Speech by John Tiner to the IIF Spring Conference, Madrid, 1st April

Introduction


1. Thank you for inviting me to contribute to today's discussion on the highly relevant topic of 'regulation and consolidation in the financial industry': Santander Central Hispano's recent acquisition of Abbey, Europe's biggest cross- border banking deal to date, is a timely reminder that we live in a world where financial markets are becoming increasingly integrated. I understand that this session is intended to provide a forum for discussion of the challenges and opportunities of cross-border consolidation, both within the EU and globally. As lead regulator for several of the world's largest international financial organisations and host regulator for many others, I would like to share with you my thoughts on the competitive pressures confronting the global financial industry and on how strengthening the EU Single Market could impact firms' competitive positions. Lastly, I would like to touch on the challenges facing regulators from further financial services integration.

 

The competitive pressures confronting the global financial industry


2. First, the main competitive pressures facing the global financial industry. Naturally, I approach this issue from a UK perspective, and looking specifically at UK banks note that they have enjoyed several years of sustained strong performance. At the same time though, banks face significant strategic challenges of which I am sure we are all acutely aware. And given how international the UK banking market is, I hope that you will recognise many of the challenges as relevant to your countries as well.

3. The general good health of banks' balance sheets, the low interest rate environment, and the benign economic cycle have prompted many market commentators to talk about a "wall of liquidity". Banks have been willing to lend "cheaply", but as the economic environment becomes more uncertain and growth slows down, this pricing may become increasingly out of line.

 

4. The squeeze on margins also mean that banks are pushed to search for yield. In the retail arena, this can mean targeting new market segments such as sub-prime customers. In the wholesale arena, banks are shifting their funds towards more complex products and less established markets. Clearly, these strategies carry greater risk which must be priced correctly; the danger being that irrational pricing might lead to the development of 'bubbles' in these riskier markets.

 

5. On the cost front, aggressive cost cutting strategies have yielded significant benefits for banks' efficiency and profitability. Outsourcing and offshoring have played a large part but these activities also pose operational and legal risks that need to be managed carefully. The challenge is to reduce, or at least contain, costs without damaging earnings quality or significantly increasing operational risk. Although many banks are tackling successfully their costs, it could nonetheless be argued that the banking system in Europe as a whole is far too laden with costs and so is unnecessarily expensive to its customers. Perhaps dramatic changes in the costs of the European banking industry can only really come about by a combination of consolidation and a fundamental re-engineering of payment, settlement and processing systems.

6. Perhaps the biggest long term strategic challenge of all is that UK and European banks' domestic markets are to a large extent mature. In their search for growth, retail banks can try to increase the amount of business they make from their existing clients by attempting to cross-sell off the back of existing product relationships. The challenge here is how to achieve cross-selling and at the same time avoid mis-selling. They also seek to attract new customers by offering innovative products and services. But it is not an easy avenue to pursue: it is a sad reflection on our society today that individuals are still statistically more likely to get divorced than to switch bank accounts.

7. One of the most attractive growth opportunities for highly profitable, capital rich European banks is that of international expansion. The EU's banks produce around a quarter of global banking profits (5 of the top 25 global banks by market capitalisation are UK banks and the rest of the EU has 7). Yet outside HSBC there is perhaps no European retail bank competing across the world's markets – or indeed even across Europe.

8. As a group, there is still a need for European banks to become more competitive if more of them are to become truly global players. Allowing competitive forces to operate more freely is, I believe, the best way to ensure banks become, and remain, efficient and can carry out their strategy without constraint. This means accepting that your banks will be subject to the discipline of knowing that they are possible takeover targets, just as they themselves may seek takeover opportunities abroad.

9. Incidentally, consolidation is likely to be catalysed by the convergence of accounting standards through IFRS: convergence of reporting will promote better investor understanding of the financial position of foreign companies thereby facilitating takeover activity. And it's worth noting that consumers will also benefit from consolidation in the form of strategic cross-border partnerships, as illustrated by Aviva, in its distribution relationship with a number of European banks.

10. However, so far, relatively few cross border mergers have taken place in European banking (though if recent press reports are to be believed, this could be changing). In the UK, as Santander's takeover of Abbey showed, the nationality of an owner is simply not a regulatory issue. There are of course many issues such as capital adequacy, experience and expertise of management, quality of control and business strategy which are critical to our decision to approve a change of control, but these should be judged purely on their merits and not on question of nationality. We recognise that consumers benefit from stronger institutions competing with each other, and in the long run local firms benefit from having to compete actively against well run rivals from whichever part of the world. We would strongly advocate all members of the European Union to adopt an approach along these lines, as only by doing so will policy makers make a real contribution to improving competitive conditions in the European Banking Market.


How strengthening the EU Single Market could impact firms' competitive positions

11. Now I want to turn to the Financial Services Action Plan and how this is likely to enhance competition in Europe's wholesale and retail markets. Integration is already quite advanced in the wholesale markets; this is no surprise bearing in mind the nature of these markets and the fact that FSAP measures were principally wholesale in focus. However, FSAP's impact on Europe's retail markets is less directly obvious: national retail markets, and the infrastructure supporting them differ widely. Information asymmetries are also more pronounced and market participants may act "irrationally": in many cases, consumers tend to confine their comparison shopping to brand names they know and trust even though foreign brands may represent better deals.

 

12. So what role will FSAP play in enhancing competition in Europe's retail markets? I think the answer is three-fold.

  • First, by entrenching the principle of mutual recognition based on the home state or country of origin, Europe is giving competitive teeth to the right of establishment and the right to provide services remotely.
  • Second, and in combination with the first, by providing greater levels of harmonisation, the FSAP makes it easier and cheaper for firms to operate in a number of Member States and to carry out business effectively on a cross-border basis. This gives retail consumers access to a wider range of more competitively priced financial products.
  • Third, modernising the prudential framework through the Capital Requirements Directive, Reinsurance Directive and Solvency II, will strengthen financial institutions and enhance market confidence: essential ingredients if Europe's consumers are able to place the same trust in non-locally authorised firms as they do in firms authorised by their home authorities.

 

13. So I would answer the question about whether the FSAP will enhance the competitive landscape with a clear 'yes'. But we should also recognise that, while these legislative interventions are important in removing barriers and enhancing competition, the role is essentially an enabling one. Once barriers are removed, the extent to which a Single Market develops, and the pace of this, are matters for the market itself. I would like to offer two examples - one from the retail and one from the corporate arena - of how market forces, via innovative solutions, are making inroads in pulling down some barriers to cross-country provision of financial services, thereby enhancing competition:

  • a 5 minute "mystery shopping" exercise revealed that transferring £100 from a UK bank to another European bank could cost a consumer as much as £20 in bank charges alone, but less than £5 when using an e-money provider; and
  • products such as Moody's RiskCalc make it possible for banks to estimate the probability of default of private Middle Market corporates in most European countries, thereby removing one of the main barriers - the lack of knowledge of local credit conditions - for banks wanting to do cross-border business.

UK's view on FSAP and the post FSAP agenda

14. Turning now to some shorter term priorities, with the legislative phase of the FSAP largely completed, the immediate focus now needs to be on effective implementation and enforcement of EU measures. Indeed, it is a key UK post-FSAP priority. If Member States do not do this, the benefits of the FSAP will, quite simply, be lost.

 

15. Whilst I ally myself fully with those calling for effective implementation of the FSAP measures, I am far more sceptical about the calls I hear for changes in regulatory structures in Europe. Let me say right away that I completely understand the frustrations of pan-European firms faced with multiple regulators and rule books: regulation is costly to firms and there is no case for unwarranted duplication. But some of the ideas for dealing with the problem seem over-simplistic while others do not seem to have been thought through properly. Our strong preference is to support and work through the Lamfalussy committees, though we acknowledge that they need to develop further. Indeed, 'making the Lamfalussy arrangements work well' is another of UK's post-FSAP priorities. I think it is incumbent on the proponents of more radical changes to European supervisory structures to demonstrate how these would build on the advantages that the UK and several other countries enjoy from being integrated regulators, and how a number of real practical problems, such as legal powers and alignment with investor and deposit protections schemes, would be overcome.

 

16. Similarly, we see real limitations to 'hard' lead supervision models for day to day supervision of multinational financial firms. These are models in which powers are concentrated in home supervisors. To be sure, some new measures such as the Capital Requirements Directive introduce more streamlined arrangements for supervising cross-border groups, as a result of a growing number of calls for the removal of inconsistencies and duplication of regulation. But we need to balance pressures for still further 'streamlining' against the risks that can arise from branches or services supplied cross-border that may be systemic in scale, over which host supervisors currently have minimal oversight. This is a potential concern for the UK, and a real worry for some newly acceded countries. Cross-border ownership already exceeds 70% in the banking systems of Slovakia, Estonia, Poland, Hungary compared with the EU 15 average of 30 (and I note here that UK banks have by no means been at the vanguard of this investment). The UK authorities support a 'softer'-lead supervision model. That is, we want to retain host powers for subsidiaries - though we may only use them for systemic entities or where there are manifest risks in the UK - and we would like to have some enhanced oversight of systemic branches – albeit within existing legal structures.

 

17. So far, I have outlined two of the UK's post-FSAP priorities: better implementation and enforcement of current EU measures affecting the financial sector and making the Lamfalussy arrangements work well. I have also touched on a third, namely the need to consider alternatives to EU regulation. I might mention two other UK priorities for the post-FSAP world. Where EU legislation is shown to be necessary, better, evidence-based regulation is essential; and, as emphasised at the beginning of my speech, in recognising the global nature of financial markets, it is essential to ensure that all future EU financial sector policy initiatives are framed with appropriate regard to their global impact. These priorities constitute a key part of the UK's post FSAP strategy. I detect a growing willingness throughout Europe to embrace these ideas, and I have been particularly encouraged by the comments of Commissioner McCreevy along similar lines.

 

Conclusion

To conclude, a variety of competitive pressures confront the global financial industry and these pressures are set to be enhanced at the EU level by the FSAP along with other non-legislative solutions. So the internationalisation of banking is a threat and opportunity for UK and EU banks and, in parallel, creates challenges for regulators. However, I am sure that those well prepared to embrace these challenges will be rewarded, whilst those that close their eyes will not.