October 16, 2012

Birthday celebrations for a European success story: the Single Market is turning 20. Just in time for the anniversary the European Commission has tabled a set of measures to bolster market integration in Europe. As the financial crisis wears on, though, banking and financial market integration shows a reverse trend. What does this mean for the single market, and can the proposals remedy this?

EU Commissioner Michel Barnier is planning concrete steps to deepen the integration of the single market. The aim is to create growth, boost citizens' trust in the single market and likewise in Europe. To this end, the Commission had already identified key levers and had launched proposals for action back in 2011 (Single Market Act I: Status of Actions). The Single Market Act II now adds on these, concentrating on four areas: 1. Integrated networks, 2. Mobility of citizens and businesses, 3. The digital economy, and 4. Consumer confidence and cohesion. The Commission announced to put forward detailed actions and legislative proposals for the individual areas by spring 2013. In some cases plans have been on the drafting board for quite a while.

After almost twenty years the single market is still not a completed project and requires continuous further development – precisely because it continues to offer growth potential. In fact, new stimuli appear to be particularly necessary especially for the area of banking and financial market integration because a renationalisation trend has emerged here since the financial crisis erupted. Country risks have returned to the fore, the significance of cross-border bank refinancing has declined, and the same applies to mergers and acquisitions. Client business is also affected since cross-border activities by euro-area banks on average also show shrinking tendencies. Price-based indicators round out the picture: following years of convergence interest rate spreads are visibly widening, which ultimately reflects the differences in economic situation and funding conditions in the member states.

The trend towards renationalisation also means real welfare losses for EU citizens. They are unable to enjoy the benefits of the single market to the full extent, such as a wider choice of suppliers and products, lower prices and better services for consumers. Can the proposals provide new impetus? Three announcements are likely to affect banking and financial services in particular.

First, payment services in the single market are to become more efficient. More precisely, the Commission plans to overhaul the Payment Services Directive (PSD) and proposes new regulation on multilateral interchange fees for card payments. The ongoing process of SEPA integration, technological innovations and the emergence of new competitors, have already set the market for payment services in motion over the past few years. In this context, new areas – such as mobile payment systems – pose a particular challenge to regulate; ultimately -like anywhere else- it remains impossible to prescribe innovation through legislation. All in all, the proposal regarding payment transactions rather focus on promoting the digital single market than on banking and financial markets integration.

Second, the Commission wants to increase finance for long-term projects by making it easier to access long-term investment funds. The plans aim to facilitate project funding while simultaneously representing an attractive investment offer – also to retail investors. The Commission emphasises the benefits of stable returns and risk diversification for this type of investment. However, long-term projects such as infrastructure are not entirely risk-free as implementation does not always run smoothly or they may prove sensitive to political decisions. Some examples that come to mind include major endeavours like the Eurotunnel or the impact of energy policy on the attractiveness of investments in grid infrastructure. What is crucial is to be clear about who ultimately bears these risks, and whether they are transparent to investors. Whether investments in long-term infrastructure contribute towards risk diversification in portfolios is of course also determined by how the other assets are allocated (remember home bias and sector diversification). At the end of the day, appetite for long-term investment instruments is likely to depend on how investors judge the opportunities and respective returns of specific projects and thus the development of longer-term growth prospects in Europe.

Third, the Commission plans to launch actions on bank accounts. The aim here is to enable all EU citizens to have a basic payment account, to improve fee transparency and facilitate switching of accounts. Measures to improve access to financial services and strengthen consumers' ability to make informed decisions about financial products and/or providers of course seem reasonable in principle. However, the question is where there are specific problems and how they can best be addressed. With regard to account access and financial product coverage, for example, the situation differs quite considerably across member states, reflecting for instance differences in economic development and market structures. This suggests a differentiated approach which takes local circumstances into account to address problems effectively. Overall, the idea of the basic account primarily aims at strengthening financial inclusion and thus has a relatively strong focus on national markets rather than providing strong stimuli for further banking market integration in the near term. Furthermore, to effectively improve transparency for financial products not only the provision of information is crucial but also how it gets used. Against this backdrop, improving financial literacy seems particularly relevant.

At present, the key problems impeding progress in the integration of the European banking market, or perhaps even driving it in the opposite direction, rather lie at the systemic level, and will hardly be touched by the proposals. The major focus at the moment is on fundamental issues of business (re)organisation in the light of a changing regulatory environment, possible implications of the Liikanen report and plans for a banking union in Europe. How these are handled in the near future will also have a substantial impact on the further development of the single market for banking and financial services as well as repercussions for the retail banking business.