The Implications of EMU for European Banking

Karel Lanno*

Monetary union will further complete the single banking market and make it irreversible. A large restructuring process can be expected to occur in response to the fundamental changes that will happen in the banking business following monetary union. This process can be compared to what happened in the wake of the 1992 programme, but the response might be even more profound. The most important change will be the disappearance of the domestic currency, and with it, the erosion of the main source of competitive advantage for local banks. This will lead to large changes in the wholesale and corporate banking business, where European-wide operations will start to assume a dominating position. The government bond market will become truly integrated. A broader corporate bond market, based on a broader currency area, can also be expected to emerge. Domestic strengths, on the other hand, will continue to reside in customer relationships and knowledge, and in the local expertise. Moreover, remaining differences in the tax and regulatory environment will allow some local competitive advantage to be retained. The changes might initially be less marked in retail banking, although this business will also undergo a general restructuring process. A further reduction in the presently extensive branch networks can be expected, retail operations will be further depersonalised and automated, and product competition will increase. One way to speculate on the effects is to compare the different European banking markets on the basis of structural, economic and financial criteria. Although national consolidated data hide many details, they can be a basis on which to highlight problems some countries might face more than others.(1) Before doing so, let us briefly review the effects of 1992.

The launch of the single market programme was the start of a big restructuring process in European banking. Although it is difficult to prove the effects of the programme at a global level, it led to an important consolidation phase at the level of the individual banks. The clearest effect of the 1992 programme was indeed the restructuring of banks in the EU. The number of bank mergers increased from 52 in 1985 to 238 in 1990; the number then declined slightly thereafter but remains at a high level. The consolidation occurred primarily at domestic level, although the number of EU and international mergers also went up. The latter form of merger was concentrated in the wholesale sector, whereas international mergers in the retail sector were very limited. The restructuring process introduced new keywords in the banking sector: competitiveness, efficiency, cost controls and profitability. No clear pattern, however, can be discerned at the European level on the basis of consolidated balance sheet data over the period 1985-1994. In some countries, branch networks continued to expand, whereas in others they were stable, and decreased in still others. The same could be said for employment, productivity (measured as gross income per employee), or profitability. European banking markets were mainly responding to local circumstances and changes in the national environment. The advent of 1999 might signal a further phase in the consolidation process. Competition will further increase, margins will reduce and costs should be further lowered. What could this lead to? At a structural level, a further reduction in the number of branches can be expected in countries with excessively extensive branch networks. As can be seen from Table 1, the number of inhabitants per branch differs from less than 600 in Belgium to over 3000 in the UK. Additional reductions can be expected in countries such as Belgium and Spain, but they might also be necessary in several other European countries as well.

Table 1: Number of inhabitants per branch (1994)

Switzerland 1837
EU average 1952
Sweden 2916
Finland 2782
Austria 1713
United Kingdom 3509
Spain 1102
Portugal 2748
Netherlands 2117
Luxembourg 1084
Italy 2865
Germany 1832
France 2212
Denmark 2318
Belgium 594

Reductions in the branch network might also lead to slight reductions in employment levels in the banking sector. Banking employment is fairly comparable in the EU and amounts to about 2% of total employment, with the exception of Luxembourg, where it amounts to almost 10%.

Employment cuts could impact productivity positively. The latter, measured as gross income per employee, show important differences. Although most countries tend to cluster on Table 2 around the European average of 124,000 ECU per employee, countries such as Greece, Portugal and Denmark lag far behind

Table 2: Gross income per employee

Japan 177
USA 124
Switzerland 194
EU average 124
Sweden 139
Finland 105
Austria 137
United Kingdom 104
Spain 107
Portugal 75
Netherlands 157
Luxembourg 238
Italy 126
Greece 73
Germany 115
France 131
Denmark 88
Belgium 135

The key is the profitability of the banking sector, measured as return on equity or return on assets. Monetary union will eat into bank profits from two sides: interest income will slide as a result of the tight fiscal criteria and more intense competition on the loan market. National banking industries which have a large share of their assets invested in government debt, as is the case in Belgium, will need to think about other sources of income. On the non-interest income side, banks will lose on foreign exchange and related commissions. To these, one must add the, albeit one-time, costs of the transition. Graph 3 shows that a group of countries tend to fall around the European average. The Netherlands and the UK are doing much better, while the problems in the French banking sector are confirmed. The restructuring process seems to be over in some countries, while it is only starting in others.

This brief overview gives a birds-eye view of the different European banking markets and the way they compare on the basis of some general structural and microeconomic indicators. The graphs illustrate the fact that the differences are still large and that some banking markets might have more problems in adapting to the euro than others. A further phase of restructuring can therefore be expected.

Banks will have to attend closely on the cost and revenue side of the business. An obvious target on the cost side will be the branch networks, and probably, employment. On the revenue side, banks will have re-orient their business and focus on their competitive strengths. Revenue growth from the domestic deposit and loan business is thought to be limited. Growth will have to come from bancassurance, investment banking or fund management.

A final word on the indirect impact of monetary union. Luxembourg has seen a tripling in the size of bank deposits from 1984 to 1994. This is of course due to the tax haven status of this country and the absence of withholding tax on interest income.

Although the EU has so far failed to harmonise withholding tax rates at the European level, such distortions will become even more glaring in monetary union, and therefore untenable.


Dermine, Jean (1996), European Banking with a Single Currency, mimeo, March
Lannoo, Karel, e.a.(1995), The Single Market in Banking, From 1992 to EMU, CEPS Research Report No.17
OECD (1996), Bank Profitability, Financial Statements of Banks (1985-1994)


* CEPS. Place du Congrés, 1 - 1000 Bruxelles.
1. The data for the graphs in this article were taken from the OECD’s Bank Profitability statistics (1985-1994), and supplemented with other data where necessary. As compared to previous editions, the OECD data have become fairly complete. They now give consolidated balance sheet information for the whole banking sector in 10 EU countries. The information is less complete for Denmark, Sweden and Greece. Statistics for the UK were supplemented with data for building societies where possible. No data were available for Ireland. EU averages refer to number of EU countries in the survey. For a detailed analysis, see Lannoo, e.a. (1995).