European Banking Transformation Catalysed via EURO and ICT? (1)

Jozef Van den Nieuwenhof (2)

In banking as well as in ICT, buzzwords have been nurtured for decades. The emergence of a single currency, the euro, is very likely to act as a catalyst to turn hype into reality. If this were true, the European financial landscape might be in for quite an earthquake.


The quintessence of banking functions is bridging the gap between buyer and seller.

This is essentially what banks have been doing for centuries. Gaps, caused by imperfections in communications, existed both in time and space. Buyer and seller lived in different places, had different levels of solvency and liquidity, used different currencies and spoke different languages. Banks acted as intermediaries between both, so that a deal could be concluded and carried out. With the emergence of euro, standards and telecom-munications, these imperfections are vanishing.

Banking distribution channels become automated.

There is no point in repeating that some functions of bank branches are disappearing, to be replaced by automated teller machines, point-of-sale terminals, home banking, phone banking, office banking and telebanking. Automation does not only cover bank-to-customer or customer-to-bank communications. The whole of the business cycle, from customer to enterprise and from enterprise to enterprise, also becomes completely electronic, for example by tele-shopping and Electronic Data Interchange (EDI). In this completely automated business cycle, the final payment is only a minor part that has to follow all the preceding stages. This means that banks are increasingly becoming processors of electronic messages, at European and global level.

Banking products are being dematerialised.

As banks are treating information about money, this information is no longer materialised on a sheet of paper, on a form or in securities, but becomes an electronic message. The core of banking products, loans and deposits, is being securitized. The valuation of the customers' creditworthiness is no longer a problem for loan officers, but is expressed in ratings by specialised agencies. With all investment products fully securitized, the market becomes very liquid and transparent. All information is available everywhere, in real time.

A very important consequence is that banks become traders of financial products, rather than lenders and borrowers. Trading requires a new approach based on mathematical models and expert systems. For implementing all of these complex mathematical optimisation formulas, banks turn to rocket scientists and start programme trading. The euro will make these electronic markets more important, and more liquid.

The unbundling of banking products reinforces this process.

Banks tend to practise relationship banking. This means that the relationship with the customer is considered as a whole portfolio, in which some services are profitable and others are not. Relationship banking has been interrupted by customers, who became shoppers of banking services, cherry-picking the cheapest services at each bank. This may lead to an unbundling of banking products, with far-reaching results. The unbundled items of the banking portfolio are by definition much more standardised and become commodities.

As for all commodities markets, transparency is enhanced, which leads to more competition and smaller margins. As banks have only recently gained experience in product-related pricing, they have difficulties in finding the true reward of risk for these unbundled items.

The emergence of higher-level standards also enhances the commoditization of banking products.

The use of EDI standards bridges the communication gap between buyer and seller. Not only are communications perfected, but also applications that once were banking functions, become readily available "off the shelf".

The unbundling of banking products, with its consequent commoditization and standardisation, facilitates in-house banking.

When the gap between buyer and seller narrows, in-house banks can fill it more easily. Large companies and financial co-ordination centres have access to all electronic systems, messages and information providers, in the same way as banks.

The possibilities of transmitting payment messages and concluding in-house pre-clearing are already widely used. Sometimes blue chip companies have the same access to capital markets as banks. They may obtain a better rating and are not always subject to the same regulation burden or capital ratios as banks.

Prudential control regulations become too heavy a burden for banks.

One day this may force banks to split up. The capital ratios (Cooke ratio) are based on balance sheet items. The problem is that some of the risks, primarily on derivatives, are "off balance sheet".

The ratios are still mostly based on accounting data, which are unable to express all the factors of the actual risk associated with the deals. For instance, accounting data are unable to cover the notions of duration, liquidity, interest turnover dates and volatility.

If a bank is heavily engaged in derivatives, this may require a very high capital ratio.

A customer of this bank, who only requires a simple loan, may object to paying the additional interest rate margin required for this capital ratio. To avoid these kinds of problems, banks may have to split up into different entities, with different balance sheets and subsequent different capital ratios. This phenomenon, called narrow banking, may lead to other problems, related to solvency and liquidity.

The results of financial engineering may also lead to a new kind of banking risk, called risk of complexity. Very few understand all the intricacies of modern banking products. In the case of Barings, this problem has been coined institutional incompetence, because of the sheer impossibility for bank management to master this complexity as a whole.


The speed of change is mesmerising.

Whereas Moore's law says that the capacity of a computer chip doubles every year, an even stronger law applies to the speed of creative innovation. It appears that in IT, a new product hits the market every 20 seconds.

Scientists are pondering about the moment of singularity, i.e. the moment at which as much innovation will be created as already exists. Can humanity, and can the economy and politics for that matter, cope with such turmoil? As industrial historians speak of the BF and AF (Before Ford and After Ford) eras to stress the importance of the changes brought about by industrial society, today's computer nerds talk in terms of BW and AW (Before the Web and After the Web).

Are today's changes that important? It might indeed be dangerous to underestimate the transition from Gutenberg to Gates. There is no more limit to the input, processing, transport and output of digital information. Anytime, anywhere, anyhow. And, most important, it is at everyone's fingertips, for the first time ever in history.

Some forecasts are being made concerning the ICT evolution, for the next decade. As far as storage capacity is concerned, it will be feasible to store 300 Megabytes on 1 square inch. This means the contents of 500 pocket books of 300 pages each. In wireless communications, 150 Megabytes will be transported in 1 second. This means 250 pocket books of 300 pages each. The theoretical maximum processing speed of the existing chip technology is 15 billion times faster than a present high-level Pentium chip.

This means that all knowledge will be available anywhere.

It will be possible to present this knowledge in the most user-friendly way. Intelligent assistance will be delivered to guide the user in the effective and efficient use of this knowledge.

For banks, amongst others, this raises important questions. What about centralisation? Is there still a need for centralised clearing, when many-to-many connections are cheap and ubiquitous? Is there still a need for centralised head offices? What about economies of scale, when such centralisation is not necessary anymore? The economic calculus of large organisations might change dramatically with such kinds of paradigm shifts.

An important macro-economic phenomenon linked to this shift is called "technological terrorism".

It is difficult to assess all the consequences of technological evolution. Worse still, it is hard to write off today's technological investment. Market structures and competition make it difficult for banks to be adequately rewarded for the services they provide.Technological advance in banking has been coined: "Creating values, destroying profits" (5) . This means that the banks' automation efforts have created customer value, but have destroyed banks' profits.


Until now, the possible massive impact of these evolutions has been restricted by domestic franchise, safeguarded by the local currency. European banks have been protected at home by local standards, local procedures, local laws and regulations, and local habits.

The domestic franchise offers a comparative advantage to domestic banks for several reasons. - The local currency fixed income market is made by local banks, because of their volumes. - Local market makers know trade patterns, buying behaviour, and customer needs. - They can create liquidity and do not run exchange risks. - The same applies for equities, with the additional advantage that local banks are more apt at analysing domestic credit risks.

The creation of a truly European financial market, via euro, will take away this comparative advantage, and thus protection.

An clear example of what can happen can be seen when comparing domestic and FX-MM banking departments. - FX and MM dealing rooms are the same everywhere. Same desks, same information providers, same front office tools, same middle and back office procedures, same message standards. - Domestic banking, however, is quite incomparable from one bank to another, even within the same country.

Will the emergence of the EURO make domestic banking as standardized as the present FX and MM departments are?

Electronic banking leads the way already.

Remote access is largely facilitated by cyberbanking. Cross border shopping for retail-related products, such as installment loans, mortgage loans, investment funds, insurance policies and pension savings, is facilitated. Cross border access to equity and deriva-tives exchanges is not much more complicated either.

For some banks this scenario will be a nightmare.

As fixed euro transition costs are extremely high, some banks with low ROE might not deem it worthwhile to proceed with the changeover. They might prefer to offer their portfolios for takeover.

However, Belgian banks might generally be well prepared for such scenarios. As for markets, not many are as international yet as the Belgian market. Competition is fierce already, and domestic franchise is not over-protected.

As far as banking systems are concerned, the Belgian long tradition of interbank projects has created a valuable back-office configuration. The combined functionality of CEC, ELLIPS, Banksys, Proton and ISABEL is quite unique. Moreover, these functiona-lities are highly standardized, coherent and transparent.

Whatever the ideal outfit for the European bank of tomorrow, whether large universal bank, specialized boutique bank, or standardized MacDonalds bank, Belgian systems should be able to cope.


1. ICT: Information and Communications Technology

2. Directeur Bancaire Informatica en Organisatie Belgische Vereniging van Banken. Ravensteinstraat 36 bus 5 - 1000 Brussel.

3. Nijenrode University, 28/04/94, Information Technology and Organisational Change - New Technologies in Banking: Catastrophe or Manageable Risk

4. Revue de la Banque n° 3, Mars/Avril 1996: Banking IT in Belgium - "The Road Ahead"

5. Technology in Banking - Creating Value and Destroying Profits - Thomas S. Steiner - Diogo B. Teixeira - Dow Jones Irwin.