balance of forces described above, potentially acting as a catalyst for pent-up and significant change in the structure of European and indeed global financial markets. We focus on two principal possibilities. First, bond markets may gain in strength, depth, and liquidity from the introduction of the euro and this will be to the disadvantage of those supplying traditional intermediated credit. Second, the euro will lead to transitional costs and an increase in European intrabank competition at a time when continental banks are already struggling to cope with global competitive pressures and other EU initiatives directed toward the single market. While, for analytic convenience, we treat separately these two threats to the competitive status quo in European banking, there could be strong interactions between them: lower credit ratings for some banks could encourage direct recourse to financial markets, still stronger competitive pressures, further harmonization, yet more competition, and so on.

The possible implications of these changes for domestic financial stability and European public policy need to be considered. Moreover, given the size of European financial markets, and their close links with the rest of the world, the repercussions elsewhere also need to be considered. The possibility that non-Europeans might also have low-cost access to a large and liquid securities market denominated in euros has international implications. Finally, the need to cope with potentially significant changes in financial structure within the euro area raises supervisory and related issues with broader international dimensions.

The Euro and European Bond Markets

Many analysts of the effect of the euro on European bond markets concede that integration of the private bond market in euros could proceed rapidly. Nevertheless, it is often contended that the government bond market in euros would be likely to remain fragmented, with significant, persistent, and variable credit spreads marking one issuer’s bonds off from those of another. What follows partly agrees and partly disagrees with each proposition. The business of pricing private credits in euros should benefit (and almost already does benefit) from a common reference yield curve, and thereby from heightened competition among underwriters of new issues. In the pricing of government debt, prospects for integration in the trading of the bonds of most creditworthy governments look brighter than is generally acknowledged. At the same time, the euro may sharpen credit differences across the full range of governments participating in monetary union.

After discussing the short-term costs of the transition to the euro, we assess the likely effects of the euro on European bond markets, and then we draw some implications. A fully integrated bond market will require a long process of legal, regulatory, and behavioral change that would free institutional investors to invest across the euro area. Given such integration, an implication for the euro area is the probable alteration of the calculus of costs and benefits of bond issuance by European corporations, tilting the balance of corporate credit away from banks and toward the bond market. From an international perspective, a deeper, more liquid bond market can be expected to attract international asset and liability managers to increase the share of euro-denominated securities in their portfolios in relation to the sum of the shares of the euro’s constituent currencies.

Transition Costs of Monetary Union

The transition to monetary union confronts the securities industry with direct costs and legal risks that at this stage appear modest. Market makers in European securities have reported that the direct costs of making the transition to the single currency would be quite moderate. A study commissioned by the International Securities Market Association, based on a survey of over 1,000 market participants, put the range at between ECU 110,000 and ECU 8 million per firm.6 This worked out to an average of 0.058 percent of the total operating costs of financial institutions. This is a tiny fraction compared with some of the estimates from banks (some of which may include these securities firms’ conversion costs; see below). In addition, some firms, “such as large brokerage firms,” reported anticipated job losses of 15–25 percent, although others, “particularly large investment banking firms,” anticipate no reductions in the workforce.

In addition, swap dealers face the risk that counterparties might plead that they cannot fulfill (losing) swap contracts owing to the disappearance of the relevant currency. One estimate is that 14–15 percent of swap contracts extend beyond 1999 and “need to be tightened up with respect to the conversion to the euro.”7 Legal counsels of securities firms in Europe have been working with Brussels to ensure continuity of contracts, but questions remain as to how New York State courts might respond to such cases (see also the next section). In sum, total transition costs in the fixed income markets appear modest.

The Euro and Private Money and Bond Markets

The euro will create a single private yield curve across the euro area. As a result, the field of competition among underwriters will open up and issuers should enjoy better pricing.

Private Yield Curve in Euros

Ranging from an overnight rate, which would be strongly affected by the repo operations of the ECB, to interbank offered rates of maturities from one week to one or two years, a single reference money market yield curve can be expected. It is an open question whether the reference yields for the euro money market will be established onshore or offshore. The location of the banks that will be polled for the most widely used reference rates may depend on whether the ECB uses unremunerated reserve requirements as an instrument of monetary policy. At present, French franc futures contracts are based on PIBOR, the Paris rates, while the most heavily traded deutsche mark (and U.S. dollar) contracts are based on London rates, rather than Frankfurt (or New York) rates, owing to the reserve requirements assessed in Frankfurt (and formerly assessed in New York). In the absence of reserve requirements, significant deposit insurance premiums, or the like, the choice of whether to collect rates from banks located in Paris, Frankfurt, Amsterdam, London, or Zurich will in normal circumstances not make any difference in terms of the rates obtained.8 Rather, the identity of the banks included in the poll would make a difference (as the Japan premium has recently reminded us). That is, a bank might at times or regularly pay a premium over the average interbank rate offered by prime banks, but such risk premiums would depend more on the bank’s risk profile than on its location. In sum, a single private money market yield curve seems to be in the offing, and the market’s choice of reference rates between onshore and offshore rates will depend on the ECB’s reserve requirements.

Whether onshore or offshore, the euro money market is likely to prove a very liquid market from its inception. By liquidity we mean the ability to transact large amounts at short order without moving the market against oneself. Operationalizing this concept presents a real challenge, but transactions measures such as bid-ask spreads and trading volumes probably better indicate liquidity than the size of underlying asset stocks. Table 5 shows derivative transactions in private money market instruments. Focusing on these has the advantage of measuring the transactions with the lowest costs. On this view, even a narrow monetary union would create a money market that would, at current exchange rates, surpass the scale of the yen money market in derivative transactions, and thus probably in liquidity. Admittedly, this comparison may flatter the euro if a substantial fraction of money market transactions in the French franc represents one leg of matched transactions in marks. In any case, a considerable gap would remain between the euro and the dollar in this respect, with futures and forward transactions of at least $40 trillion a year in Europe, compared with eurodollar transactions in excess of $100 trillion. At such scale it is reasonable to expect that three-month euro futures would offer greater liquidity than do deutsche mark futures, especially in contracts settling four to eight quarters ahead (see Karsenti, 1996).

Table 5.Derivative Transactions in Private Money Market Instruments in Dollars, Yen, and Euros(In millons of dollars a year)
Instruments19951996
U.S. dollar
Eurodollar futures (CME, SIMEX)104.12597.068
Federal funds (CBOT)3.2193.042
Forward rate agreements14.667
Eurodollar option (CME, SIMEX)22.36922.238
Japanese yen
Euroyen futures (TIFFE, SIMEX)45.54334.475
Forward rate agreements12.518
Euroyen options (TIFFE, SIMEX)0.5210.714
Selected European currencies
Euro-deutsche mark/franc-lira futures35.93242.405
Forward rate agreements5.244
Euro-deutsche mark/franc-lira options7.0766.907
Deutsche mark
Euromark futures (LIFFE)17.96024.090
Forward rate agreements12.200
Euromark options (LIFFE)2.3923.251
French franc
PIBOR contracts (MATIF)15.51313.818
Forward rate agreements2.5932
PIBOR options (MATIF)4.6233.038
Italian lira
Futures (LIFFE)2.4594.497
Forward rate agreements0.4512
Options (L1FFF)0.0610.618
Sources: Various futures exchanges: BIS(1996b): and authors’ estimates.Note: Japanese yen, deutsche mark, french franc, and Italian lira amounts converted at year-average exchange rates.

Estimated as average daily turnover in April times 255.

Estimated as deutsche mark forward rate agreements (FRAs) times the ratio of FRA trading Paris or Milan to FRA trading in Frankfurt.

Sources: Various futures exchanges: BIS(1996b): and authors’ estimates.Note: Japanese yen, deutsche mark, french franc, and Italian lira amounts converted at year-average exchange rates.

Estimated as average daily turnover in April times 255.

Estimated as deutsche mark forward rate agreements (FRAs) times the ratio of FRA trading Paris or Milan to FRA trading in Frankfurt.

At longer maturities, the most frequently used private reference rates will be the yields on the fixed rate side of interest rate swaps. These standard and liquid prime-name rates extend from 2 years out to 10 years in maturity and already serve as the most important private reference rates in today’s bond markets. The convergence among these swap yields for contracts in Belgian francs, deutsche mark, Dutch guilders, and French francs over the past two years (see Figure 2) carries the strong message that market participants attach a high probability to stable exchange rates among these currencies.9 This inference is supported by the possibility that, if exchange rates were expected to move, one could contract to pay fixed (and receive floating) payments in the weak currency and to receive fixed (and pay floating) payments in the strong currency. The swap market is precisely where such private arbitrage/speculation takes place at the lowest transaction costs. (In this respect, the swap yield curve represents an extension to longer maturities of the private money rate, LIBOR.) At the inception of monetary union, the currently nearly identical swap curves will collapse into a single swap curve.

Figure 2.Private Interest Rates in Europe

(In percent a year)
(In percent a year)

Sources: Datastream; Reuters; and BIS.

Note: The yield curves are based on eurodeposit rates and, for longer horizons, on swap (midpoint) yields.

Sources: Datastream; Reuters; and BIS.

Note: The yield curves are based on eurodeposit rates and, for longer horizons, on swap (midpoint) yields.

The private capital market in euros is also likely to prove to be a very liquid market from its inception. On current evidence, even a narrow monetary union would offer a swap market about as active as those in the U.S. dollar and in the Japanese yen (see Table 6). Even recognizing that convergence trades are providing a temporary boost to the European transactions (see Bradbery, 1996; and Burgess, 1996, p. 4), the euro looks set to offer a private yield curve with world-class depth, breadth, and liquidity.

Table 6.Transactions in Interest Rate Swaps and Swaptions in Dollars, Yen, and Euros(In trillions of dollar a year)
Central Bank Survey1ISDA
1995199519962
U.S. dollar5.981
Swaps4.2832.8563.690
Swaptions1.698
Japanese yen4.904
Swaps4.3782.2593.128
Swaptions0.527
Selected European currencies4.678
Swaps3.9072.3153.485
Swaptions0.771
Deutsche mark1.948
Swaps1.6610.9851.935
Swaptions0.287
French franc2.303
Swaps1.87931.1131.550
Swaptions0.4244
Italian lira0.427
Swaps0.36730.217
Swaptions0.0604
Sources: ISDA: BIS (1996b): and authors’ estimates.

Estimated as average daily turnover in April times 255.

First half at annual rate.

Estimated as deutsche mark swaps times the ratio of ISDA-reported French franc swaps or ISDA-reported Italian lira swaps to ISDA-reported deutsche mark swaps.

Estimated as deutsehe mark swaptions times the ratio of swaption transactions in Paris or Milan to such transactions in Frankfurt.

Sources: ISDA: BIS (1996b): and authors’ estimates.

Estimated as average daily turnover in April times 255.

First half at annual rate.

Estimated as deutsche mark swaps times the ratio of ISDA-reported French franc swaps or ISDA-reported Italian lira swaps to ISDA-reported deutsche mark swaps.

Estimated as deutsehe mark swaptions times the ratio of swaption transactions in Paris or Milan to such transactions in Frankfurt.

In view of the uncertain prospects for the integration of government bond markets in the euro area, discussed below, some analysts have suggested that the swap yield curve might perform a benchmark role in Europe (see Adler, 1996; Huteau, 1997; Karsenti, 1996; and Krämer. 1996). Normally, one thinks of the benchmark as the lowest yield, with other yields quoted (and in effect determined) as spreads over the benchmark. However, in principle, the bonds of various governments could be priced as spreads under the swap yield curve. The problem with this suggestion is not a formal but a practical one. Transactions in swaps and swaptions, while very large at trillions of dollars equivalent a year, pale in comparison to the tens of trillions of dollars of transactions in government bonds, government bond futures, and government bond options, as will be demonstrated below. As things stand, it is hard to imagine the private yield curve in euros serving as the benchmark for government as well as private risks in the European bond market.10

Increased Competition in Underwriting Private and Foreign Bonds

If multiple currencies in Europe tend to segment its bond markets, keener competition in the bond market should result from monetary union. As background, consider the range of factors that bear on competition in a primary bond market. One can conceive of bond underwriters drawing their competitive advantage from one of three sources: relations with the issuers, general understanding of the money and bond markets, including the direction of rates and associated movements in spreads, and relations with end-investors. Government bond auctions seek to limit the influence of the first factor, and studies of the U.S. Treasury market have in fact emphasized “a large customer base with heavy order flow” as the principal source of competitive advantage (see Ruocco, LeBlanc, and Dignan, 1991).

The source of competitive advantage bears directly on the question of the effect of monetary union. If relations with issuers are key, then the euro will tend not to disturb competition. But if an underwriter benefits from understanding the direction of national interest rates, or from access to investors, then the euro will sharpen competition. No longer will a French bank have a natural edge in understanding the monetary and fiscal policies that can move the French bond market, and eventually a French bank will not be able to use its French investor base to win deals.

One test for whether the euro will sharpen competition in the bond market, therefore, is to check whether currency makes a difference in the choice of underwriter, controlling for the nationality of the bond issuer. The test can be performed on the international bond market for reasons both of data availability and of relevance. The data are relevant because the international bond market is, to a considerable extent, the euro bond market to be: one-fourth of the outstanding issues feature EU issuers in EU currencies, and a substantial fraction of investors are EU institutional investors. An early study of this question documented a decline of issuer-underwriter relations and a rise in the role of currency in the selection of underwriter (see Courtadon, 1985). A more recent study (Balder, Lopez, and Sweet, 1991) found a strong association between the nationality of the lead underwriter and the currency denomination of the bond for all but eurodollar issues, where customer relations seemed important. Most recently, Dermine (1996) points to the dominance of home-country lead managers in the league tables by currency sector, without distinguishing the influence of customer from that of currency.

An analysis of the effect of customer nationality and the currency denomination of the bond on the choice of lead managers (dubbed bookrunner after a period of title inflation) points to the strong predominance of currency effects over issuer effects in European currency sectors (see Table 7).11 German, French, U.K., and Dutch underwriters capture fairly close to the same share of the business of home-country issuers and foreign issuers, but show huge differences in market shares in their home currencies as against all other currencies. As found previously, the influence of customer and that of currency is much more balanced for U.S. underwriters.

Table 7.Currency and Home-Country Relationship in the Choice of Bond Bookrunner, 1996(Percentage market share won by bookrunners of indicated nationality)
German BookrunnersFrench Bookrunners
CurrencyCurrency
BorrowerDeutsche

mark
OtherAllBorrowerFrench

franc
OtherAll
German441624French861025
Other3725Other7525
All3948All7726
Sources: Euromoney Bondware; and BIS.Note: Each entry shows market share of German, French, U.K., Dutch, U.S., or Japanese bookrunners for issuers of the indicated nationality in the indicated currency. For example, the 44 percent in the upper left-hand corner means that German underwriters ran the books for 44 percent of the bonds of German issuers that were denominated in deutsche mark. Data include all bonds in the Euromoney database, including international bonds issued under medium-term note programs, that are not equity-related. Total amount of bond issuance by currency: deutsche mark: $81 billion; French franc: $37 billion; pound: $54 billion; guilder: $22 billion; dollar: $319 billion; yen: $91 billion; grand total: $725 billion.
U.K. BookrunnersDutch Bookrunners
CurrencyCurrency
BorrowerPoundOtherAllBorrowerGuilderOtherAll
U.K.402131Dutch832648
Other4835Other8523
All4447All8425
Sources: Euromoney Bondware; and BIS.Note: Each entry shows market share of German, French, U.K., Dutch, U.S., or Japanese bookrunners for issuers of the indicated nationality in the indicated currency. For example, the 44 percent in the upper left-hand corner means that German underwriters ran the books for 44 percent of the bonds of German issuers that were denominated in deutsche mark. Data include all bonds in the Euromoney database, including international bonds issued under medium-term note programs, that are not equity-related. Total amount of bond issuance by currency: deutsche mark: $81 billion; French franc: $37 billion; pound: $54 billion; guilder: $22 billion; dollar: $319 billion; yen: $91 billion; grand total: $725 billion.
U.K. BookrunnersJapanese Bookrunners
CurrencyCurrency
BorrowerDollarOtherAllBorrowerYenOtherAll
U.S.864676Japanese754659
Other541328Other87614
All641637All84817
Sources: Euromoney Bondware; and BIS.Note: Each entry shows market share of German, French, U.K., Dutch, U.S., or Japanese bookrunners for issuers of the indicated nationality in the indicated currency. For example, the 44 percent in the upper left-hand corner means that German underwriters ran the books for 44 percent of the bonds of German issuers that were denominated in deutsche mark. Data include all bonds in the Euromoney database, including international bonds issued under medium-term note programs, that are not equity-related. Total amount of bond issuance by currency: deutsche mark: $81 billion; French franc: $37 billion; pound: $54 billion; guilder: $22 billion; dollar: $319 billion; yen: $91 billion; grand total: $725 billion.
Sources: Euromoney Bondware; and BIS.Note: Each entry shows market share of German, French, U.K., Dutch, U.S., or Japanese bookrunners for issuers of the indicated nationality in the indicated currency. For example, the 44 percent in the upper left-hand corner means that German underwriters ran the books for 44 percent of the bonds of German issuers that were denominated in deutsche mark. Data include all bonds in the Euromoney database, including international bonds issued under medium-term note programs, that are not equity-related. Total amount of bond issuance by currency: deutsche mark: $81 billion; French franc: $37 billion; pound: $54 billion; guilder: $22 billion; dollar: $319 billion; yen: $91 billion; grand total: $725 billion.

The upshot of this analysis is that separate currencies in Europe have tended to segment the international bond market and that, over time, currency has shown more persistence as a factor bearing on competition than have relations between customers and underwriters. Brown (1996, p. 4) argues that the competitive challenge is not symmetrical: “the advantage German banks have had in the no. 2 international capital market, the euro-DM market, will not carry over into the euro capital market.” As underwriter competition becomes sharper under the euro, the cost of corporate issuance of debt should decline. Another factor that could ease the marketing of European corporate bonds would be a more integrated European market for government bonds. To this we turn before discussing the implications of cheaper bond issuance.

The Euro and European Government Bond Markets

The euro is likely to exert both centripetal and centrifugal forces on the European government bond market. The market’s demand for liquidity, and its reward for policies that contribute to liquidity, provide powerful integrative forces. At the same time, the unification of monetary policy, and the reevaluation of government risk in terms of fiscal position rather than international asset position, might highlight credit differences that could widen pricing distinctions. Markets might, therefore, simultaneously make little of differences among the most creditworthy of European governments while making much more of a distinction between these and more heavily indebted governments. Thus the centripetal and centrifugal forces need not cancel each other out.

Prospects for an Integrated Government Bond Market in the Core of Europe

The countries judged most likely to enter monetary union in 1999 are among those that tend to enjoy the highest credit ratings (see Table 8). Moreover, bond buyers currently price the bonds of these governments in a very similar manner. To see this similarity, recall the convergence of private yields, as measured by interest rate swaps, in the Belgian, Dutch, French, and German bond markets. Lower than these, more or less AA-rated, private yields are the respective government yields, which are solidly AAA-rated for Dutch, French, and German bonds.

Table 8.EMU Membership Poll Results and Sovereign Credit Ratings
Expected Participation in EMU

at Outset (In percent)1
Poll

published in

January 1996
Poll

published in

August 1996
Rating2
CountryMoody’sS&P’sIBCA
Germany100100AaaAAAAAA
France97100AaaAAAAAA
Netherlands76100AaaAAAAAA
Belgium7995AalAA+AA+
Austria7993AaaAAAAAA
Ireland6082AalAAAA+
Finland3648AalAAAAA
Denmark5043AalAA+AA+
Sweden713Aa3AA+AA−
United Kingdom228AaaAAAAAA
Spain77Aa2AAAA
Portugal04Aa3AA−AA−
Italy23Aa3AAAA−
Greece00BaalBBB−BBB−
Sources: Consensus Economics, January aud August 1996, p. 26; Moody’s; Standard & Poor’s; and IBCA.

‘The polls of over 200 financial and economic forecasters indicate the percentage of respondents predicting that countries will join EMU at the outset. Respondents’ assumptions regarding the likly starting date differed, Luxembourg rated Aaa and AAA. respectively, was nor included in the poll.

Ratings refer to foreign currency issues.

Sources: Consensus Economics, January aud August 1996, p. 26; Moody’s; Standard & Poor’s; and IBCA.

‘The polls of over 200 financial and economic forecasters indicate the percentage of respondents predicting that countries will join EMU at the outset. Respondents’ assumptions regarding the likly starting date differed, Luxembourg rated Aaa and AAA. respectively, was nor included in the poll.

Ratings refer to foreign currency issues.

The pricing of generic private risk in relation to government risk bears a great similarity in bond markets along the Rhine (see McCauley, 1996). The spreads between the yield on a 10-year interest rate swap and the yield on a 10-year government bond are unusually close in these three bond markets, where these spreads have converged to a common level of about 20 to 30 basis points (see Figure 3). Never in the history of the swap market has this spread been so similar, for so long, across so many markets.

Figure 3.Spreads of Ten-Year Government Bond Yields over Interest Rate Swap Yields

(Monthly averages, in basis point)

Sources : Datastream; and Reuters.

These measured credit differences are small. In particular, they are small in relation to the potential liquidity benefits of practically fungible trading of European government bonds. To many observers, such trading is inconceivable because it would require accepting “joint and several liability” of the relevant EU governments for each other’s debt. Given all the associated moral hazard, this is not likely to happen very soon. Such a legal arrangement would indeed be sufficient to unify the bond markets of the participating governments. But is it necessary to render the “sovereign debt of EMU participants largely substitutable products” (Mayer, 1996, p. 10)?

One operational criterion of an integrated bond market is that it be served by a single futures contract (or, more precisely, a single contract at each maturity). One way to achieve such a market is by virtue of a single issuer becoming the benchmark and its obligations serving as the basis for a futures contract. Thus, today, the German government bond contract is used by dealers in Dutch and Belgian government debt for hedging, although changes in the yield spreads render these hedges imperfect (i.e., they introduce “basis risk”). Much market commentary is focused on which government will attain benchmark status. Cited in favor of France’s debt assuming such a role is the liquidity and size of individual issues, as well as the French treasury’s preannounced issuance calendar. Cited in favor of Germany’s debt assuming such a role is its greater size and the greater turnover in the Bund futures. The choice of a single benchmark issuer, however, implies purchasing credit homogeneity at the expense of imbuing only a narrow range of bonds with the liquidity benefits of an associated futures contract. Greater liquidity might result from a contract in which a number of issuers’ bonds might be delivered into the same futures contract, so-called multiple-issuer deliverability (see Duesing, 1997; Fox, 1996; and Mazzucchelli, Clarke, and Parry, 1996). However, the art of contract design is to avoid permitting such a wide range of signatures as to bring a sort of Grcsham’s Law into play, according to which the worst signature drives out the other signatures (see Box 1).

Box 1.ECU Bond Future: A Cautionary Tale

Mention to London financiers the possibility of a single bond future based on a number of European government bonds, and they often recall the case of the ECU bond contract (see Mazzucchelli, Clarke, and Parry, 1996). Both LIFFE and MATIF inaugurated an ECU bond contract in 1990. LIFFE permitted the bonds of any EU government issuer, as well a number of supranationals, to be delivered into the contract. By contrast, the MATIF limited the deliverable paper to issues of France and the United Kingdom and certain supranationals, and precluded the delivery of Italian ECU bonds.1

In the event, given the considerable yield premium of Italian government bonds over French and U.K. government bonds denominated in ECU, the Italian government bonds proved the bonds consistently cheapest to deliver in London. As a result, the LIFFE ECU contract reflected not only the variation of ECU long-term interest rates, but also the volatility of the credit spread between A-rated Italian debt and AAA-rated French government debt. For most portfolios of ECU bonds, or for most underwriters of ECU bonds, the Italian volatility in the LIFFE contract made it an inferior hedge. Partly as a result, the Paris contract stole the march over the London contract. Eventually, LIFFE changed the rules to preclude the delivery of Italian paper, but by then liquidity had tipped to the Paris contract. The lesson drawn in London is that an excessively inclusive collection of credit risk in a futures contract, permitting the delivery of a number of issuers’ bonds, can turn that contract into a loser (see Bloem, 1996).

Gerard Pfauwadel, President of MATIF, told Reuters on February 15, 1991, the day that a U. K. ECU bond was admitted into the MATIF ECU bond pool: “The Italian government’s signing conditions are such that, looking at the year 2000 time line for Italy, there was a risk that our contract, which after all relates to a basket of underlying securities of three billion in OATs (French treasury bonds), would be transformed into a contract relating only to one billion Italian ECUs, because the construction of the notional bond future is such that the market price is based on the lowest-cost bond to be delivered. These technical conditions at this initial stage of building the market would have made it extremely dangerous to take too small a basket”

Last December the financial futures exchange in Paris published a report on plans to switch its futures contracts to the euro (see MATIF, 1996).12 The working group entertained two scenarios: one in which the current long-term contract on French government securities in francs becomes a contract on euro-denominated French government securities, and another scenario in which it becomes a contract on euro-denominated bonds of a number of euro-area governments. The report held that a “single yield curve,” for at least a small group of European governments, was a necessary condition for a contract into which bonds of more than one issuer could be delivered. On the above evidence, financial markets have come very close to trading the French, Dutch, and German government bonds on a single yield curve.

Somewhere down the road, prospective interest savings through higher liquidity might encourage cooperative debt management by national treasuries. Governments need not hold joint auctions; they could simply match each other’s coupons and maturities, in effect “reopening” each other’s issues. The potential benefit of such an approach is evident in Table 9, in which the value of transactions in a European government bond market compares favorably with that in Japan and falls not far short of that of the United States.

Table 9.Derivative Transactions in Long-Term Government Securities in Dollars, Yen, and Euros(In trillions of dollars a year)
19951996
OptionsExchange-

traded options
Memorandum: Cash Market
Bonds and notesFuturesExchange-tradedOTC1FuturesTradingOutstanding
U.S. treasury bonds12.3743.6270.43512.0113.66735.8432.547
Japanese government
bonds15.9562.1631.53912.2621.8246.5021.996
Selected European
government bonds14.0672.3840.46517.8482.75918.2251.608
German bonds9.0901.2740.17312.3881.55016.5660.727
French bonds3.3670.9540.25623.4520.8691.6580.490
Italian bonds1.6100.1560.0362.0080.3400.42030.3914
Sources: Salomon Brothers BIS, (1996b; and various futures exchanges and national sources.Note: Data on cash market trading and outstandings are for 1995 and end-1995 respectively.

Estimated as average daily Turnover in April times 255.

Estimated as OTC trading in interest rate options on traded securities in deutsche marks times the ratio of total OTC trading in interest rate options in Paris or Milan to that in Frankfurt.

Euroclear and Cedel only.

Lira-denominated treasury bunds only; excludes variable rate notes.

Sources: Salomon Brothers BIS, (1996b; and various futures exchanges and national sources.Note: Data on cash market trading and outstandings are for 1995 and end-1995 respectively.

Estimated as average daily Turnover in April times 255.

Estimated as OTC trading in interest rate options on traded securities in deutsche marks times the ratio of total OTC trading in interest rate options in Paris or Milan to that in Frankfurt.

Euroclear and Cedel only.

Lira-denominated treasury bunds only; excludes variable rate notes.

Liquidity and Cooperative Debt Management: Evidence to Date

The prospect of European treasuries cooperating in debt management may well seem far-fetched. After all, representatives of the German federal government, which has had to bail out ailing Länder (including Bremen and Saarland), worked for the “no-bailout” provision in the Maastricht Treaty to reinforce market discipline on European governments. Any mixing of governmental approaches to the market might seem to raise the (moral hazard) risk that one government would support the other. Cooperation could lead to, or be seen to lead to, coresponsibility. Nevertheless, the brief history of the choice as to whether to redenominate government debt into euros at the first opportunity, now planned for early 1999, points to the power of liquidity to shape a common policy.

EU members agreed in Madrid in December 1995 that, at the margin, new public debt issues should be denominated in euros from the inception of the euro. The intention was to contribute to the euro’s reaching a critical mass of transactions, including interbank transactions as well as these public debt transactions, so that private sector parties would opt to use the euro before its use became mandatory (some three years later). Subsequently, the French treasury indicated that it would convert the entire stock of its debt from French francs to euros on day one, creating a whole yield curve in euros. In so doing, the treasury drew attention to its book-entry (“dematerialized”) system, which would make such a debt conversion more feasible. The Belgian government has followed suit, announcing that it would convert most of its debt into euros, leaving unconverted only some notes in Belgian francs held mostly by households. The Dutch finance ministry has stated that the prospect for liquidity of the guilder market will figure importantly in its decision whether to redenominate.13

Early indications from the German finance ministry suggested that there would be no conversion of existing German debt. Yet strong and apparently successful arguments were subsequently advanced by German banks against such a policy.14 Essentially, the German banks argued that new issues of German bonds denominated in euros would have to yield 10–15 basis points more if the stock of German government debt were not converted into euros. Such a difference between the deutsche mark stock and the euro debt at the margin would probably be sufficient to interfere with auction strategies, cash/futures arbitrage and cash/cash yield curve positioning. In addition, Frankfurt stood to lose out to Paris as a financial centre were a large mass of French bonds deliverable into a euro contract there while only brand-new issues were deliverable in Frankfurt. Note that the first argument could be made in the absence of any competitive threat. The German government is now expected to redenominate its Bunds (although not the no-longer issued Treuhand bonds that financed reunification with eastern Germany). Without ignoring the competitive tensions—sometimes dubbed the “race to benchmark status”—one should recognize that the liquidity argument has already brought two finance ministries to the same decision on the first important policy question regarding debt management in the single currency area.

Many challenges remain to integrating government bond markets in the euro area. Market conventions (such as interest day counts) and the organization of the primary and secondary markets still vary from one market to another.15 There may be a prisoners’ dilemma here, with major governments tempted by the prospect of achieving benchmark status on their own terms rather than cooperating to maximize liquidity (see Keating, 1996). The liquidity argument could give impetus to the difficult process of harmonizing differences.

Rerating High-Debt European Sovereigns: Lessons from Canada?

How should the bonds of the more indebted European governments trade after the introduction of a single currency? The rating agencies have adopted different approaches to this question, but the remarkable outcome is that ratings judgments are closer together under the scenario of monetary union than they are now (see Box 2). For the most creditworthy governments, no change in their ratings is foreseen; for the rest, their ratings are foreseen at the AA level.

The question may be interpreted as turning on the importance of the “printing press” as the last-ditch mode of debt payment. Governments have been granting rather more independence to central banks, so this option has not been gaining plausibility. A central bank can, however, help its government by increasing the duration of its portfolio of government debt, without running the printing press. Some would say only that with monetary union the probability of one kind of bailout—the central bank buying government debt under duress—would diminish while the probability of another class of bailouts involving European-wide institutions would rise.

It may be informative to consult the experience of Canada, a federation of provinces, for guidance as to how European government debt might be treated under the single currency (see Brookes, 1997; Bulchandani, 1996; Clarke and Parry; 1996; Islam, Eyerman, and Taylor, 1996; Lipsky and others, 1996; SBC Warburg, 1996; and Serfaty, 1996; but also Fox, 1996, and Keating, 1996). In the domestic Canadian bond market, the federal government represents the top-rated benchmark and the cost of provincial debt bears a close relation to provincial credit ratings, with Quebec yielding a premium that may reflect a risk of exit from the federation (see Figure 4). To compare the situation in Canada with that in Europe requires a common measure of spreads across different markets, and the interest rate swap yield in Canadian dollars and in European currencies can be taken as a common (AA-rated) reference point. When the spreads of the Canadian provinces and European governments (see Figure 3) are plotted against their respective ratings, it appears that these various bond markets price lower ratings in a reasonably similar fashion (see Figure 5).16

Figure 5.Government Bond Yields in the Canadian and European Markets

(Spread over the respective interest-rate swap yields, fourth quarter 1996)

Sources: Moody’s, Standard & Poor’s; and Morgan Stanley.

1For Canadian provincial governments (including the Commonwealth), long-term domestic currency rating; for New Brunswick and Quebec, split rating. For European governments, indicated rating in the event of monetary u for Italy, split rating; for Sweden, no Moody’s indication.

Figure 4.Credit Spreads in the Canadian Bond Market

(At fourth quarter 1996)

Sources: Moody’s; Standard & Poor’s; and Morgan Stanley.

1 Long-term domestic currency rating; for New Brunswick and Quebec, split rating.

But a juxtaposition of the Canadian and European observations raises a question regarding the consistency of the determinants of the ratings themselves (see Figure 6). When the Canadian ratings are plotted against the debt burdens of the Canadian provinces, the ratings all line up; when the prospective ratings of the European governments under the assumption of monetary union are plotted against current debt burdens, the ratings do not line up so well.17 How good an analogy does the Canadian bond market provide for European debt markets under monetary union?18 Those who have looked most carefully at such questions have identified three critical dimensions that affect the capacity of a government to carry higher debt burdens: whether household and corporate taxpayers can readily move to avoid tax rises; the degree of federal support in the event of difficulties in debt servicing; and the capacity of the political system to produce coherent governments capable of making difficult choices (see Eichengreen and von Hagen, 1995). On the first dimension, European governments may have scope to carry heavier debt burdens because labor (and capital?) is less mobile than in Canada. On the second dimension, Canada’s federal redistribution and constructive ambiguity must be contrasted with the EU’s limited budget and Maastricht’s clear statement that there would be no Community liability for, or assumption of, the debts of any troubled government. On the third dimension, Canadian parliamentary democracy, like that of the United Kingdom, produces more coherent governments than the electoral systems of some EU countries. The Canadian provinces thus provide a useful if imperfect analogy for European governments under the single market, with two of the three arguments above implying that debt levels should be of more import than in Canada.

Figure 6.Debt Burdens and Credit Ratings in Canada and Europe

(At fourth quarter 1996)

Source: Morgan Stanley; Moody’s; Standard & Poor’s; and OECD.

1As a percentage. Debt data for European countries are the OECD estimates based on the Maastricht definition.

2See footnote 1 to Figure 5; in addition, split rating for Finland, Greece, Ireland, and Portugal.

3Not included in the provincial regression.

Implications for Money and Bond Markets

The greater depth, breadth, and liquidity of the euro bond market carry implications both internal to the euro area and external to it. Internally, one should expect the portfolios of institutional investors gradually to lose their bias toward home country assets. As this diversification occurs, one should expect that the lower cost and greater benefit of using the bond market should move the boundary between the banking market and the securities market in favor of securities away from loans. Thus, the shift by banks from acquiring and holding assets to underwriting and distributing paper should accelerate, with different implications for banks with strengths in these two aspects of the business. Repurchase markets can also be expected to grow, to some extent at the expense of bank deposits.

Box 2.Monetary Union and Sovereign Ratings

Over the years, the major rating agencies have approached country (or transfer) risk in a fairly similar fashion. They assign a ceiling to the foreign currency ratings of all the borrowers in a country that reflects the possible unavailability of foreign exchange, even in cases in which the underlying debtor has ample domestic currency to service its debt and the currency is fully convertible. Until Moody’s recent rating of Panama, this foreign-currency debt ceiling was also the foreign debt rating of the central government, and was thus often known as the sovereign ceiling. The rating agencies have in addition assigned ratings to the central government’s domestic debt. These ratings have tended to be higher than the corresponding foreign currency ratings, particularly for Standard & Poor’s and IBCA, on the grounds that the national central bank would help prevent a default in domestic currency or, more generally, that the government’s tax base in domestic currency made default less likely.

Generally, the rating agencies are treating EMU as a likely event, and they have already begun to factor the prospect into the sovereign ratings of potential members. Of course, the fiscal discipline of the Maastricht criteria means that a prospective participant in monetary union can hope to see its ratings improve, as with Moody’s recent upgrade of Ireland. (Reuss, 1996, shows, however, that of the nine countries with lower than AAA ratings in Table 10, five have seen their Standard & Poor’s foreign currency ratings downgraded since their initial ratings, and only two have seen them upgraded.) But the prospect of EMU poses two other questions for the major rating agencies: what should the sovereign ceiling for the euro area be, and how should the foreign currency and domestic currency debt ratings, where they differ, be united?

Table 10.Effect of EMU on Central Government Debt Ratings
Moody’sStandard & Poor’sIBCA
CountryFXDomesticEMUFXDomesticEMUFXDomesticEMU
AustriaAaanrAaaAAAAAAAAAAAAAAAAAA
FranceAaaAaaAaaAAAAAAAAAAAAAAAAAA
GermanyAaaAaaAaaAAAAAAAAAAAAAAAAAA
LuxembourgAaanrAaaAAAAAAAAAAAAAAAAAA
NetherlandsAaaAaaAaaAAAAAAAAAAAAAAAAAA
Uinked KingdomAaaAaaAaaAAAAAAAAAAAAAAAamb
BelgiumAalAalAalAA+AAAAA+AA+AAApos
DenmarkAalAalAalAA+AAAAA+AA+AAApos
FinlandAalAaaAaaAAAAAAAAAAAAAamb
GreeceBaalA2A2BBB−nrBBB−BBB−nramb
IrelandAalAaaAaaAAAAAAAA+AAAamb
ItalyAa3Aa3Aa3AAAAAAAAA+AAApos
PortugalAa3Aa2Aa2AA−AAAAA−AAAAAamb
SpainAa2Aa2Aa2AAAAAAAAAAAApos
SwedenAa3AalnrAA+AAAAA+AA−AAAamb
Sources: Moody’s (1997); Standard & Poor’s; and IBCA (1996).Note: For each rating agency, FX indicates the current foreign currency rating; Domestic, the current domestic debt rating; and EMU, the prospective unified rating under the hypothesis of participation in the single money, nr denotes no rating. For IBCA, amb denotes ambiguous effects and pos denotes positive effect.
Sources: Moody’s (1997); Standard & Poor’s; and IBCA (1996).Note: For each rating agency, FX indicates the current foreign currency rating; Domestic, the current domestic debt rating; and EMU, the prospective unified rating under the hypothesis of participation in the single money, nr denotes no rating. For IBCA, amb denotes ambiguous effects and pos denotes positive effect.

Moody’s (1997) recently agreed with the views of Standard & Poor’s (see Beers, 1996, and IBCA, 1996) as outlined last year, that the risk of a transfer problem affecting foreign currency issues by borrowers in the euro area should be negligible. That is, these agencies treat as practically zero the likelihood that a government or other obligor in the euro area would have euros but would be unable to convert these into the dollars or Swiss francs needed to service its debt. This conclusion would apply more or less regardless of the participants in monetary union because the aggregated external creditor status of Europe would be very strong in any case. Moody’s and Standard & Poor’s, however, approached differently the question of what to do with the split between their foreign currency rating and their domestic currency rating for some European governments.

Moody’s argued that the euro would effectively become the domestic currency of any member country, just as the dollar is the domestic currency of Massachusetts.

Therefore, the rating of a government in the euro area should correspond to its (in many cases higher) current domestic currency rating. By contrast, Standard & Poor’s argued that under EMU central governments lose their privileged position and that therefore it makes sense to unify the ratings of individual sovereigns on the (in many cases lower) current foreign currency ratings.

The agencies’ divergent views seem to be primarily based on a differing weighting of the value of a national central bank to the creditworthiness of the central government. Standard & Poor’s believes that the national central bank would help its government to avoid default. Moody’s questions this “printing press” view and says that most governments have already abolished this policy option by giving autonomy to their central banks. Thus, market discipline, including the prospect of capital flight, already makes it almost impossible for a central bank to help its government even in extremis. As a result, Moody’s has made less of the distinction between foreign currency and domestic currency ratings and has lower domestic debt ratings. The difference between the current domestic currency rating for Italy, rated AAA by Standard & Poor’s and Aa3 by Moody’s, illustrates this point. It might be noted that the yields on Italian interest rate swaps for prime (AA) names have often been below those for the Italian treasury (see Figure 3), suggesting that financial markets have seen more risk in the treasury’s lira debt than has Standard & Poor’s (see Banca d’ltalia, 1995, pp. 125–26; and Kavero, Giavazzi, and Spaventa, 1996).

These differing views of the rating agencies led to speculation that there might be wide disparities (and resulting uncertainty) between sovereign ratings under EMU. In practice, however, Standard & Poor’s foreign currency rating for Italy (AA) is just a notch higher than the Aa3 domestic rating of Moody’s. Thus, owing to Standard & Poor’s more buoyant current ratings of domestic debt, the different approaches to unifying the government ratings will not result in large differences under the euro (see Table 10). Although Standard & Poor’s has been described as rating sovereigns marginally higher than Moody’s (see Cantor and Packer, 1996, p. 39), at this stage Standard & Poor’s indicated EMU ratings are lower than those of Moody’s for Finland, Greece, Ireland, and Portugal.

Table 11.International Security Issues by Issue Size and Currency(In billions of U.S. dollars, 1990–95)
Size of Issue
Currency by Region<$1.0 billion≥$1.0 billionTotal
Developing countries141.710.5152.2
U.S. dollar96.87.4104.2
EU currencies17.60.017.6
Japanese yen27.33.230.5
Developed countries1,555.7209.11,764.8
U.S. dollar554.9119.5674.4
EU currencies660.158.9719.0
Japanese yen340.830.6371.4
International institutions117.139.9216.9
U.S. dollar34.115.049.1
EU currencies113.915.3129.3
Japanese yen29.19.538.6
Total1,874.5259.52,134.0
U.S. dollar685.8141.9827.7
EU currencies791.674.3865.9
Japanese yen397.143.3440.4
Grand total,
including offshore centers2,078.6276.92,355.5
Source: BIS.Note: Including bunds :md medium-term notes.
Source: BIS.Note: Including bunds :md medium-term notes.

Despite the different starting points of the two ratings agencies, and their different analysis, in the end their ratings would thus not be very different. Moody’s could portray its decision to treat the euro as a domestic currency as more logical than Standard & Poor’s treatment. In addition, it is easier for the affected governments to accept Moody’s planned abolition of their foreign currency ceiling, since only upgrades are implied, than it is for them to accept Standard & Poor’s planned downgradings of domestic debt. Standard & Poor’s, for its part, could back off somewhat from its domestic currency ratings.

Internationally, the euro bond market can be expected to be a more attractive place for asset managers, both official and private, in which to invest. Many analysts stop here and draw the conclusion that the euro could be secularly strong, as it benefits from portfolio reallocations at the expense of the dollar. But debtors, both companies and governments, outside the euro area can also be expected to find the euro bond market a more attractive market into which to issue. Thus a larger, broader, deeper, and more liquid bond market in Europe does not necessarily imply that the value of the euro will benefit from net portfolio shifts.

Internal Implications

Gradual process of portfolio diversification. A single reference yield curve for the pricing of private credit risks, in conjunction, perhaps, with a government benchmark yield curve, is a necessary but not sufficient condition for an integrated bond market. As long as the portfolios of insurance companies, pension funds, and mutual funds show a strong bias toward home-country issuers, then integration will remain partial.19 Many such portfolios have currency-matching requirements (see OECD, 1996a, pp.5–17) intended to limit the risk inherent in having obligations to policyholders or fund claimants denominated in one currency and assets in another. Some of these requirements are written in such a fashion that monetary union will automatically permit investment by the affected institutional investors in the euro debt of issuers of a different nationality. Other such requirements confound the nationality of issuer with the currency denomination of the bond and would continue to be binding after EMU. Pressure to remove such portfolio restrictions can be expected, but the European Commission’s proposed Pension Funds Directive, which would have limited regulatory restrictions requiring investment in national assets, has not yet been adopted (see OECD, 1996b, p. 19). The process of portfolio diversification within the euro area will not, in these circumstances, be an instantaneous process like the development of a single private yield curve in euros. “Old habits and preference for national debt die hard” (see Bloem, 1996).

Growth of securities markets in the euro area. Bigger and better money and bond markets could lead to a migration of assets from banks’ balance sheets through the commercial paper and corporate bond market to the balance sheets of insurance companies, mutual funds, and pension funds. But a widespread misunderstanding of the process of securitization in the United States risks a significant overestimate of its potential in Europe. Much of what goes under the heading of securitization in the United States is the bundling of home mortgages into securities, which has depended on government and quasi-government guarantees to remove the idiosyncratic credit risk from the underlying assets. To be sure, these guarantees have also induced technical developments in the bundling of assets to back bonds and these techniques have also been applied to assets not benefiting from such guarantees, including large mortgages, credit card receivables, automobile loans, and even boat loans and aircraft and equipment leases. But such techniques are only now finding application in Europe (see Jeanneau, 1996). Here we concentrate on the prospects for the growth of the commercial paper corporate bond markets in Europe.

After the euro arrives, corporate treasurers in the euro area would make a different calculation of costs and benefits in choosing whether to issue commercial paper and bonds or to borrow from a bank. The cost of a new bond issue would be lower because of more competitive underwriting in a market no longer segmented by currency. Moreover, to the extent that the government bond market in Europe becomes more liquid, the cost to underwriters of hedging a new issue, through taking a short position in government bonds in the cash or futures market, would decline and this saving would also be expected to pass through to the borrower. Other costs, such as the cost of obtaining a credit rating and the cost of marketing to a given class of investors, would not rise with the euro. Moreover, with time, the benefits of issuing its own commercial paper or bonds would rise for a corporation in the euro area. That is because the range and size of the investment portfolios to which the securities could be marketed would also rise as asset managers in the euro market looked beyond national boundaries to improve their performance. In these circumstances, a lower yield could be required to place paper and bonds of a given quality.

From the perspective of asset managers in Europe, a greater capacity to analyze credit risk and a greater tolerance for credit risk could be expected to result from the euro’s elimination of currency risk. As things stand, the manager of a multicurrency bond portfolio faces a hierarchy of choice, in which the most important choice is across countries, the second-tier choice is duration, and the last choice is credit risk. As matters stand, this last choice is a very safe one: “Almost 50% of nonsovereign issuance is AAA in the European currencies segments” of the eurobond market (see Karsenti, 1996, section 4.4). The elimination of the currency choice within Europe can be expected to result in greater attention to the duration and credit choices and, in the search for higher yields, a greater tolerance of risk in both dimensions.

How far could this improved calculus alter the corporate securities market in Europe? The potential for assets to be stripped out of the banking system is illustrated by the growth of the original-issue junk bond and commercial paper markets in the United States. From a base near zero in the early 1980s, ourtanding bonds of non-investment-grade firms rose to over $200 billion in 1996 (see Fridson and Garman, 1996, p. 28), equivalent to about a quarter of oustanding corporate bank loans. In addition, outstanding commercial paper of mostly well-rated nonfinancial firms approached $200 billion in 1996, well beyond the levels reached in the late-blooming European paper markets (see Alworth and Borio, 1993).20 Following these precedents, security markets could place at risk one-third of European banks’ corporate loans.

If the euro can be expected to accelerate the expansion of securities at the expense of bank loans, it can also be expected to accelerate competition from securities markets on the deposit side. The euro repo market, essentially a money market instrument collateralized against government bonds, would compete with bank deposits for short-term funds. In the United States, mutual funds, state and local governments (and their pension funds), foreign investors, pension funds, and insurance companies are the largest providers of funds under repo arrangements. In contrast, these kinds of investors in Europe would currently hold bank deposits.21 While banks themselves are the largest takers of funds in the U.S. repo market, followed by securities dealers, these collateralized instruments may compete directly for funds with high-quality European banks that are now able to offer low yields on their low-risk liabilities.

In Europe, repurchase markets are developing rapidly (see BIS, 1996a, p. 74; and BIS, 1996c, pp. 20–24). Once the ECB starts operating in the repo market, with an undifferentiated range of government-paper accepted collateral, then the euro can be expected to accelerate the growth of the repo markets in Europe.

In summary, the stimulus given to the European money and bond markets by the euro can be expected to make commercial papers and bonds more serious competitors for bank loans. More European firms will find it rewarding to issue paper and bonds, and the euro repo market will offer a deep and high-quality alternative to bank deposits.

International Implications: Investment and Borrowing in the Euro

Many analysts foresee that international portfolio shifts into an increasingly broad, deep, and more liquid euro market have the potential to make the euro a strong currency. On the basis of a similar portfolio reasoning, however, we view this presumption as an unsafe one, because the euro would also be a more attractive currency in which to borrow.

Greater liquidity and depth could increase the international demand for bonds denominated in euros relative to the total demand for bonds in the constituent currencies. In considering the potential for shifts by private portfolio managers into euro-denominated bonds, a difficult question arises as to whether interest rates in a large euro bond market might show a smaller correlation with U.S. bond yields than current European government bond rates. This is an interesting question because private portfolio managers would find the euro bond market particularly attractive if it offered diversification benefits superior to anything available in the constituent bond markets. Large and diverse investors could provide ballast to a European bond market subject to spillovers from New York. However, it is notable that the trend toward higher correlations across European bond markets in recent years has not to date brought any diminution of the correlation between the German and U.S. markets.

The scope for a potential reallocation of private portfolios from the dollar to the euro is necessarily extremely conjectural. One starting point is the shares across Group of Ten currencies of GDP, trade, and international assets, including both international bank deposits and international bonds. The Group of Ten members of the EU produce about one-third of Group of Ten output and would show a slightly smaller share of international trade (net of their intra-EU trade). After a similar consolidation, however, the share of international assets denominated in euros would be only about one-eighth. For the euro share to match the output and trade share of Group of Ten members of the EU would require a shift of some $0.7 trillion (see McCauley, 1997). This figure should not be taken too seriously. Nevertheless, it serves to make an important point, namely, that private portfolio shifts could prove to be much larger than any possible official reserve shifts.

As well as having strong attractions for asset managers, a more integrated bond market in Europe would also attract debt managers in the steady state. The development of a broad and deep euro bond market could potentially affect debt management more strongly than asset management, and the greater supply of euro-denominated assets could place downward pressure on the euro.

It may seem strange that something as welcome as the development of broad, deep, and liquid markets could weaken the currency concerned, but portfolio theory holds that the shift of funding from one currency to another will result in some combination of a higher interest rate and a lower exchange rate for the currency experiencing the increased supply. For instance, were Thailand to issue new deutsche mark securities and use the proceeds to buy in all its dollar debt, private investors would need to be induced to hold more marks and fewer dollar assets. Depending on the size of the operation, one might expect some combination of higher deutsche mark interest rates and a lower mark in order to make the investors willing to hold the new proportion of assets supplied. The flow conception of exchange rate determination agrees with the result: as the Thais exchanged the marks raised for dollars with which to buy their outstanding debts, demand for the dollar would rise.

The current choice of currency for large issues for global debt managers and the current financing habits of emerging economies make the prospect of heavier use of the euro by debt managers plausible. As things stand, international bond issuers favor the dollar for large deals (see Table 11). A plausible interpretation is that U.S. treasury bond benchmarks in the cash market are larger, the bond futures markets serving the dollar bond markets are more liquid, and the ultimate bond buyers are bigger. If an underwriter of a large bond in euros could more easily hedge against movements in the underlying euro yields, issuing costs might fall, eliminating this bias. The likely result would be more issuance in euros.

Faced with a broader, deeper, and more liquid bond market in Europe, debt managers outside Europe could be interested in increasing the proportion of their debt denominated in euros. The estimated currency composition of the international debts of countries in Asia and Latin America (see Table 12) shows a very low share of European currencies.22 Even if the euro does not displace the dollar or, in Asia, the yen as a reserve currency, there is great scope for additional borrowing in euros to cover existing exposures. Currently, the weight placed on European currencies in the reserves of nonindustrial countries is noticeably heavier than that in the debts of those countries.

Table 12.Currency Composition of Developing Country Debt(In billions of U.S. dollars and percentages at end-1996)
(Currency)
ObligorsU.S. dollarJapanese yenEU currenciesOther1Total
Latin America421.166.072.065.2624.3
67.4%10.6%11.5%10.4%100.0%
Banks2100.32.27.14.2113.7
World Bank3320.863.865.061.0510.7
Asia344.7243.471.785.4745.1
46.3%32.7%9.6%11.5%100.0%
Banks2135.780.110.616.9243.3
World Bank4209.0163.361.168.5501.9
Eastern Europe138.042.6101.990.9373.4
37.0%11.4%27.3%24.3%100.0%
Banks2,57.30.514.35.327.4
World Bank6130.842.287.585.6346.1
Total1,044.5377.1329.4331.42,082.5
50.2%18.1%15.8%15.9%100.0%
Banks2245.073.932.922.3374.1
World Bank799.5303.2296.6309.11,708.4
Sources; World Bank; and BIS.Note: Obligor total includes other developing countries. World Bank figures for 1996 are preliminary and refer to debt maturity greater than one year. Multiple-currency debt reported by the World Bank is distributed among underlying currencies according to the composition of the World Bank currency pool. Figures may not add due to rounding.

Including unidentified.

Excludes bank claims of more than one-year maturity; including medium-term debt with remaining maturity less than one year. Semiannual maturity distribution applied to quarterly currency distribution. Includes own estimates of currency breakdown of debt to banks in offshore centers and other debt to banks for which no official currency breakdown is available.

World Bank subtotal for Latin America and the Caribbean.

Comprises World Bank subtotals for East Asia and Pacific and South Asia.

Includes the former Yugoslavia.

Comprises World Bank subtotals for Europe and Central Asia.

Sources; World Bank; and BIS.Note: Obligor total includes other developing countries. World Bank figures for 1996 are preliminary and refer to debt maturity greater than one year. Multiple-currency debt reported by the World Bank is distributed among underlying currencies according to the composition of the World Bank currency pool. Figures may not add due to rounding.

Including unidentified.

Excludes bank claims of more than one-year maturity; including medium-term debt with remaining maturity less than one year. Semiannual maturity distribution applied to quarterly currency distribution. Includes own estimates of currency breakdown of debt to banks in offshore centers and other debt to banks for which no official currency breakdown is available.

World Bank subtotal for Latin America and the Caribbean.

Comprises World Bank subtotals for East Asia and Pacific and South Asia.

Includes the former Yugoslavia.

Comprises World Bank subtotals for Europe and Central Asia.

It is possible that the attraction of a larger supply of euro-denominated assets, which in a portfolio balance framework would push down the value of the euro, could outweigh the attraction of a larger demand, which would push it up. Even if the demand shift is foreseen to be larger or faster, it should be recognized that the international bond market regularly shifts the composition of new offerings toward the strengthening currency.23 At any rate, one should not attempt to calculate the effects of the greater attraction of the euro for official and private asset managers without considering that it might hold a similar attraction for debt managers.

The Euro and the European Banking System

The successful introduction of a single currency will have direct effects on individual financial institutions. In particular, in the transition it seems certain to raise some costs, cut some revenues, and increase uncertainty in some respects. It is also certain to alter the macroeconomic environment in which financial institutions operate. What is much more problematical is whether the introduction of the euro will catalyze a significant increase in international competition between financial institutions. On this issue, views differ widely and predictions are highly uncertain.24

Transition Costs of Monetary Union

What is clear is that banks will have to bear increased costs during the transition. Customers will seek advice on EMU matters; computer systems have to be altered; stationery and forms must be reprinted; and personnel need to be trained.25 Moreover, these costs, especially for computer systems, are liable to increase dramatically for those institutions that choose to delay their preparations in light of perceived uncertainties about the introduction of the single currency. Influenced as well by the need to deal with the “year 2000” problem, the salaries of information technology personnel have already begun to rise significantly. Indeed, given shortages in this area and the number of financial firms that have not yet commenced their preparations,26 some commentators have even started to question whether current deadlines for EMU are technically feasible.27

After the introduction of the single currency, banks will have extra note-handling costs and will lose revenues in other ways. An obvious point is that trading revenues from foreign exchange transactions between currencies subsumed into the euro will disappear. On the basis of turnover data collected by 26 central banks for the Central Bank Survey of Foreign Exchange and Derivatives Market Activity 1995,28Salomon Brothers (1996, p. 9) estimates that the net revenues derived from foreign exchange trading might fall by up to 10 percent, although this would imply only about a 1 percent decline in total revenues. Receipts from intra-European funds transfers might also be expected to decline, as would fees from the exchange of travelers’ checks and banknotes. Revenues from bond trading across European currencies might also be reduced, given that changes in perceptions about credit risk are less volatile than expectations about exchange rate changes. Bond trading is also likely to migrate to larger centers, which could have significant effects on financial institutions based in smaller centers. It is also yet to be determined whether financial institutions within EMU will be subject to reserve requirements. If they are, and these reserves are not interest-bearing, this will be a further charge for banks to bear even if some part of it might well be passed on to their customers.29 Finally, there may be certain national conventions that are currently profitable for banks but that might disappear under EMU; for example, “sight deposits” in France still do not pay interest even though ECU “sight deposits” do.

The introduction of the euro will also raise other uncertainties for banks. First, the replacement of national currencies with the euro could call into question the legal validity of some outstanding contracts. It cannot be ruled out that (particularly non-European) counterparties on the losing end of contract will seek to avoid that loss by having recourse to non-European courts.30 A closely related possibility is that borrowers with high, long-term, fixed-rate obligations in national currencies will litigate for the right to renegotiate at lower euro rates.31 The final effects of this on banks individually and colleclively are not obvious. Second, during the whole period prior to Stage III of EMU, shocks could occur that might call the commitment of individual countries to participation into question, complicating advance planning by banks.

A last consideration is that many of the sovereign participants in EMU should eventually gain the benefits of faster growth, lower inflation, and lower market volatility that EMU is expected to provide. However, for banks this will be a mixed blessing. Banks will share in the benefits of faster growth, but lower inflation, could well lead to a reduction in interest rate spreads. Lower inflation may also (over the medium term) exacerbate problem loans associated with current low property prices, although (over the longer term) it might make a repetition of such exposures less likely. As for volatility in financial markets, banks will face less market risk themselves but they will also lose the revenues derived from helping their clients cope with market risk. In a more stable environment, credit risk should also be easier to evaluate and should generally be lower. In contrast, under EMU the likelihood of bailouts of national (nonbank) firms by national governments may be significantly reduced, which would imply higher levels of credit risk in some cases.

The Euro and Increased Competition in Banking

Rating agencies do seem to feel that EMU will increase competitive pressures between financial institutions.32 Indeed, this must happen if the very significant gains for consumers, foretold in the Emerson report of 1988, are to be realized. However, in light of the relatively limited competitive response to date, this conclusion might seem questionable unless one were to ascribe an important catalytic role to the introduction of the euro itself. A number of arguments have been made in this regard, though they vary widely in their persuasiveness and no single argument seems to us to be totally persuasive. The euro is projected variously to cause bank customers, regulators and legislators, and financial institutions themselves to alter their behavior.

Perhaps the loftiest of these arguments has to do with the attitude of bank customers. Recall that the introduction of the euro is intended to serve as a powerful political symbol uniting Europeans and reducing the importance of national differences. Would it not then be expected to play the same role in the financial sector? Indeed, Johnson 1996, pp. 51–52) goes even further to argue that “It is intuitively obvious that the existence of separate currencies must divide the market in money even more than those in other goods and services.” However, it remains to be seen how long it might take for a Yorkshire farmer to view German, French, and U.K. banks with equanimity.

Another argument pertaining to customer attitudes has been put forward by the Association Cambiste Internationale (1995, p. 24), which considers that “the single currency, by eliminating foreign exchange rate risk and converging interest rates…will result in a greater willingness on the part of customers to look outside national borders for financial services.” While more prosaic than the first argument, it is also more compelling. Multinational firms may consolidate their European treasury operations and with them their banking relationships. Increased transparency and increased comparability between fee structures and rates offered by banks in different national jurisdictions should also help to promote convergence. This might apply particularly in border regions, but it could apply much more broadly given the growing influence of electronic banking (often being introduced by firms unencumbered by traditional branches) and the use of credit scoring techniques. The essence of both is that physical proximity to customers is not required. An important counterargument, which may have some force during the transition period at least, is that smaller customers may choose to rely still more heavily on their traditional bankers for advice in a period of change.

It has been further contended that separate currencies also serve to segment the market for bank credit in Europe. However, some limited evidence suggests that separate currencies may not have a great impact on borrowers’ preferences. As indicated in Table 13, the effect of currency on the choice of syndicated loan arrangers stands out less than does the home-country relationship. This finding contrasts with that discussed in the section on the euro and European bond markets, where currency plays a more important role in the choice of bond underwriters.

Table 13.Currency and Home-Country Relationship in the Choice of Syndicated Loan Arranger, 1996(Percentage market share won by arrangers of indicated nationality)
German Arranger BanksFrench Arranger Banks
CurrencyCurrency
BorrowerDeutsche

mark
OtherAllBorrowerFrench

franc
OtherAll
German827180French461039
Other4634Other5622
All6234All4723
Sources: Euromoney Bondware; and BIS.Note: Each entry shows market share of German, French, U.K. or U.S. banks as arrangers of loans for borrowers of the indicated nationality in the indicated currency. For example, the 82 percent in the upper left-hand corner means that German banks arranged 82 percent of the loans for German borrowers that were denominated in deutsche marks. Data include all loans in the Euromoney database that were signed and for which amounts were given, and are therefore more inclusive than the usual data reported by the BIS, which exclude, inter alia, refinancing. Total syndicated loan amounts by currency: deutsche mark: $25 billion; French franc: $31 billion; pound: $102 billion; dollar: $1,254 billion; grand total: $1,514 billion.
U.K. Arranger BanksU.S. Arranger Banks
CurrencyCurrency
BorrowerPoundOtherAllBorrowerDollarOtherAll
U.K.563953U.S.832882
Other2422Other271320
All5336All711361
Sources: Euromoney Bondware; and BIS.Note: Each entry shows market share of German, French, U.K. or U.S. banks as arrangers of loans for borrowers of the indicated nationality in the indicated currency. For example, the 82 percent in the upper left-hand corner means that German banks arranged 82 percent of the loans for German borrowers that were denominated in deutsche marks. Data include all loans in the Euromoney database that were signed and for which amounts were given, and are therefore more inclusive than the usual data reported by the BIS, which exclude, inter alia, refinancing. Total syndicated loan amounts by currency: deutsche mark: $25 billion; French franc: $31 billion; pound: $102 billion; dollar: $1,254 billion; grand total: $1,514 billion.
Sources: Euromoney Bondware; and BIS.Note: Each entry shows market share of German, French, U.K. or U.S. banks as arrangers of loans for borrowers of the indicated nationality in the indicated currency. For example, the 82 percent in the upper left-hand corner means that German banks arranged 82 percent of the loans for German borrowers that were denominated in deutsche marks. Data include all loans in the Euromoney database that were signed and for which amounts were given, and are therefore more inclusive than the usual data reported by the BIS, which exclude, inter alia, refinancing. Total syndicated loan amounts by currency: deutsche mark: $25 billion; French franc: $31 billion; pound: $102 billion; dollar: $1,254 billion; grand total: $1,514 billion.

Another argument having to do with transparency notes that regulatory and other such differences that segregate national markets will be put into higher profile in a single currency area; the opt-out clause in the Second Banking Directive (for “the general good”) might be particularly vulnerable in this regard. Pressures on regulators and legislators for further change might then be expected to arise from those judging themselves to be disadvantaged. Calls for effective “national treatment” might be expected to lead to pressure for “reciprocal” treatment, which could only be fully satisfied through complete harmonization.

If and when competition does begin to increase significantly, a further and important dynamic process might be generated. With profits under pressure as a result, and some banks’ credit ratings potentially declining even below those of some of their customers, the process of disintermediation might be expected to accelerate significantly. In fact, this is broadly what happened in the United States in the early 1980s in the wake of the debt crisis. And as profits decline, there would likely be a further intensification of the attacks on those market practices deemed to give some institutions an unfair competitive advantage. In sum, a number of interacting factors could (and this is a possibility rather than a forecast) sweep away remaining barriers to international competition in the banking area while at the same time putting all banks under increasing pressure from securities markets.

A single currency could also change the behavior of financial institutions, inducing them to internationalize both their corporate and retail businesses. The need to change internal computer and information systems could (indeed, should) prompt a strategic rethinking of the business functions those systems are designed to support.33 Turning first to corporate lending, it must be noted at once that this is not at present a very profitable business in continental Europe.34 This in itself could inhibit expanded competition, as could concerns by lenders that most available foreign clients would be clients that no one else wanted (the adverse selection problem). In contrast, it could also be argued that cross-border “cherry-picking” might become even more attractive given a single currency than it is today.35

It has also been contended that making medium-term loans in foreign currencies, using short-term domestic funding sources, exposes banks to special liquidity risks.36 This discouragement of cross-border lending will certainly disappear with the introduction of the euro, though the magnitude of the resulting effects remains to be determined. However, some guidance on this can be obtained by noting that lenders currently have the possibility, albeit at a cost, of obtaining the required foreign currency for a medium-term period using cross-currency basis swaps; the cost of such swaps (see Table 14) might be seen as a measure of how much different currencies segment the European lending market. In fact, two conclusions arise from Table 14. First, the cost of such swaps is modest, though not trivial. Second, segmentation seems to work to the advantage of banks in some countries more than others. In particular, bank lending in marks, guilders, and French francs seems more protected by borrowing costs than does lending in the lira or Belgian franc.

Table 14.Pricing of Cross-Currency LIBOR Basis Swaps1
Currencies with

Narrower Bid/Ask. Spreads2
Currencies with

Wider Bid/Ask Spreads3
ReceivePayReceivePay
Belgian franc−1−4Australian dollar4−2
Deutsche mark41Austrian schilling95
Dutch guilder41Canadian dollar73
ECU1−4Danish krone4−2
French franc30Finnish markka60
Italian lirao−3Hong Kong dollar2015
Pound sterling2−1Irish pound5−5
Swiss franc30Norwegian krone4−2
Yen−13−16Portuguese escudo−1−8
Spanish peseta73
Swedish krona1−3
Average0−3Average60
Source: Intercapital Brokers.

Basis points above or below respective LIBOR that dealers were prepared so receive and pay versus U.S. dollar LIBOR flat on January 8, 1997.

Spread between receive and pay of 3 basis points.

Spread between receive and pay of 4 or more basis points. The correlation between bid/ask spread and the natural log of trading in local currency in April 1995 is–0.69 (see Central Bank Survey of Foreign Exchange and Derivatives Market Activity, 1995, Table 1-G).

Source: Intercapital Brokers.

Basis points above or below respective LIBOR that dealers were prepared so receive and pay versus U.S. dollar LIBOR flat on January 8, 1997.

Spread between receive and pay of 3 basis points.

Spread between receive and pay of 4 or more basis points. The correlation between bid/ask spread and the natural log of trading in local currency in April 1995 is–0.69 (see Central Bank Survey of Foreign Exchange and Derivatives Market Activity, 1995, Table 1-G).

Whether the introduction of the euro will induce banks to compete more vigorously for retail customers across international borders, ceteris paribus, is even more problematic. Hoschka (1993) and others have argued that foreign banks need some other competitive advantages to stimulate cross-border entry in European retail banking since they face such well-known disadvantages as “reputation” problems, a smaller transaction base, less experience with the local market, and the potential costs of new branches. Could it then be argued in turn that the introduction of the euro might increase the likelihood of such competitive advantage? On the one hand, a consideration of Hoschka’s individual arguments gives few grounds for believing that the introduction of the euro would have any more than a marginal influence.37 On the other hand, a single currency will simplify the accounting of cross-border activities and will allow banks more easily to distinguish those cross-border niche activities that are profitable from those that are not. Moreover, should new competitive opportunities open up in retail banking, because of other changes related to the euro, there is no reason to believe that the banks would be any less inclined to respond than is currently the case.

Need for Adjustment and Potential Difficulties

The direct costs associated with the introduction of a single currency, and the associated increase in competition in the context of EMU, will put further pressure on bank profits and encourage adjustment of various sorts. The severity of that pressure will depend partly on the extent to which the introduction of the euro catalyzes other changes and may well vary in intensity across countries.38

Whatever one believes in this particular regard, market sentiment is that the European banking industry will be radically transformed over the coming years. A 1993 survey39 of 65 bankers in 15 different countries foretold a collapse of profits in corporate banking and the survival of only 10 to 20 retail banks across Europe by the year 2005.40 It is worth considering briefly how banks might react to increased competitive pressures and some of the pitfalls along the way.

Within individual firms, competitive pressures could result in three sorts of efforts to increase profits. In the first place, there could be efforts to increase productivity and to cut costs. Tables 1517 indicate that this process is not well advanced in Europe. In partial contrast, Gual and Neven (1993, p. 176) note that deregulation in European banking prior to 1990 did lead to some increases in productivity, but that the “rents” earned by workers were nevertheless generally well maintained.41 One particularly important problem in many European countries is the existence of labor legislation (or the general nature of existing contracts), which not only makes it difficult to lay off staff in general, but also makes it particularly difficult in the financial sector.42 Indeed, in some cases there are even significant impediments to relocations and other initiatives short of outright loss of employment. The high degree of unionization, allied with strong state involvement in banking, also increases the likelihood of an associated politicization of all measures designed to increase efficiency. All this having been said, the good news is that major efficiency gains are potentially still there to be achieved if these obstacles can be overcome.

Table 15.Restructuring: Number of Institutions and Size Concentration1
Number of InstitutionsConcentration: Top Five (Top Ten)
19802199019953Peak (since 1980)19804199019955
CountryYearPercent

change6
Percentage share in total assets
Belgium1481291501631992−864(76)58(74)59(73)
Finland6314983526311985−4463(68)65(69)74(83)
France1,0337865931,0331984−4357(69)52(66)47(63)
Germany75,3554,1803,4875,3551980−3517(28)
Italy1,0711,0679411,1091987−1526(42)24(39)29(45)
Netherlands2001801742001980−1373(81)77(86)81(89)
Norway3461651483461980−5763(74)68(79)58(71)
Spain83573273183781982−1638(58)38(58)49(62)
Sweden5984981125981980−8164(71)70(82)86(93)
United Kingdom7966655607961983−3063(80)58(79)57(78)
Memorandum items
Japan6186055716181980−825(40)30(45)27(43)
Switzerland4784994154991990−1745(56)45(57)50(62)
United States935,87527,86423,85435,8751980−349(14)9(15)13(21)
Sources: British Bankers’ Association; Building Societies’ Association; and national data, as reported in BIS (1996a).

Deposit-taking institutions, generally including commercial, savings, and various types of mutual and cooperative banks, for Japan excluding various types of credit cooperative.

For Finland. 1985; for France, 1984; for Spain, 1981; for the United Kingdom, 1983.

For Finland, Sweden, and Japan, 1994.

For Finland and the Netherlands, 1985; for France, 1986; for Italy, 1983; for Switzerland, 1987.

For Belgium, the United Kingdom, Japan, and Switzerland, 1994; for Finland, 1993.

From peak to most recent observation where applicable.

For number of institutions, western Germany only. Data for the whole of Germany: 1995, 3,784; percentage change, -30 percent.

Concentration data for commercial and savings banks only.

Excluding credit unions: 1995, 12,067; percentage change, −36 percent.

Sources: British Bankers’ Association; Building Societies’ Association; and national data, as reported in BIS (1996a).

Deposit-taking institutions, generally including commercial, savings, and various types of mutual and cooperative banks, for Japan excluding various types of credit cooperative.

For Finland. 1985; for France, 1984; for Spain, 1981; for the United Kingdom, 1983.

For Finland, Sweden, and Japan, 1994.

For Finland and the Netherlands, 1985; for France, 1986; for Italy, 1983; for Switzerland, 1987.

For Belgium, the United Kingdom, Japan, and Switzerland, 1994; for Finland, 1993.

From peak to most recent observation where applicable.

For number of institutions, western Germany only. Data for the whole of Germany: 1995, 3,784; percentage change, -30 percent.

Concentration data for commercial and savings banks only.

Excluding credit unions: 1995, 12,067; percentage change, −36 percent.

Table 16.Banks’ Restructuring: Number of Branches1
Peak (since 1980)Memor

andum:

Bank

density5
19802199019953Percent

change4
CountryNumber (in thousands)Year
Belgium7.88.37.88.51989−80.77
Finland3.43.32.13.51988−390.42
France24.325.725.525.91987−20.44
Germany639.339.837.940.01985−50.46
Italy12.217.723.923.9199500.42
Netherlands5.58.07.38.01989−90.47
Norway1.91.81.42.21987−370.36
Spain25.835.236.036.0199500.92
Sweden3.73.32.73.71980−270.31
United Kingdom20.419.016.621.21985−220.28
Memorandum items
Japan18.524.825.725.7199400.21
Switzerland3.74.23.84.21990−100.53
United States58.367.769.669.6199400.27
Sources: British Bankers’ Association; Building Societies’ Association; and national data, as reported in BIS (1996a).

Deposit-taking institutions; for Japan and the United States, excluding various types of credit cooperative.

For France and the Netherlands, 1981.

For Belgium, Finland, the Netherlands, Sweden, the United Kingdom, Japan, Switzerland, and the United States, 1994.

From peak to most recent observation where applicable.

Number of branches per 1,000 inhabitants in the latest available year.

Western Germany only, excluding commission agencies of Bausparkassen. Data for the whole of Germany: 1995, 48.2; percentage change, −2 percent.

Sources: British Bankers’ Association; Building Societies’ Association; and national data, as reported in BIS (1996a).

Deposit-taking institutions; for Japan and the United States, excluding various types of credit cooperative.

For France and the Netherlands, 1981.

For Belgium, Finland, the Netherlands, Sweden, the United Kingdom, Japan, Switzerland, and the United States, 1994.

From peak to most recent observation where applicable.

Number of branches per 1,000 inhabitants in the latest available year.

Western Germany only, excluding commission agencies of Bausparkassen. Data for the whole of Germany: 1995, 48.2; percentage change, −2 percent.

Table 17.Banks’ Restructuring: Employment and Staff Costs
Employment1Staff Costs2
19803199019944Peak (since 1980)1980–8251986–881992–94
CountryNumber(in thousands)YearPercent

change6
As a percentage of gross income
Belgium687976791990−54133397
Finland425036531989−32433324
France3993993824011988−5474444
Germany853362165865819940484439
Italy2773243323331993−0.3464844
Netherlands1131181121191991−6424138
Norway243123351987−34423530
Spain2522522452561991−4474337
Sweden394542461991−5292322
United Kingdom3244253684301989−15473836
Memorandum items
Japan6125976186221993−0.6443339
Switzerland841201121201990−7403733
United States91,9001,9791,8912,1361987−12363127
Sources: For staff costs, OECD; for employment, British Bankers’ Association, Building Societies’ Association; and national data, as repotted in BIS (1996a).

In deposit-taking institutions; for Japan, excluding credit cooperatives.

For Belgium, the Netherlands, and Switzerland, all banks; for other countries, commercial banks (OECD definition).

For France, 1985; for the Netherlands and Sweden, 1984; for Spain, 1981.

For Italy, Norway, and Spain, 1995.

For Belgium and France, 1981–82.

From peak to most recent observation where applicable.

1992.

For employment, western Germany only. Data for the whole of Germany: 1994, 728.

Employment data excluding credit unions: 1994, 1,732; percentage change, −14 percent.

Sources: For staff costs, OECD; for employment, British Bankers’ Association, Building Societies’ Association; and national data, as repotted in BIS (1996a).

In deposit-taking institutions; for Japan, excluding credit cooperatives.

For Belgium, the Netherlands, and Switzerland, all banks; for other countries, commercial banks (OECD definition).

For France, 1985; for the Netherlands and Sweden, 1984; for Spain, 1981.

For Italy, Norway, and Spain, 1995.

For Belgium and France, 1981–82.

From peak to most recent observation where applicable.

1992.

For employment, western Germany only. Data for the whole of Germany: 1994, 728.

Employment data excluding credit unions: 1994, 1,732; percentage change, −14 percent.

A second possibility is that individual firms might be tempted to restore sinking profit margins by taking on more risk. This is not implausible. Indeed, the behavior of U.S. (and many other) banks after the debt crisis of the early 1980s—behavior that led successively to heavy investment in commercial property, leveraged buyouts, market trading, and emerging market debt once again in the early 1990s—may well have been motivated by such considerations. Even if such a possibility were to be discounted, any significant increase in cross-border competition after the introduction of the euro will likely imply that many banks will be making credit evaluations of previously unfamiliar counterparties. Errors of judgment will be easier to make in such an environment.

A third and more positive possibility is that banks will turn to new products and lines of business to enhance returns. Indeed, this has already begun, with German banks in particular buying up U.K. firms with a view to increasing profits from investment banking. Should there be (as suggested in the second section of this paper) a substantial increase in the issue of euro securities, European banks should be first in line to profit given the revealed preference of issuers to choose underwriters from the same currency area. However, following an investment banking strategy involves enormous infrastructure and staffing costs up front. As for other aspects of the investment banking business, it must be noted that global competition may be more fierce. For example, in 1996 five of the top ten firms doing cross-border mergers and acquisitions in Europe were U.S. firms, and Goldman Sachs for the first time did more business in France than did Lazard Frères. Asset management is another area where fee income seems likely to increase sharply on the basis of changing demographics and a potential substitution of private saving for state-sponsored schemes. Again, however, positioning has already begun and continental banks may expect strong competition from both U.K. and U.S. financial firms.

Other opportunities at the interfirm level will also be exploited to deal with competitive pressures. Mergers and acquisitions are one possibility,43 though such moves may also run into political resistance and labor legislation, which limits the ability to gain the full benefits of either scope or scale.44 As indicated in Table 18, not a great deal has happened in this respect in continental Europe to date. Another possible strategy will be the pursuit of cross-border alliances, which will allow firms to supply special services over a much wider area than would have been possible otherwise. In itself, however, such a strategy of alliances among existing market participants does not materially address the underlying problem for the industry as a whole, namely, that the rate of return on capital is likely to remain too low.

Table 18.Merger and Acquisition Activity in Banking1
NumberValue
(In billions of U.S. dollars)(As a percentage)2
Country1991–921993–941995–9631991–921993–941995–9631991–921993–941995–963
Belgium2218121.00.60.414.17.07.9
Finland511640.91.00.822.321.711.3
France13371432.40.53.24.31.010.4
Germany7183273.51.90.76.57.63.5
Italy122105655.36.13.015.617.719.7
Netherlands201370.10.10.80.20.59.5
Norway232420.10.20.41.25.74.4
Spain7644264.34.52.113.521.534.1
Sweden382381.10.40.13.82.00.4
United Kingdom7140287.53.321.76.53.412.4
Total62743722226.118.533.37.36.711.0
Total nonbank financial1,3831,36183428.038.827.27.814.09.0
Memorandum items4
Japan228170.02.233.80.318.877.0
(22)(14)(17)(0.3)(1.5)(0.2)(3.6)(12.8)(0.4)
Switzerland4759140.43.90.79.543.41.6
(30)(30)(28)(0.4)(2.0)(1.3)(9.7)(21.9)(3.1)
United States1,3541,4771,17656.855.382.518.79.013.5
(984)(1,426)(1,125)(30.4)(72.8)(56.9)(10.0)(11.9)(9.3)
Source: Securities Data Company. as reported in BIS (1996a).

Classified by the industry of the target; only completed or pending deals; announcement dare volumes.

Of mergers and acquisitions in all industries.

As at April 4,1996.

Numbers in parentheses: nonbank financial.

Source: Securities Data Company. as reported in BIS (1996a).

Classified by the industry of the target; only completed or pending deals; announcement dare volumes.

Of mergers and acquisitions in all industries.

As at April 4,1996.

Numbers in parentheses: nonbank financial.

The final possibility is that some of the capital currently in the financial services industry in Europe will be withdrawn and/or consolidated in some way. Hopefully, this will happen in an incremental and nondisruptive fashion as smaller firms are closed or taken over. Yet, as the process of consolidation continues, and remaining firms become larger and larger, the likelihood of a disruptive failure could also increase (see Schoenmaker, 1995). This likelihood may also be further increased if two recent trends continue. First, given the high costs of the information technology that will be needed to ensure survival (at least for a time) in such an environment, fixed costs will rise relative to variable costs. This implies that, in the later stages of any restructuring process, it may make sense for some firms to continue to operate at a loss for an extended period of time. Second, if the recent trend toward using “branding” as a competitive tool continues, the purpose of which is to ensure that all parts of a business are associated with the brand name, it may become harder to close down unprofitable parts of a business than in the past. Should the current resistance of national governments to closures also be maintained, ongoing competition from nonviable banks could continue to threaten the prospects of other banks and the health of the financial system more broadly.

Implications for Banking Systems

The possibility of intensified competition and the need for restructuring within European financial markets highlight a number of issues for public policy. Prudence of course demands that these be addressed in the spirit of “planning for the worst,” even while anticipating the best. Within Europe itself, the first issue has to do with the incentive structure for sound banking provided by the authorities. Closely related is the issue of preventing problems from occurring and managing them when they do. A third issue is the implications of a single currency for the transmission mechanism of monetary policy and related implications for financial stability. Given the importance of Europe in integrated global markets, all of these issues are of interest to non-Europeans. Finally, the European experience of cooperation might well provide lessons for others as to how to improve global financial cooperation.

Internal Implications

Incentive structures for sound banking. Sound banking practices tend to be discouraged by the likelihood of state bailouts, particularly if the shareholders and management are left intact. Competition policy at the EU level strongly discourages such interference, yet, given the current degree of state involvement in the national banking systems of many countries, it may be politically hard to avoid for some years to come (see Table 19). The continuing important role of mutual and cooperative banks in some European countries is a further complication. However, with time, a different set of problems could emerge. A successful process of consolidation could result in a smaller number of international financial institutions (with no truly national affiliation other than legal incorporation), which might begin to consider themselves either too big or too complex to fail. In such a multinational context, and one without a central fiscal authority, the difficulties of organizing a bailout even for an individual bank could be considerable. Perhaps the good news is that knowledge of this fact would be a welcome incentive for more prudent private sector behavior.

Table 19.Intrinsic Strength and Ordinary Ratings of European Banks
CountryNumber of

Rated Banks
Range of BFSRsAverage BFSRAverage

Long-Term

Deposit Rating
Austria7B to D+CAa3
Belgium7B+ to CBAa3
Denmark3BtoCC+A1
Finland4D+ to EDA2
France27A to DC+A1
Germany21AtoD+c+Aa1
Ireland4B to C+B/C+A1/A2
Italy16BtoEcA2
Luxembourg3BBAa2
Netherlands5A to C+B+Aa1
Portugal3C+ to CCA3
Spain11AtoCBAa3
Sweden4C+ to CCA2
United King dom24A to C+BA1
Source: Moody’s (1997).Note: Bank financial strength ratings (BFSRs) measure intrinsic safety and soundness on a legal standalone basis. Ordinary long-term deposit ratings factor in external credit support from owners, industry group and/or official institutions.
Source: Moody’s (1997).Note: Bank financial strength ratings (BFSRs) measure intrinsic safety and soundness on a legal standalone basis. Ordinary long-term deposit ratings factor in external credit support from owners, industry group and/or official institutions.

Deposit insurance has obvious merits but there can be associated incentive problems as well. In Europe, the Directive on Deposit Guarantee Schemes (adopted on May 30, 1994) ensures that all EU countries offer a minimum level of deposit insurance, though there continue to be significant differences in these schemes across countries.45 While deposit insurance may make depositors less careful in their choice of bank, this may not be of major concern given that the insurance limit is explicit (barring expectations of a bailout), that it is has often been set at a relatively low level, and that higher insurance levels may be matched (as in Germany) by commensurately strict supervision. However, another problem is that deposit insurance schemes differ across European countries and are essentially “home”-determined. With a single currency, this could lead to an increased flow of deposits to banks domiciled in the most heavily insured jurisdiction, assuming their deposit insurance covers nonresidents.46 In recognition of this problem, it has recently been agreed that (until December 31, 1999) home-country protection schemes offered by branches abroad cannot provide better depositor protection than the host-country scheme. The European Commission is currently preparing a report on the rationale and consequences of the present situation and will report by the end of the decade.

A final issue having to do with incentives is related to the fact that all European sovereign debt is zero weighted under the Basle Capital Accord and the Capital Adequacy Directive. Since the introduction of the single currency will heighten the credit risk in sovereign debt, these capital provisions may provide an inappropriate incentive for financial institutions to hold sovereign debt. Moreover, most banking systems in Europe (and also pensions funds) tend to hold only debt of their national sovereign, which means a significant degree of exposure should the credit risk of that particular country be revised upward (see Table 20).47 The implication seems to be that any remaining national restrictions on outward portfolio flows should be abolished, and that international diversification of bank assets with respect to sovereign risk should be actively encouraged. As discussed earlier, this would also encourage further the development of a single European bond market denominated in euros.

Table 20.Claims on Central Government1(Percentage of Total Bant Assets)
Country19751980198519901995
Belgium17.515.319.218.628.9
France3.99,711.57.211.2
Germany9.912.814.012.415.1
Italy10.118.321.915.3
Spain22.920.419.0
United Kingdom25.53.11.30.91.3
Memorandum item
United States10.07.68.65.87.5
Source: IMF, International Financial Statistics.

Exctudmg reserves.

Net claims.

Source: IMF, International Financial Statistics.

Exctudmg reserves.

Net claims.

Preventing and managing banking problems. A number of supervisory issues arise in the context of the single currency. The first and most important, at least in principle, is whether supervisory authority should rest with the ECB or the national supervisors. At the moment, it is clearly intended that the national supervisory authorities should continue to carry out their current responsibilities. This will have the effect of helping to separate the monetary policy function from the supervisory function,48 and of ensuring that supervisors are physically close to those being regulated. Moreover, it would seem broadly consistent with a system of national deposit insurance. However, such a diffuse system will also make it harder to monitor exposure to single creditors borrowing in different parts of the integrated market, and will put a large premium on the efficient exchange of information. It also seems likely to encourage the maintenance of existing differences in both supervisory practices and capital standards among member nations, which, as noted above, continue to impede formation of the single market.

It will be important to maintain an efficient information flow under the currently envisaged supervisory arrangements. About half of the national supervisory authorities are central banks, whereas other agencies are involved in other countries (some attached to treasuries and some not). Domestic relations between these generic groups of institutions have not always been easy, though to date it appears that the different kinds of national supervisors interact in an admirable way at the international level (see Kapstein, 1994). A second problem may be differences of philosophy about the extent to which privileged supervisory information should be shared, not only between institutions, but also between supervisors and those responsible for monetary policy.49 A third issue has to do with the prospective role of the Banking Supervisory Sub-Committee, which meets at the EMI. On the one hand, playing up its role implies that non-central-bank officials have an important role within the framework of the ECB. On the other hand, to the extent that its influence is downplayed, that influence might migrate to the Banking Advisory Committee of the European Commission. Since this committee also includes treasury representatives, the number of parties requiring to be fully informed about banking sector difficulties rises even further, as does the scope for misunderstanding in times of difficulty.

A number of commentators (e.g., Levitt, 1995) have suggested that these problems could prove insurmountable and that authority in the supervisory area would tend to migrate to the ECB.50 While at present the ECB has only advisory powers in this area,51 Article 105.6 of the Maastricht Treaty states that it could be given “specific tasks concerning policies” conditional on a unanimous decision of the Council on a proposal by the Commission. Whether this is a likely development remains to be seen but, barring a major crisis that might call into question existing arrangements, it could well take a very long time. Another development supporting such an outcome would be the creation of big European banks whose “home” supervisor was not obvious. It is also worth noting that, were there to be such a major change in approach, the issue of a pan-European supervisor outside the ECB might also be raised again. Whatever the affiliation of the European supervisor, the character of its mandate (in particular, which institutions to oversee), the legal basis of its powers (powers that are currently based in national legislation), and the methods through which it would be made accountable would all still have to be decided upon.

Some similar issues arise in the context of potential official lending facilities under EMU. Rightly respecting the principle of “constructive ambiguity,” the Treaty is unclear whether such a facility should exist, and thus provides no guidance as to whether those potentially involved should be national central banks, the ECB, or both. Nor does it assign responsibility for banks whose business is predominantly international. With supervision being conducted by the national authorities, presumably they (if anyone) would be in the best position to advise the national central bank whether an individual bank was solvent and whether liquidity support for the bank was warranted. Moreover, should a bank initially deemed solvent ultimately prove insolvent, it would seem more appropriate that the associated fiscal charge be borne at the national rather than the European level.52 Such an approach might also be thought attractive in that it would contribute to a separation between the official lending function and the monetary policy function. Yet it also seems clear that, in some circumstances, the ECB might also wish to play a lending role. Within the single market created by EMU, there would be a greater chance of contagion across institutions and borders and this could imply the need for a system-wide response. Indeed, responding to a market-wide shortage of liquidity might be thought the natural function of the ECB. However, while the ECB would presumably be monitoring markets in the course of its everyday operations,53 it might still be uncomfortably dependent on national supervisors for information that might be crucial in a crisis.

Interest rate effects and financial stability. During the ERM crisis of 1992, it became clear that the relatively greater reliance on variable rate mortgages in the United Kingdom meant that the effects of monetary tightening on spending propensities were both faster and greater than in France. Given these different circumstances, the French authorities felt able to effect a more successful defence of their currency within the ERM than did the U.K. authorities. More recently, the BIS (1995) has documented more fully the extent to which the transmission mechanisms of monetary policy seem to differ across the major countries, and the extent to which these differences have their roots in differences in financial structure.54 The reaction of loan rates charged by banks (at the margin) is much slower in some European countries than in others. Moreover, in some countries, fixed rate loans and longer-term loans are much more common than in others. Some countries also rely less on credit rationing devices (relatively high down payments for houses, cars, etc.), implying that much larger swings in interest rates are required to have the same effects on spending.55

Differences of this sort within a single currency area imply that common short-term interest rate changes will have different effects in different national jurisdictions.56 This is obviously of interest for those who will be concerned about the transmission mechanism of monetary policy within EMU. However, these differences in financial structure could potentially have implications for financial stability as well. Suppose interest rates did have to rise significantly to ensure price stability in the EU as a whole. Those countries in which the impact of this was particularly great, because of their national financial structure, would presumably suffer a commensurate reduction in the quality of both public and private credits.57 Moreover, if the national banking system was heavily invested in national government debt (see point on incentive structures for sound banking, above) and/or was initially weak for other reasons, the direct impact on bank profits could be quite significant. By the same token, any country with a particular tradition of longer-term lending at fixed rates, financed to whatever degree with shorter-term deposits, could find its profits under pressure from this source.

The upshot of this line of thought is that concerns about financial fragility in particular countries could act as a potential constraint on the conduct of monetary policy for the EU as a whole. It is, of course, likely that the single currency will lead to these structural differences disappearing over time. Indeed, it is evident that, once there is a single money market and bond market, all market interest rates (reflecting shifts in implicit forward yields) should move uniformly in different national jurisdictions, barring shifts in risk premiums. Yet other national differences may be longer lasting, implying that transitional difficulties cannot be wholly ignored. This point is further reinforced if the need for fiscal restraint under the Maastricht Treaty, and potentially further agreements still to be reached, call into question the fiscal capacity of national governments to deal with systemic problems in their national banking system.58 The fundamental point is that both a sound financial system and a sound fiscal position will be required to ensure macro-economic stability after the introduction of the single currency. It is obvious that not having the former threatens the latter,59 but the converse may be true as well.

International Implications

To prognosticate about the possible implications for public policy within Europe resulting from the possible effects on financial structure of the possible introduction of the euro involves at least three levels of speculation. To introduce a fourth level, the possible international implications of all the above, is even more fanciful. Yet some broad lines of thought do seem to be suggested, having to do with the harmonization of domestic financial and regulatory structures, the process of international regulation and supervision, and the specific issue of “host-versus-home” supervision.

A process of enhanced competition within Europe will leave a smaller number of large banks, many of which will have a presence outside Europe. With a view to possible bankruptcy or other difficulties, it would seem all the more desirable to harmonize bankruptcy laws for financial institutions as well as other aspects of the legal and regulatory framework within which such institutions operate. Indeed, it is possible that under the pressure of intensified international competition and concern about regulatory arbitrage a dynamic-might arise in the direction of such harmonization. For example, Barth, Nolle, and Rice (1997, pp. 31–32) make a strong case that, compared with emerging standards in Europe, the regulatory burden for financial institutions in the United States is both too heavy and too diffuse. Such pressures for harmonization are also likely to increase as it becomes clearer that the industrial world’s three major financial groupings (North America, Europe, Japan) are all moving toward free trade in financial services, at least within their own geographical area, and that all are now on the road to some version of universal banking as well.

The process of international cooperation in the area of regulation and supervision may also change in light of European developments. Regardless of the degree of harmonization of domestic rules, supervisors will have to cooperate more closely to ensure proper oversight of larger banks with an international presence. Since supervision of financial conglomerates in Europe is already carried out, as much as possible, on a consolidated basis, there may also be increased pressure for a similar approach in other jurisdictions (especially the United States) where this is not currently the case. On the one hand, this would facilitate the pursuit of the “lead regulator” strategy to deal with the problem of international conglomerates. On the other hand, it might increase pressure for a migration of supervisory authority to bodies outside central banks, which some central banks might welcome but others would certainly not. The evolution of supervisory practices in Europe (who, where, what) may also raise further questions. For example, will European banking supervisors increasingly come to the Basle Committee on Banking Supervision with a single voice and, if so, how will that affect the dynamics of achieving consensus: will it be easier or more difficult? If responsibility for supervisory practice migrates to the ECB, what might be the implications for membership of the Basle Committee? In particular, will the current need for international agreements to be ratified by national legislation demand the presence of national supervisors, or not?

A related issue has to do with the question of “home-versus-host” responsibility for supervision. Within Europe, supervisory responsibility is now clearly allocated to home supervisors, and host supervisors (especially in London) are increasingly inclined to remind home supervisors of their responsibilities. It is also the case under the NAFTA that, as Glass-Steagall disappears, foreign branches will replace subsidiaries and home-country supervision may play a greater role in that region too (see White, 1994, p. 18). This raises the possibility of a worldwide agreement to accept home-country supervision, presumably also based on consolidated reporting. Such an agreement would have some obvious advantages. For example, it might eventually allow both internationally active firms and their supervisors to take due account of the global risks being assumed by individual firms as well as the interrelationships between separate categories of risk. This would certainly be the hope of financial institutions themselves. In contrast, the practical difficulties involved in potentially entrusting small countries (with commensurate supervisory capacities) with much larger responsibilities than hitherto should not be underestimated.

The authors would like to thank, without implicating them and in alphabetical order, Palle Andersen, Stephan Arthur, Jeremy Barson, Florence Béranger, Henri Bernard, Claudio Borio, Dierk Brandenburg, Stephen Collins, Clifford Dammers, Phil Davis, Angelika Donaubauer, Charles Goodhart, Gregor Heinrich, André Icard, Serge Jeanneau, Frederick Marki, Danielle Nouy, Denis Pêtre, Costas Tsatsaronis, and Jürgen von Hagen.

It is appropriate to begin this paper with a warning. We try to provide a brief summary of some very broad trends in the European financial industry. We recognize that, in the process, assertions will be made that do not apply at all (or only in part) to banks from particular national jurisdictions. For individual banks, broad statements may be even less applicable.

In the late 1980s, a lower cost of equity for German banks allowed them to earn as much as a 20 basis point lower return on their (risk-adjusted) assets than their U.K. or U.S. competitors. See Zimmer and McCaulcy (1991).

Much of this can be related to losses on loans collateralized with commercial property. The value of such property fell sharply through the first half of the 1990s in many continental European countries (albeit with wide regional variations), though the implications for the profit and loss account tended to be recognized only with a lag.

See Economic Research Europe Ltd. (1996). The market for wholesale banking services is intensely competitive and highly international. However, this reflects the influence of offshore markets and euromarkets much more than regulatory change within Europe itself.

Emerson’s study (see Emerson, 1988) documented the extent of these price deviations. The more recent study by Economic Research Europe Ltd. (1996) indicated that not a great deal had changed on average, although the prices of some financial services had fallen discernibly in some of the countries that had been most highly regulated to begin with.

See Scobie (1997, p. 48), No response rate was specified.

Ibid., p. 66.

The London International Financial Futures and Options Exchange announced in March 1996 that March 1999 eurocurrency contracts for the deutsche mark, pound sterling, and Italian lira would provide for settlement in euros if these currencies were irrevocably fixed to the euro by three weeks before contract expiry (see LIFFE, 1996). Rates on euros would be collected by the British Hankers’ Association in London, according to Gregorio (1996. p, 5). Similarly, the MATIF has made provision in Article 12 of the regulations for the three-month PIBOR futures contract for the replacement of the French franc with the euro (see Scobie, 1997, p. 65). Such moves already anticipate a market in which prime names from across the currency area would be able to fund themselves, and manage their interest rate exposure in euros, at rates that would be determined areawide.

See BIS (1996a, pp. 112–113) for the use of swap rates to assess the market outlook for EMU. See also De Grauwe (1996).

It must be admitted in this connection that transactions in U.S. treasury bills and treasury bill futures also exceeded by a wide margin transactions in bank deposit futures in the early 1980s, only to be left behind by the growth of eurodollar futures.

The association of currency of issue and nationality of underwriter, however, seems weaker in 1996 than it was in 1983 for the mark, pound and guilder sectors (see Courtadon, 1985. pp. 40–41). And even today, some sectors of the international bond market show a stronger influence of customer ties, in contrast to the general finding in the text. For instance, the Neue Zürcher Zeitung of February 20. 1997, p. 25, reports that the Japanese big four securities firms plus Tokyo-Mitsubishi and Kankaku captured 46.5 percent of the underwriting mandates of Japanese issuers in the Swiss franc market, more than the 39 percent captured by the Swiss big three plus Gotthard Bank. But this SF 7.4 billion sector features small, often equity-related, issues, and the customer base may include a large proportion of Japanese accounts.

LIFFE is keeping all options open. See Gregorio (1996, p. 9).

See Scobie(1997. p. 74).

The Working Group on the Gilt Market after EMU recommended the “complete and simultaneous redenomination of existing gilts from sterling into euro by law … early in 1999, if the United Kingdom joins EMU at the outset or as soon as possible after it joins if it participates at a later date” (see Bank of England. 1996, p.34).

The draft paper of the consultative group on the impact of the introduction of the euro on capital markets (see European Commission, 1997) notes that the French and German governments appear to be considering different modes of redenomination and cites the difficulties and costs resulting from the difference, The draft paper also discusses differences in day counts, coupon frequency, business days, and settlement lags. See also Davies (1996).

While market pricing qualitatively corresponds to the credit rating, the BBB-rated province pays a smaller premium than most similarly rated private borrowers. Some observers interpret the relative flatness of the relationship to suggest that the market attaches more weight to the possibility of a federal bailout than do the rating agencies.

It is easy to draw this analogy inappropriately by neglecting differences in fiscal structures. “A 55 percent debt to GDP (gross domestic product) ratio appears to define the limit at which Canadian provinces can maintain investment grade status. What’s going to make it possible for European governments to maintain good credit ratings with debt ratios significantly higher?” says Bernard Connolly, addressing a conference in London and quoted in “EMU said to mean higher inflation, weaker bonds,” Reuters, February 25, 1997. Moody’s (1997, p. 5): “… a statistical comparison between the debt burdens of EMU entrants and subnational units in federal systems would not be completely appropriate because EMU countries should be able to service higher debt loads than individual American states or Canadian provinces.”

The Canadian parallel has the advantage that there is no federal tax exemption for provincial debt interest receipts, as there is in the United States. In the latter case, a combination of federal tax exemption with state tax exemptions for in-state municipal bond interest has produced an extremely segmented and illiquid market. For the comparison between U.S. states and European governments, see Goodhart (1997).

OECD (1996a, p. 16) shows pension fund holdings of foreign assets in Europe to be bimodal. with funds in Belgium, behind, and the United Kingdom having 30 percent or more of their portfolios invested in foreign assets, compared with less than 10 percent for funds in Denmark, France, Germany, Italy, Portugal, Spain, and Sweden. The Netherlands, at 17 percent, is in between. Page 22 shows life insurers in Germany with 1 percent of their assets in foreign securities in 1941 and those in the United Kingdom with 14 percent in 1994.

See Table L.102 in Board of Governors (1996, p. 63). Overall, these accounts place the bond debt of the U.S. nonfarm nonfinancial corporate sector at $1.4 trillion and commercial paper debt at $0.2 trillion, against bank debt of $0.6 trillion. The inclusion of offshore corporate loans brings the corporate loan total closer to $0.8 trillion (see McCauley and Seth, 1992). The one-third figure following in the text ((junk + commercial paper)/(junk + commercial paper + bank loans)) is apposite under the conservative assumption that all the European firms that could obtain investment grade ratings have already effectively ceased borrowing long-term, fixed rate funds from banks.

Contrast Bénassy-Quéré (1996), which takes World Bank-reported debt as representative.

This shift (which reflects more than valuation effects) is a leitmotif of the BIS International Banking and Financial Market Developments. See in particular BIS (1997) and BIS (1996c).

Among those expecting profound changes are Standard & Poor’s (see Bugie, 1996). Among those who expect a much smaller impact are Salomon Brothers (see Salomon Brothers, 1996).

The Banking Federation of the EU published the results of a survey of members in March 1995. Assuming a single date of conversion for all forms of business in all EU countries, the costs of conversion were estimated at between ECU 8 and 10 billion. National estimates of conversion costs are broadly consistent. The actual costs of conversion are likely to be significantly higher (the British Bankers’ Association estimates up to 50 percent) given the necessity for banks to keep accounts in both national currencies and the euro during the period from January 1999 to 2002. This implies added costs of about 1–1.5 percent of total revenues a year over a three- to four-year period. See Salomon Brothers (1996, p. 5).

A survey reported in the Financial Times of February 5, 1997, indicated that 91 percent of European banks polled were confident that they would be ready for the introduction of the euro but only 15 percent of the same banks had allocated a budget for this objective (see Denton 1997),

See BIS (1996b), p. 96,

For a fuller discussion of this potentially important issue, see Levitt (1995).

See Livingston and Hutchinga (1997), p, 63, and International Law Association (1996). See also the subsection above on the transition costs of monetary union.

See Levitt (1995), Levitt notes that litigation in different national jurisdictions might result in different rulings. EU legislation might be called for but, of course, it would have no force outside the EU.

EMU “will be negative or neutral for European banks” (see: IBCA, 1996); “the profound changes that a successful EMU will bring to the financial services sector will pressure the competitive position and earnings of many banks” (see Bugie, 1996).

The likelihood of this approach being taken, in contrast to a minimalist solution, will depend on how much advance planning has been possible. Recent surveys assessing the degree of preparedness for EMU indicate that simple “coping” may be the order of the day for many financial institutions. See footnote 26.

Citicorp in Germany has already had a significant degree of success in attracting the business of high-income investors away from German banks.

See McCauley (1984) The bank lending in a foreign currency is likely to have less well-diversified funding sources. In addition, it does not have access to its own central bank for foreign currency.

Hoschka’s first point is that foreign banks may have an advantage from being able to follow domestic clients as their activities become increasingly international. The euro would certainly promote this, though the effects on corporate business would seem greater than the retail effects. A second potential source of firm-level advantage is “know-how” about new products. It is not obvious that the introduction of the euro would have much effect in this regard, and the same might be said about a third possibility mentioned by Hoschka: namely, that cross-border entry might be attracted by ologopolistic profits in domestic retail banking. A fourth possibility, that foreign banks might benefit from diversification of risk through cross-border retail activities, would seem more likely to be reduced than increased by the introduction of the euro.

The banking systems of smaller countries might be thought particularly exposed. They tend to be more reliant on foreign exchange receipts from transactions in their own currencies, and are geographically closer to competing financial systems. In cases where the banking system also relies heavily on “core” deposits paying less than market rates, the implications would be still more serious. See Berlin and Mester (1996).

It is not clear what the forecast was for retail banking in Germany, where there are currently thousands of mutual and cooperative banks. While independent and actively merging, these banks operate within the framework of national associations offering extremely sophisticated central services. In this respect, they already look much like large retail banks with many branches.

Gual and Neven also note (p. 179) that compensation in European banking continues to be substantially above economy-wide compensation.

For example, in France there are the constraints imposed by the decrees of 1936 and 1937. In Italy, the parliament recently passed a special law regarding the restructuring of the Banco di Napoli. Presumably, this reflected an assessment of the difficulties imposed by existing law.

It is not easy to evaluate the extent to which mergers and acquisitions do add value. Borio and Tsatsaronis (1996) look at movements in relevant share prices (in major industrial countries) just before and after announcements of mergers and acquisitions in the finance area. The evidence for a significant increase in “expected” value is not strong. See also BIS (1996a).

In the United Stares, the biggest gains have generally come from consolidating back- and middle-office functions. A new development in Canada has been the spinning-off of such functions and their merger into a single and more efficient company owned by a number of banks.

See Barth, Nolle, and Rice (1997). The minimum amount insured is ECU 20,000. Up to this limit, only 90 percent of losses will be reimbursed.

As is commonly the case. See Barth, Nolle, and Rice (1997, Table 9).

Consider the case of Italian or Belgian banks in a situation where very high interest rates were imposed (for whatever reason) in a single currency area. Given high debt ratios in those countries, debt-servicing capacity might be called into question and credit premiums could rise. Recall as well the arguments put forward in the subsection on lessons from Canada. Any such revision of credit ratings would have a direct effect on the value of bank holdings of those securities (see Bruni, 1990, p. 250).

The Bundesbank has traditionally argued that a supervisory role for the central bank may cause it wrongly to subordinate its price stability objective (in setting monetary policy) to the financial stability objective associated with its supervisory function. Concerns have also been expressed that the supervisory function is more easily politicized and that this interference could easily slide over into the monetary area. It should be noted for completeness, however, that the Bundesbank does collect supervisory information for the Federal Banking Supervisory Office.

Some would argue that supervisors should not even tell the operational arm of a central bank that an institution was about to fail. Should the central bank close out its position with that institution, it would be accused of “bringing it down.” If it did nothing with the information, it would be accused of “wasting the taxpayers’ money.” On the one hand, this logic ignores the fact that insider information might also help the central bank to better prepare itself to deal with any of the fallout (contagion, etc.) arising from the failure itself. On the other hand, some fear that systemic concerns raised by the disclosure of such information might also lead to an overly expansionary monetary policy.

Schoenmaker (1995) presents the pros and cons of an intermediate outcome in which a pan-European supervisor might supervise only those large institutions whose failure was thought likely to have systemic implications. National supervisors would concern themselves with all the rest.

This contrasts with the U.S. system, where the Federal Reserve Board of Governors has authority over the regional Federal Reserve Banks, and exercises that authority.

If this were not so, there would be a clear incentive for national supervisors to deem insolvent banks “solvent” such that the fiscal charge would be borne by others.

This would also depend on the extent to which the ECB relied on the national banks to implement monetary policy. If that reliance were as great as the reliance put by the Federal Reserve Board on the Federal Reserve Bank of New York, the ECB might have little hands-on contact.

Another useful reference is provided by Barran, Coundert, and Mojon (1996).

An interesting but often unremarked variation on this theme is the way in which German savings banks and cooperatives try to shelter their business clients from interest rate swings. Such behavior is consistent with the model assumed by Berlin and Mester (1996), but conflicts with most of the recent literature on “credit rationing,” which assumes that a separate credit channel makes interest rate swings even more effective. In reality, both hypotheses may be true depending on which set of banks (perhaps differing across countries or by size) one is talking about.

In general it would be simpler and therefore preferable to have a common set of transmission processes. Moreover, it would be particularly unfortunate if a country having a relatively fastacting and powerful response to higher interest rates were to begin from a starting point of relatively subdued activity due to some asymmetric shock. Conversely, it would be rather fortunate if the starting point were a relatively higher level of economic activity.

The effect on sovereign credit rankings would be particularly severe in cases where the initial level of debt was high and/or its term was relatively short.

A rough measure of how the market might react to this change in perception is the difference in the credit ratings given to banks (by Moody’s) on an “ordinary” as opposed to an “intrinsic strength” basis. See Table 19.

Caprio and Klingebiel (1996) provide estimates of the direct costs to governments (relative to GDP) of resolving banking crises in Spain (1977 to 1985, 17 percent), Finland (1991 to 1993, 8 percent), Sweden (1991, 6 percent) and Norway (1987 to 1989, 4 percent). Honohan (1997) estimates that emerging countries have spent $250 billion for the same purpose since 1980.

References

    AdlerOliver1996“EMU and Banking,”paper presented at the 1996 ICMB conference on Forces of Change in International Banking, International Center for Monetary and Banking Studies,Geneva,November78.

    AlworthJulian andC.E.V.Borio1993“Commercial Paper Markets: A Survey,”BIS Economic Papers No. 37 (Basle: Bank for International Settlements,April).

    Association Cambiste Internationale1995The Single Currency in Europe: A Working Paper (Paris: ACI).

    BalderJohnJoséA. López andLawrenceM. Sweet1991“Competitiveness in the Eurocredit Market,”in International Competitiveness of U.S. Financial Firms: Products Markets and Conventional Performance MeasuresFederal Reserve Bank of New York Staff Study (New York: Federal Reserve Bank of New York,May) pp. 2641.

    Bancad’Italia1995Ordinary General Meeting of Shareholders,Abridged Report for the Year 1994May31.

    Bank of England1996Practical Issues Arising from the Introduction of the EuroVol. 3 (London: Bank of England).

    Bank for International Settlements1997International Banking and Financial Market Developments(February).

    Bank for International Settlements1996a66th Annual Report (Basle: BIS,June).

    Bank for International Settlements1996bCentral Bank Survey of Foreign Exchange and Derivatives Market Activity 1995 (Basle: BIS,May).

    Bank for International Settlements1996cInternational Banking and Financial Market Developments (Basle: BIS,November).

    Bank for International Settlements1995Financial Structure and the Monetary Policy Transmission Mechanism (Basle: BIS.March).

    BarranFernandoVirginieCoundert andBenoîtMojon1996“The Transmission of Monetary Policy in the European Countries,”LSE Financial Markets Group Special Paper No. 86 (London: London School of Economics,June).

    BarthJamesR.DanielE. Nolle andTaraN. Rice1997“Commercial Banking Structure, Regulation, and Performance: an International Comparison,”OCC Working Paper976 (Washington;Office of the Comptroller of the Currency,March).

    BeersDavidT.1996“Stronger-Rated Sovereigns Will Lead Way into EMU,”Standard & Poor’s CreditWeek(November13)pp. 1318.

    Bénassy-QuéréAgnés1996“Potentialities and Opportunities of the Euro as an International Currency,”CEPII Document de Travail, No. 96-09 (Paris: Centre d’Etudes Prospectives et d’Informations Internationales,August).

    BerlinMitchell andLorettaJ. Mester1996“Why is the Banking Sector Shrinking?”Federal Reserve Bank of Philadelphia Working Paper No. 96-18 (Philadelphia, Pennsylvania: Federal Reserve Bank of Philadelphia,August).

    BloemMary1996“The Effect of the Euro on European Bond Markets,”paper presented at a Euromoney seminar on Implications of EMU for the International Debt Markets,London,October1718.

    Board of Governors of the Federal Reserve System1996Flow of Funds Accounts of the United States(December11).

    BorioClaudiaE.V. andKostasTsatsaronis1996“Restructuring in Banking: The Role of Mergers and Acquisitions,”paper presented at the conference Toward a Common European Banking Market: National Strategies and Policy Issues, Paolo Baffi Centre for Financial and Monetary Economics,Bocconi University,Milan,May10.

    BradberyAdam1996“Swap Traders Say ‘Sure Bet’ Is Uncertain,”Wall Street Journal(Europe edition),May8.

    BrookesMartin1997“Credit Risk and Bond Yield Spreads Within EMU,”European Economics AnalystGoldman Sachs, No. 97/07(March26).

    BrownBrendon1996“EMU: Implications for the International Debt Markets,”paper presented at a Euromoney seminar on Implications of EMU for the International Debt Markets,London,October17–18.

    BruniFranco1990“Banking and Financial Regulation: The Italian Case,”in European Banking in the Nineteen Ninetiesed. byJeanDermine (Oxford: Blackwell).

    BugieScott1996“EMU and the Banks: Costs vs. Opportunities,”Standard & Poor’s CreditWeek(November13).

    BulchandaniRavi1996“Spread Economics: Interest Rates After EMU,”Investment Research EuropeMorgan Stanley(November8).

    BurgessArthur1996“An Issuer’s Perspective on the European Markets Pre- and Post-Euro,”paper presented at the IBC UK conference on Evaluating the Impact of the Euro on the European Securities Market,London,November56.

    CantorRichard andFrankPacker1996“Determinants and Impacts of Sovereign Credit Ratings,”Economic Policy ReviewFederal Reserve Bank of New York,Vol. 2(October) pp. 3753.

    CaprioGerard andDanielaKlingebiel1996“Bank Insolvency: Bad Luck, Bad Policy, or Bad Banking?”paper presented to the Annual World Bank Conference on Development Economics,Washington,April2526.

    ClarkeIan andCliveParry1996“Government Credit Spreads Too Narrow for the Post-EMU World?”Morgan Stanley,Fixed Income Portfolio Strategy(October8).

    TimCongdon1996“EMU? Not a Chance,”The BankerVol. 46(October) pp. 1416.

    CourtadonCarolL.1985The Competitive Structure of the Eurobond Underwriting Industry (New York: New York University, Center for the Study of Financial Institutions).

    DaviesJonathan1996“Assessing the New Post-EMU-Framework of the Fixed Income Markets,”paper presented at the IIR conference on Assessing the Practical Implications and Impact of EMU on the Financial Markets,London,November1819.

    De GrauwePaul1996“Forward Interest Rates as Predictors of EMU,”CEPR Discussion Paper No. 1395 (London: Centre for Economic Performance Research,May).

    DentonNicholas“European Monetary Union: Impact on IT Systems,”Financial TimesFebruary51997.

    DermineJean1996“European Banking with a Single Currency,”Financial Markets Institutions and Instruments(December) pp. 62102.

    DuesingJan1997“European Futures Union: What Benchmark Long Futures Contract after EMU?”Global Strategy and Relative Value (London: CS First Boston, February 19).

    Economic Research Europe Ltd.1996A Study of the Effectiveness and Impact of Internal Market Integration on the Banking and Credit Sector (London: Economic Research Ltd.,September).

    EichengreenBarry andJürgenvon Hagen1995“Fiscal Policy and Monetary Union: Federalism, Fiscal Restrictions and the No-Bailout Rule,”CEPR Discussion Paper No. 1247 (London: Centre for Economic Policy Research,September).

    EmersonMichaeland others,1988“The Economics of 1992,”European EconomyVol. 35(March).

    European Commission1997“Draft paper on the technical preparations of the bond markets by the consultative group on the impact of the introduction of the euro on capital markets”(March).

    FaveroCarloFrancescoGiavazzi andLuigiSpaventa1996“High Yields: The Spread on German Interest Rates,”CEPR Discussion Paper No. 1330 (London: Centre for Economic Policy Research,January).

    FoxMark1996“The Shape of the Future Euro Market,”Strategic investorLehman Brothers(August15).

    FridsonMartinS. andM. ChristopherGarman1996“This Year in High-Yield 1995,”Extra CreditMerrill Lynch(January/February)pp. 433.

    Gemini Consulting and EFMA1993European Banking: A View to 2005 (London: Gemini Consulting).

    GoodhartCharles1997“The Two Concepts of Money, and the Future of Europe,”paper presented at a conference on Optimum Currency Areas: The Current Agenda for International Monetary and Fiscal Integration, organized by the Bank of Israel and the International Monetary Fund in Jerusalem and Tel Aviv,December461996.

    GregorioGiuliano1996“Weighing up the Consequences of EMU on Exchange Traded Derivatives When Formally Converted into Euros,”paper presented at the IIR conference on Assessing the Practical Implications and Impact of EMU on the Financial Markets,London,November1819.

    GualJordi andDamienNeven1993“Deregulation of the European Banking Industry (1980–1991),”European Economy/Social EuropeNo. 3,pp. 15183. (Also published as CEPR Discussion Paper No. 703,August1992.)

    HonohanPatrick1997“Financial System Failures in Developing and Transition Countries: Diagnosis and Prediction,”BIS Working Paper No. 39 (Basle: Bank for International Settlements).

    HoschkaTobiasC.1993Cross-Border Entry in European Retail Financial Services (New York: St, Martin’s Press).

    HuteauGuillaume1997“A Benchmark Swap Curve: The Full Convergence of Post-EMU Swap Curves,”Global Strategy and Relative Value (London: CS First Boston, London,February19).

    IBCA1996The Rating Impact of EMU(November28).

    International Law Association1996Report by the Committee on International Monetary Law,presented at a meeting of the International Law Association,Helsinki,May31.

    IslamIftyEdwardEyerman andJosephTaylor1996“The Outlook for Intra-European Spreads after EMU: Assessing Sovereign Credit Risk Within a Monetary Union,”Global Fixed Income ResearchMerrill Lynch(November1).

    JeanneauSerge1996“The Market for International Asset-Backed Securities,”International Banking and Financial Market DevelopmentsBIS(November) pp. 3646.

    JohnsonChristopher1996In with the Euro Out with the Pound: The Single Currency for Britain (London: Penguin).

    KapsteinEthanB.1994Governing the Global Economy: International Finance and the State (Cambridge: Harvard University Press).

    KarsentiRené1996“EMU: Impact on Financial Markets and Practical Implications for a Large Issuer,”paper presented at a Euromoney seminar on Implications of EMU for the International Debt Markets,London,October1718.

    KeatingGiles1996“The Politics of Sovereign Default: An Essay on Credit Spreads after EMU,”Economics Research–EuropeCS First Boston(October30).

    KrämerWerner1996“Impact of the Euro for European Bond Markets,”Paper presented at the IBC UK conference on Evaluating the Impact of the Euro on the European Securities Market,London,November56.

    LevittMalcolm1995“Economic and Monetary Union Stage III: The Issues for Banks” (London: Centre for the Study of Financial Innovation).

    LIFFE1996“EMU: LIFFE’s Response,”LIFFE Market MonitorNo. 7(April3).

    LipskyJohnand others,1996“Managing Convergence: Market Implications for 1997 and Beyond,”Economic & Market AnalysisSalomon Brothers(December).

    LivingstonDorothy andBillHutchings1997“Legal Issues Arising from the Introduction of the Euro,”Journal of International Banking LawVol. 12(February) pp. 636.

    MATIF Working Committee on the Changeover to the Euro1996Report(December).

    MayerThomas1996“Volatility, Liquidity, and Demand: Preparing for the Euro-Market,”paper presented at a Euromoney seminar on Implications of EMU for the International Debt Markets,London,October1718.

    MazzucchelliMarcoG.IanClarke andCliveParry1996“European Government Bond Markets After EMU,”Morgan Stanley presentation to the European Commission Consultative Group,Brussels,October25.

    McCauleyRobertN.1997“The Euro and the Dollar,”BIS Working Paper (Basle: Bank for International Settlements,forthcoming).

    McCauleyRobertN.1996“Prospects for an Integrated European Government Bond Market,”International Banking and Financial Market DevelopmentsBIS(August) pp. 2831.

    McCauleyRobertN.1984“Maturity Matching in the Euromarkets,”Quarterly ReviewFederal Reserve Bank of New York,Vol. 9 (Spring) pp.3233.

    McCauleyRobertN.RamaSeth1992“Foreign Bank Credit to US Corporations: The Implications of Offshore Loans,”Quarterly ReviewFederal Reserve Bank of New York,Vol. 17 (Spring) pp. 5265.

    Moody’s Investors Service1997“Credit Risk Implications of EMU for European Sovereign Credits”(February).

    Organization for Economic Cooperation and Development1996a“Institutional Investors and Financial Markets in OECD Countries,”DAFFE/CMF(96)18/ANN1 (Paris: OECD).

    Organization for Economic Cooperation and Development1996b“Public Policy and Financial Market Access in the Global Economy,”DAFFE/CMF(96)19/REV1 (Paris: OECD).

    ReussKonrad1996“Standard & Poor’s Presentation,”paper presented at a Euromoney seminar on Implications of EMU for the International Debt Markets,London,October1718.

    RuoccoJohnJ.MaureenLeBlanc andPatrickDignan1991“Competitiveness in Government Bond Markets,”in International Competitiveness of U.S. Financial Firms: Products Markets and Conventional Performance MeasuresStaff Study by the Federal Reserve Bank of New York (New York: Federal Reserve Bank of New York,May) pp. 130155.

    Salomon Brothers1996“What EMU Might Mean for European Banks,”European Equity Research(October29).

    SBC Warburg1996EMU: Opportunity or Threat?(London:SBC WarburgDecember).

    SchoenmakerDirk1995“Banking Supervision in Stage Three of EMU,”LSE Financial Markets Group Special Paper No. 72 (London: London School of Economics,June).

    ScobieHannahM.1997The Cost and Timescale for the Switchover to the European Single Currency for the International Securities Market (Zurich: European Economics and Financial Centre for the International Securities Market Association).

    SerfatyBruno1996“Risks and Opportunities Created by EMU in a Bond Environment,”paper presented at a Euromoney seminar on Implications of EMU for the International Debt Markets,London,October1718.

    WhiteWilliamR.1994“The Implications of the FTA and NAFTA for Canada and Mexico,”Bank of Canada Technical Report No. 70 (Ottawa: Bank of Canada,August).

    ZimmerStevenA. andRobertN. McCauley1991“Bank Cost of Capital and International Competition,”Quarterly ReviewFederal Reserve Bank of New York,Vol. 15 (Winter) pp. 3359.

    Other Resources Citing This Publication