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The Changing Structures of European Banking: The Greek Experience

14/02/2003 - Speeches

The Changing Structures of European Banking:

The Greek Experience

Address by Nicholas C. Garganas

Governor of the Bank of Greece

14 February 2003

at the Bulgarian National Bank


Ladies and Gentlemen,

It is a great pleasure to talk to you today about the changing structure of European banking and, in particular, the Greek experience. In many ways the Greek experience is especially relevant for the accession countries. Greece is the most-recent member of EMU, and the rapid transformation of the economy, including the banking system, can provide valuable lessons for the accession countries.

Central bankers have a special interest in the working of the financial system. Financial markets throughout the world are becoming increasingly integrated and banks are the workhorses of financial markets. The further integration of the European banking and financial system is in the interests of banks, the European Central Bank, and, most importantly, all the citizens of Europe. For banks, further integration carries with it the liquidity benefits of deeper and broader markets, and lower costs, especially when making cross-border transactions. It also brings access to the latest technology and know-how. For the European Central Bank, integration enhances the efficient and consistent implementation of its single monetary policy. For Europe’s economic agents, it means increased opportunities for channeling funds from savers to investors. An efficient allocation of capital is a precondition for robust growth and a higher standard of living in the medium term. Let me discuss, therefore, developments in financial markets in the euro area.

The remarkable pace of integration of world financial markets has been one of the most profound and far-reaching economic developments of the late twentieth and early twenty-first centuries. The integration of financial markets worldwide has had several origins, including the revolution in communications and information technologies, macroeconomic stabilization and policy reform, the deregulation of domestic financial systems, and the removal of restrictions on capital-account transactions. In the European Union, two additional factors have underpinned the integration of financial markets - - first, advances in creating a common regulatory framework across the EU as part of the effort to complete the Internal Market in financial services and second, the adoption of the euro. The introduction of the euro has eliminated exchange-rate risk as a source of fragmentation in the EU financial system. Deeper integration in the euro area is reflected in more-homogeneous financial products, a wave of consolidation among intermediaries and exchanges, and the emergence of new, innovative financial products and techniques. Here are some examples.

  • With the creation of TARGET, the efficient cross-border real-time gross settlement system, an integrated money market exists for liquidity transfers in euro. There is virtually full convergence in very-short-term interest rates across the euro area, with essentially no differences in rates wherever the funds are exchanged.
  • There has been a significant increase in integration of market activities at the wholesale level. The corporate finance markets for major customers have become highly integrated. A high level of integration has also occurred in wholesale asset management, with investments increasingly diversified across borders.

Meanwhile, economies-of-scale in area-wide activities have led to a concentration of business via mergers and acquisitions. The ECB reports that the top ten intermediaries typically control 60 per cent to 70 per cent of European investment banking markets; the top three control one-quarter to one-third. There appears to be less and less room for medium-sized intermediaries, which have been faced with the choice to compete at the European level or to concentrate on retail business in the domestic market. Many medium-sized intermediaries have chosen the second option.

One reason they have done so is that domestic markets have remained fragmented so that there is less competition than at the wholesale level. At the retail level, national banks maintain an important competitive advantage over their foreign counterparts because they have better knowledge of local conditions, possess branch networks, and have cultivated well-established relations with local customers. When entrusting their savings, depositors want to make sure that they are in safe hands. Knowledge of the bank and the national legal system provide powerful incentives to deposit in the local banks; this is what economists call “home-country bias”. In these circumstances, small and medium-sized national banks have tended to concentrate on domestic consolidation and have expanded cross-border mainly by entering into agreements with banks in other countries in order facilitate the supply of services to their largely domestic customers.

In sum, the picture that emerges from developments in the euro area is one of a fully-integrated money market, a highly-integrated market for corporate/investment banking services, and a fragmented banking market at the retail level.

What can be done to reduce market segmentation in the retail banking market? The challenge is to remove institutional and economic factors that raise the cost of cross-border operations. Further integration will require harmonization of accounting and tax regimes, and legal frameworks, and the acquisition of the necessary technical infrastructure for handling cross-border holdings and settling securities. The costs of regulatory obstacles are identified in the Financial Services Action Plan, issued by the European Commission. The Action Plan lists priorities and time-scales for legislative and other measures to remove these obstacles. To date, 30 of 42 measures contained in the Action Plan have been completed. I hope the remaining obstacles identified in the Action Plan will be removed by the scheduled deadlines.

Against this backdrop of developments in European-wide banking, let me turn the banking situation in Greece. In a nutshell, the past 15 years or so have seen a seachange in Greece’s banking system. The system has been transformed from one that was highly regulated to one that is entirely unregulated, and the capital account has been opened so that there is free movement of funds into and out of the country.

A number of changes that have taken place in Greece occurred prior to Greece’s entry into the euro zone while the adoption of the euro by Greece has accelerated other changes. How has adoption of the euro directly affected the Greek banking system? For one thing, the pricing of banking products and services has become more transparent, enhancing competition. This increased competition, along with the stability and low-inflation regime provided by the euro, - - and its guardian, the European Central Bank - - has led to a narrowing of the spread between Greek lending and deposit rates of more than 3 percentage points over the past 4 years. For another, however, a source of income generation from foreign exchange transactions has been lost. This loss has added to the drive for banks to generate new products and seek new customers.

Another characteristic of the changing landscape in recent years has been the withdrawal of the state from commercial banking. Privatisation has reduced the number of directly or indirectly state-controlled banks from 10 in 1995 to 3 - - Agricultural Bank, General Bank and the Postal Saving Bank - - today. Yet, the size of the Greek banking industry and of the individual banks, even after the recent mergers and acquisitions, remains small relative to those in most of the other countries participating in the euro area. Hence, Greek banks have tried to reinforce their positions in the domestic market and strengthen their presence in the Balkan area.

In the increasingly-competitive euro-area environment, Greek banks have made concerted efforts to change their ways of conducting business and transform their organizational structures. They have proceeded with a series of mergers and acquisitions. Since 1996, sixteen mergers and takeovers have occurred. Banks’ balance sheets have been restructured to make their financial positions sounder. Banks have improved their capital bases by raising funds from the capital market. Greek banks have formed alliances with foreign banks; Eurobank and Deutsche Bank formed an alliance, as have Commercial Bank with Credit Agricole and Piraeus Bank with the ING Group. In the light of Greece’s geographical position and its economic links with the Balkan countries, Greek banks, as I mentioned, have expanded activities in these countries. As you know, in recent years Greek banks have strengthened their links with Bulgarian banks.

Greek banks have also rationalized their expenses. Although Greek banks' expenses relative to their total assets remain above the average figure for the euro area, between 1999 and 2001, they fell nearly thirteen per cent - from 2.7 percent to 2.4 per cent.

Moreover, Greek banks have been offering an expanding array of new products and services. Many of these products and services are attractive to the household sector. Strong competition among banks in serving this sector has contributed to a reduction in interest rates and a rapid increase in consumer and household loans. Almost 60 per cent of total credit expansion in the past year was accounted for by household and consumer loans.

In the light of the foregoing developments in both the EU financial market, in general, and in Greece’s banking sector, in particular. Let me now turn to the crucial role of supervision. The soundness of the financial sector plays a key role for monetary-policy implementation and transmission, macroeconomic stability, and economic development. Financial-sector soundness can be ensured through a strong supervisory framework and effective corporate governance. These factors will be important in accession countries as future financial development in these countries is likely to involve significant growth in banks’s balance sheets and the widening and deepening of financial markets.

In Greece, the Bank of Greece is responsible for the supervision of the banking system and for monitoring developments to ensure the soundness of the system. In the latter connection, in recent years the Bank has undertaken a number of measures. In the last two years alone, the following measures have been introduced.

  • The Bank has increased the minimum initial capital for establishing a bank in Greece (from 11.7 million euros to 18 million euros).
  • Under certain conditions, it has allowed banks to use internal models for calculating their capital needs to cover market risks.
  • It has reduced to six months (from 12 months) the period allowable for a bank loan not to be serviced and during which banks can continue writing interest on this loan.
  • It completed and codified in a single text the relevant rules and provisions concerning transparency of terms and procedures of transactions between banks and their customers.

Greece's experience can shed light on the importance of a sound financial system and the role of supervision. Consider, in this connection, the following example of the role of supervision in Greece. Participation in EMU has provided Greece with a stable economic and financial environment. It has also provided fertile ground for high credit growth, particularly in the household sector. For example, the annual rate of increase in consumer loans reached a peak of about 52 per cent in June 2001, before decelerating to 24.2 per cent this past December. Several factors have been responsible for the high rates of growth of bank lending, including the relatively-high rate of growth of the Greek economy, the convergence of Greek lending rates to those in the rest of the euro area, increased competition among banks, especially with regard to extending credit to households, and the release of commercial bank funds from the Bank of Greece because of the harmonisation of reserve requirements in the Eurosystem.

Although credit growth has decelerated significantly over the past year and a half, as part of its supervisory role the Bank of Greece has been closely monitoring the situation. Last month [in January], the Bank introduced stricter provisioning rules; banks are now required to increase by 10 percentage points (in two installments) their provisions on loans that are not serviced for over 12 months. In addition, the Bank is, for the time being, maintaining the relevant limits that apply to consumer loans. To enhance its oversight function, the Bank has commissioned a survey of households' indebtedness. The results of this survey will help determine whether these limits should be removed.

Supervision of the banking system is always important in ensuring stability of that system. Supervision, however, can have added importance in a monetary union because, in a monetary union, there is a single monetary policy that applies to all countries. In the absence of a national monetary policy, the responsibility for maintaining an economy’s competitiveness falls on other areas, including on fiscal adjustment and structural reform. Yet, the rapid credit growth in Greece, if left unconstrained, would have had implications for Greek competitiveness. In such conditions, there was a clear need for action. This situation explains why the Bank of Greece introduced stricter provisions.

Bulgaria, with its currency board arrangement, faces similar constraints on the ability to use a national monetary policy. Fortunately, the banking sector in Bulgaria is well-regulated and well supervised.

Let me now say a few words about the financial sectors in accession countries. I will focus on accession countries as a group and refrain from country-specific assessments.

Over the past decade, a remarkable transformation has occurred in the financial sectors of the accession countries. Considerable progress has been made in restructuring and consolidating the banking sector though the liberalisation of markets, privatisation of state-owned banks, and the opening of the banking sector to foreign ownership. These broad developments parallel changes that have been taking place in Greece.

Yet, for most accession countries, particularly those in central and eastern Europe, the level of financial intermediation is relatively low and the provision of bank financing represents a much smaller share of GDP than in the euro area. To provide some context, bank assets in the euro area amount to about 265 per cent of GDP. In Greece, which is still in the catching up phase, the comparable figure is over 150 per cent of GDP. In contrast, according to data reported by the ECB, banks in most accession countries have assets amounting to between 30 per cent to 100 per cent of GDP. This relatively-low level of financial intermediation can serve as an obstacle to credit institutions’ channeling financial savings into investment. Additionally, although the banking industry in accession countries is widely considered stable and sound, the presence of structural weaknesses and inefficiencies – for example those reflected in the continued high spreads between lending and deposit rates or the relatively large proportion of bad loans in some countries - requires that an extra effort be made to consolidate the financial sector in order to avoid adverse future implications.

In these circumstances, and in view of the key role of the banking system in invigorating and broadening economic growth and improving welfare, it seems crucial that accession countries complete a number if structural reforms, including the implementation of a well-functioning regulatory and legal framework, corporate restructuring, and improvements in corporate governance. Ongoing reforms in the euro area make such changes in the accession countries all the more necessary, because they increase the gap between current practices in those countries and in the euro area.

In conclusion, let me stress that developing the size, depth, and efficiency of the banking sector will help accession countries to develop their full growth potential. The resulting increase in competition, combined with sound supervisory practices, will lead to lower costs of funds and financial services, higher rates of return to investors, and a wider array of financial products.

The Greek experience illustrates the effects of European integration on a national banking system. As I have discussed, the most notable effect has been the increase in competition, whether through privatisation, the rationalisation of banks’ expenses, or the restructuring of their balance sheets to make banks’ financial position sounder. Through its supervisory functions, the Bank of Greece play a vital role in maintaining the soundness of the banking system, helping to ensure the ability of Greek banks to reap the full potential benefits of participation in Europe’s single currency area.

The Greek banking sector continues to undergo change as it adapts to the new regime of the euro zone. Despite the substantial progress made in recent years by the accession countries, their financial sectors will need to undergo further significant changes in the future. By so doing, their financial sectors will be able to fully support economic growth, and, hence, the process of real convergence to euro-area levels.

Ladies and Gentlemen, thank you for your attention.

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