Banking and Finance in the European Economic Area

Paddy Roe *

I. Introduction

The EEA Agreement was signed in Oporto in May 1992 and the European Parliament gave its assent in October 1992. Following the Swiss no-vote in December 1992 the remaining Contracting Parties signed an Adjusting Protocol on 17 March of this year which in effect deletes the references to Switzerland from the Agreement and allows for its extension to Liechtenstein at a later date.

The procedures for ratifying the Agreement itself together with the amending protocol are well underway in the EC and EFTA states concerned and will be approved by the Community after the assent procedure of the European Parliament according to article 238 of the EEC Treaty. Originally it was hoped that the EEA Agreement could come into force on 1 July 1993, but due to delays encountered by a number of the contracting parties in their ratification procedures it will now enter into force on the first day of the second month following the deposit of the last instrument of ratification or approval, possibly 1 October 1993.

As stated in the European Community Council's negotiating directive the Agreement is designed to apply the European Community's internal market legislation to the participating EFTA States. The Agreement will thus extend the four fundamental freedoms enshrined in the EEC Treaty - the free movement of goods, services, persons and capital - into the wider EEA area. This will ensure that the conditions of a single market, ensuring equal competitive conditions, will exist for all companies operating in the EC/EFTA zone.

The EEA legal order will be achieved in two ways:

(i) by laying down basic rules corresponding (but not necessarily identical to) the articles of the EEC Treaty on the four freedoms and the flanking policies;

(ii) by requiring the EFTA states to incorporate into their domestic legislation all the secondary Community law (Directives, Regulations and Decisions) together with the European Court case law relevant to these fields; as with EC Member States this body of law will be incorporated into the national law of the participating EFTA states.

Initially it might seem that the application of the Community's financial services legislation posed an excessive burden on the EFTA states. However this is not true when one considers that financial reforms were already underway in many EFTA states prior to the start of negotiations, as these states had already recognised the need for such reforms for the sake of their own financial markets and for their industries generally. The EEA Agreement therefore provided them with a ready-made framework within which to modernise their financial services industries.

2. The importance of the financial services sector - including insurance

Financial services account for a substantial share of the economies of the contracting parties to the EEA. The activities of banks and insurance companies together represent about 7% of GDP in the European Community and over 3% of total employment. There is, of course, a wide variation in this respect within the Community, with output and employment in the financial services sector relatively more important in Luxembourg and the United Kingdom. The sector plays a somewhat less important, but nevertheless significant, role in the EFTA on average. (See table 1 hereafter).

This is not true however of Switzerland where in terms of employment and output the sector is on a par with Luxembourg and the United Kingdom. Thus Switzerland's non-participation in the EEA arrangements at this stage will mean that a relatively large European financial market will not come under the scope of the financial services internal market legislation.
Table 1: Financial services activities in the EEA
(variables expressed as % of GDP, 1990)


Net Insurance
Stock Market
Equity Turnover
Belgium 4.2 167.6 5.0
Denmark 4.5 99.3 8.8
Germany 5.7 157.2 34.7
Greece 1.6 101.3 5.6
Spain 3.3 122.6 8.2
France 5.9 144.7 9.9
Ireland 9.5 105.7 6.5
Italy 2.6 99.4 3.9
Luxembourg 4.8 3950.5 2.5
Netherlands 8.0 170.1 14.7
Portugal 3.4 104.7 1.9
United Kingdom 9.6 222.1 56.1
Austria 4.9 170.4 35.1
Finland 6.5 96.1 2.9
Iceland 3.1 842.3 -
Norway 4.9 96.1 13.2
Sweden 4.8 169.2 6.7
Switzerland 8.1 362.8 166.0

Sources: International Financial Statistics, IMF
Sigma, Suisse de Réassurances
F.I.B.V. 1990

Not only is the financial services industry important in its own right as a generator of valued added and provider of employment, but because the product in many cases is in fact an input into other economic activities, the gain that will accrue as a result of greater competition and larger economies of scale occurring both within the EC's internal market and now the extended internal market - the EEA - will have important spill-over effects throughout the whole economy.

3. The main features of the EEA Agreement

3.1 The internal market in financial services

Article 36 of the Agreement commits the contracting parties to allow for the free provision services within their territories. The modalities for doing this are specified in a number of annexes to the Agreement - one of which refers to financial services. The Agreement, however, does not attempt to rewrite Community Directives, rather it employs the technique of referring to specific Directives in the annex on financial services. The first stage of the negotiations therefore dealt with the identification of the existing legislation necessary to extend the internal market to the EFTA countries. All Directives that were considered relevant to the freedom to provide financial services were then included in the annex. The references to Community Directives are qualified by some limited exemptions from the scope of Directives and transition periods.

The Community's negotiating position regarding exemptions or transition periods was that they had to be properly justified on the grounds of safeguarding fundamental interests and that they would not disturb the fundamental balance of the agreement. Thus in the banking sector certain exemptions were made to the scope of the directives on the same grounds as applied within the EC. In the case of the Finnish Pension system, which is provided by private insurance companies but with a high degree of state involvement in controlling their activities, no exact equivalent could be found in the European Community. It was therefore agreed that Finland could maintain its national legislation controlling the pension activities of the companies involved in the system, but at the same time they would have to open the system to firms from the Community. This conclusion balanced, on the one hand, the wishes of the Finnish side to protect their system and, on the other, the Community's desire to see full competition in insurance markets. In addition to the general exemptions, short transition periods were granted to a limited number of small banks and insurance companies to comply with the solvency requirements of the directives.

In practice therefore the EEA Agreement - when it comes into force - will follow the same logic as the Community's internal financial services market. It is founded on the same principles of home country control and mutual recognition, based on agreed minimum prudential standards. It must be remembered however that the Agreement as it now stands, and the one that will first come into force, was based on Community legislation as it stood at the time of negotiations - 1 August 1991.

One of the most interesting aspects of the Agreement is that it is dynamic rather than static, in that provision is made for the incorporation of new Community legislation as the EC's internal market evolves. In fact, while the problems associated with the rejection by Switzerland of the Agreement are being addressed at the political level, negotiations are continuing in sectoral groups between the European Community and the EFTA side on the incorporation of new directives into the Agreement. It is intended that all the relevant financial services directives adopted subsequent to the original cut-off date will thus be incorporated into the Agreement soon after it comes into effect. On the insurance side this will involve the third generation insurance directives, the directive on the annual accounts of insurance companies. In banking and securities trading new legislation under discussion includes the directives on the own funds, consolidated supervision and large exposures of credit institutions and the long-awaited investment services and capital adequacy directives.

3.2 Institutional Questions

Because of this very dynamism the Agreement includes a very comprehensive institutional framework to allow for the on-going nature of Community legislation and to oversee the Agreement in general, particularly with respect to the maintenance of common rules and uniform conditions of competition. The institutions established by the Agreement include:

- The EEA Council: which will be responsible for giving the political impetus and guidance regarding the implementation of the Agreement;

- The EEA Joint Committee: which will be responsible for the implementation and operation of the Agreement and will take decisions on the implementation of new Community acts;

- The EEA Joint Parliamentary Committee and EEA Consultative Committee of the economic and social partners which will express views on the Agreement in the form of resolutions and reports.

3.2.1 New Legislative Developments

Throughout the negotiations the European Community side had to ensure that the final Agreement would preserve the Community's independence regarding the development of new legislation. On the other hand it was obvious that provision would have to be made to allow the EFTA states make some input into the decision-making procedure on laws that would ultimately affect them in the same way as any Member State of the European Community. Under Article 99 of the Agreement the Commission has promised to seek the views of EFTA experts in the same way as it consults with its own Member States in drawing up new legislation. After a formal proposal for a new Council Directive has been presented by the European Commission, discussions will take place on a continuous basis in the EEA Joint Committee. At this stage any major problems with the application of the proposed legislation in an EFTA state will be raised and any adjustments made to facilitate the ultimate incorporation of the legislation into the EEA Agreement. Once a proposal has been adopted as a Directive the EEA Joint Committee will then formally seek to include it in the EEA Agreement.

If, despite the information and consultation procedure just outlined, the EEA Joint Committee cannot agree on a new measure it is possible that sections of the Agreement relevant to the sector concerned could then be suspended vis-à-vis all EFTA states. However this should only happen in rare circumstances and as a last resort.

3.2.2 Comitology

Special arrangements will also apply to committees established under Community legislation - including the Banking Advisory Committee and the Insurance Committee. In order to keep the EFTA side fully informed of developments in Community policy regarding the financial services sector the chairmen of these committees together with representatives of Member States will meet with EFTA representatives before and after meetings of the relevant Committees. In particular the EFTA side will be informed of the topics under discussion by the Committees and of the outcome of these discussions. This arrangement was considered to be the most suitable to meet the twin objectives of keeping the EFTA side as informed as possible about activities within the Community while at the same time preserving the independence of committees, such as the Banking Advisory and Insurance Committees, that advise the Commission on the implementation of directives and decide on policy issues in a number of cases.

3.2.3 Surveillance Procedure

The EEA Agreement provides for a "two-pillar-system" to ensure that the same rules apply in both the European Community and EFTA states in relation to the implementation and application of legislation. The EFTA side will in fact adopt a similar procedure to the Commission regarding surveillance and to this end the Agreement establishes the EFTA Surveillance Authority (ESA). Obviously there will be close co-operation between the Commission and the ESA to ensure as far as possible a common interpretation and application of legislative acts, in particular legislation on competition rules and state aids. Furthermore the EFTA states will establish an EFTA Court which will be competent for actions concerning the surveillance procedure in EFTA States and appeals concerning competition initiated by the EFTA Surveillance Authority.

The EEA Joint Committee will also keep under constant review the case law of the European Court of Justice and the EFTA Court and the Joint Committee "shall act so as to preserve the homogeneous interpretation of the Agreement." Where a difference in the case law of the two Courts arises which cannot be solved by the EEA Joint Committee and if it involves provisions of the Agreement that are identical in substance to Community rules, the Contracting Parties to the dispute may agree to request the Court of Justice of the European Communities to decide upon the interpretation of the relevant EEA rules. Thus the independence of the European Court of Justice is preserved regarding competition rules that will apply throughout the whole EEA.

3.3 Relations between the EEA and third countries

An important feature of the Community's financial services legislation is what is called the Third Country Regime. This regime applies to the banking, insurance and securities trading sectors. The objective of the Community's third country regime for financial services is to create global free trade in financial services. The Community aims to do this firstly by setting a good example to third countries in granting full national treatment to foreign banks, securities firms and insurance companies established in the Community. Article 58 of the EEC Treaty guarantees that any foreign owned financial institution established in any Member State of the Community is treated in exactly the same manner as a domestically established firm. This means in effect that foreign owned banks and insurance companies can avail of the freedoms provided by the internal market legislation to establish branches and provide cross-border services throughout the whole Community. Secondly, the Community can only apply sanctions against a third country - by refusing to grant new authorisations to banks, securities firms and insurance companies that wish to incorporate in the Community - in cases where it is proven that national treatment is denied and the conditions of effective market access are not fulfilled in the particular third country.

It was the wish of both sides during the EEA negotiations that a common third country regime would apply for the whole EEA. This to a large extent has been achieved so that in the vast majority of cases a third country financial institution established in the United Kingdom, for instance, will be able to branch into and to provide services in all the other EEA countries and vice versa. However if in the application of the Third Country Regime the Community refuses to grant new authorisations to a financial institution originating in a particular third country, such a financial institution will not have the right to branch into the EC or to provide services in the EC by establishing in an EFTA state. Furthermore if any third country applies discriminatory practices against financial institutions established in an EFTA state, that are not applied against Community firms, the EFTA state in question will also be free to refuse branching and cross-border provision of services into its territory from the European Community. It must be stressed that a refusal to grant an authorisation either by the Community or an EFTA state applies only to new applications to establish a subsidiary and existing foreign owned establishments in the Community remain totally unaffected.

In so far as branches of third country insurance undertakings are concerned, while no common rules apply regarding establishment, there are agreed rules on solvency margins that must be respected. These requirements do not of course apply to EEA established companies as they are considered to be adequately covered by the requirements imposed on the parent company by the Directives.

There is also provision in EC insurance legislation for the Community to conclude agreements with third countries to harmonise requirements on branching from a third country. This has been done in the area of non-life insurance with Switzerland. The legislation to conclude such agreements has also been taken over by the EFTA countries in the EEA context, but on an independent basis, so that they can conclude agreements bilaterally with third countries. Whenever they conclude such an agreement with a third country the EFTA side will inform the Community of its contents in order to avoid any major divergence with Community agreements.

4. Economic Aspects of the EEA Financial Services Market

The EEA Agreement will further enhance the benefits of the internal market by extending it beyond the frontiers of the Community. The economic effects of liberalising trade in financial services are similar to other products. Firstly, liberalisation should help to achieve better resource allocation within the financial services sector - the main benefits arising from economies of scale and greater competition. Secondly liberalisation in financial services should help to improve resource allocation throughout the whole economy. The creation of the EEA financial services market will thus give an additional impetus to the Community's own internal market. It is estimated that in terms of financial services activities the EEA market will imply an immediate expansion of the internal market by 10%.
Table 2: Estimated gains resulting from EEA integration of financial services markets


Average price
Effect on
% of GDP
Gain in
consumer surplus
% of GDP
Belgium 21 1.0 1.2
Germany 21 1.0 1.1
Spain 34 2.2 2.6
France 28 1.1 1.2
Italy 31 1.4 1.6
Luxembourg 20 1.9 2.0
Netherlands 17 0.8 0.9
Utd Kingdom 21 2.6 2.9
EC 8 24 1.5 1.7
Austria 34 1.9 2.2
Finland 20 0.7 0.7
Iceland 14 0.6 0.7
Norway 33 1.2 1.3
Sweden 29 1.0 1.2
Switerland 31 2.8 3.2
EEA 25 1.4 1.6

Based on data for 1987
EEA includes Switzerland
Source: Occasional Paper No. 33, P.M. Gardner and Jonathan L. Teppett, EFTA

Although it is difficult to quantify the price reductions that might occur as a result of the EEA, an EFTA paper published in 19901 allows us to identify the countries that stand to gain most from the liberalisation of the market. This paper subjected the financial markets in the EFTA countries to the same analysis as that employed by Cecchini in the study on the internal market effects within the European Community2 . The results suggested potential price reductions for financial services of 25% in the EEA, equivalent to 1.4% of GDP. The gain in consumer surplus, which takes into account the increase in demand resulting from the price reductions was estimated at 1.6% of GDP. These gains, however will not be uniform throughout the EEA. In the case of Spain and Austria the fall in prices could exceed 30%, with gains in consumer surplus of 2.6% and 2.2% of GDP respectively. Although the fall in prices in the United Kingdom will be lower, estimated at 21%, the large output of financial services in that country could result in a consumer surplus gain of 2.9% of GDP.

5. Industry Response

One may therefore ask what mechanisms apply that will allow the suppliers of financial services to take advantage of the necessary economies of scale to put downward pressure on the prices of their products and thus increase economic efficiency. In the financial services area one must first distinguish between wholesale and retail markets. In many countries the wholesale markets are already liberalised or almost so. These markets are therefore operating under highly competitive conditions already. It is therefore in the middle segments of the wholesale markets and in the retail markets where significant gains from greater competition should result.

It is in these very markets however where proximity to clients via branch networks and national and cultural preferences are most important in the financial services industry. Because of these factors it is difficult for any foreign establishment to gain a significant market share at the retail level even when the investor and consumer are protected by harmonised prudential requirements. Nevertheless, there will be pressures on the suppliers in the industry to change their strategies to take advantages of the opportunities provided by the EEA or to guard against new threats. In the smaller countries one possible response is for mergers to take place between traditional domestic competitors to ward off what is seen as a "foreign" threat. An alternative is for mergers to take place across national boundaries. This strategy facilitates, on the one hand, firms operating in the larger domestic markets to gain a foothold in hitherto unfamiliar territory, and on the other, firms operating in smaller domestic markets which seek the support of a relatively large partner that will help them to survive in the new competitive environment.

Financial institutions throughout the EEA therefore need to adopt clear strategies to survive in whatever form. Most administrations have foreseen the need to reform their financial markets as much in response to globalization of financial markets as the creation of the Single European Market. The liberalisation that has taken place is beneficial in its own right but it will also help firms to strengthen and modernise an respond to the challenges that lie ahead.

6. Conclusions

At its simplest the EEA Agreement is an extension of the internal market to an additional five countries. It provides a framework for the EFTA countries to reform their financial services industries to allow them to compete in the modern world. The reforms will benefit consumers of financial services directly and will then have significant knock-on effect on industry generally. The question is not whether the new framework will have a significant impact on the market but rather when and in what manner will the changes take place.


* Commission of the European Communities, Directorate General Internal Market and Financial Services - General Matters and coordination - External dimension of the internal market and financial services. (DG XV A-4). Rue de la Loi, 200 - B-1049 Bruxelles. Views expressed in this article are those of the author and do not necessarily correspond with those of the Commission of the European Communities