Most American banks are still domestically focused.

Citigroup does have a global focus - especially in retail. And other banks operate internationally in businesses ranging from custody to trading. But 95% of the industry's attention is concentrated within U.S. borders.

Technological progress and other factors are rapidly breaking down the rules that made this inward-looking strategy economically feasible. These elements range from hedge funds with huge bets on European interest rates to the capital crisis and "big bang" in Japan, to the impending arrival of the euro, the European Union's common currency.

Though there are mitigating factors, the net result for banks will be a need to better understand events outside the United States and how the progress of technology is pulling all national banking systems closer together.

One place to start is the euro. On Jan. 1 many wholesale and interbank systems will switch immediately to accepting and encouraging euro transactions.

For example, Germany's Electronic Access Frankfurt, the largest German clearing system, is competing to become the leading interbank clearing system for high-value euro payments. Its preferred currency will be the euro though other currencies will still be handled.

With one currency serving many countries, whole parts of European national banking systems would be ripe for rationalization. There's no economic rationale for each country to have its own national clearing system, securities depository, and central bank. These systems will remain in place for at least the next three and a half years, however, as retail consumers continue using the old currencies.

The leading candidates for clearing euro payments are Electronic Access Frankfurt and euro-Chaps, or Clearing House Automated Payment System, a system-based on the United Kingdom's high-value interbank clearing system- for handling the euro. Each is aggressively seeking business from banks and using technological innovations to encourage them to clear directly.

For example, the German system will allow a dial-up connection from anywhere in the world for banks with low transaction volumes.

These evolving real-time gross settlement systems will significantly reduce risk by settling each transaction as soon as possible. They use relatively sophisticated algorithms to queue up transactions for short periods until they can be processed.

These euro clearing systems are connected by Target, the high-value cross-border euro clearing system from the Society for Worldwide Interbank Financial Telecommunications, or Swift. It lets any real-time gross settlement system communicate with any other and accesses 50,000 financial institutions, including banks that are not part of the European Monetary Union. Payments are irrevocable and executed on the same day. Volume tests are at 15,000 payments per hour.

Liquidity risk will increase because of the euro and require new information technology investments. Today wholesale systems liquidity is controlled by being captive to one national settlement system. Next year there will be many euro clearing systems, each requiring liquidity. It will become difficult to manage these multiple pools of liquidity.

To make new services possible, Swift is embarking on what it calls "the new generation" technology investment. Starting with $50 million, Swift intends to turn its global network and messaging system from today's store- and-forward technology into a TCP/IP network. It believes that this protocol, the same one used for the Internet, is the protocol of the future. By converting and making its network more user friendly, Swift aims to reduce the risk of users connecting themselves directly over the Internet and disintermediating Swift.

A major project that Swift will build on is Continuous Linked Settlement, or CLS. There will be both a CLS bank, to be located in New York, and a CLS services group, in London. The services group got a fast start by absorbing the multilateral clearing houses Echo and Multinet.

CLS aims to reduce risk in foreign exchange transactions by bringing both sides of a transaction together in one real-time settlement system. For example, today each side of a dollar-to-franc exchange settles in different places - the dollars in New York and the francs in Paris. By settling each side of a transaction in the same place, the risk is reduced. The technology and development for CLS have been outsourced to IBM.

And don't underestimate the effect of the current merger wave in Europe. For example, although banking was invented in Italy, no Italian bank has ever been one of Europe's top 25. Today Italian banking is still relatively fragmented. But a wave of mergers in Italy is aimed at changing this.

In other countries, the trend is the same. Switzerland's merged UBS AG is now the largest non-American bank in terms of information technology spending-at about $2 billion per year. Sweden's Nordbanken and Finland's Merita Bank recently concluded one of the first true cross-border mergers.

Merger jockeying is the result of four primary factors: the single euro- defined marketplace, the anticipated "invasion" of Europe by U.S. banks, some remaining privatizations and the need to raise more capital, and the need for greater industry efficiency and capacity reduction.

Mergers are inevitably going to change the competitive landscape and the shape and nature of banks' information technology investments. Most European banks have less experience than U.S. banks with back-office mergers and conversions. As mergers multiply, the Europeans' difficulties with their generally proprietary and country-specific applications and operations will increase. The rich variety of best-of-breed solutions found in the United States is generally not present in Europe but should become more so.

Adjusting will require mental, cultural, and financial changes. A higher level of interest in - and commitment to - modern technology will be required. Technology-driven business developments such as call centers, consumer credit bureaus, and securitization lag substantially, and investments in these areas must increase. Country-specific payment methods will decline in volume, and banks must be more proactive in moving to higher value-added payment vehicles like the revolving credit card.

Common applications across borders are likely to become a real issue. Traditionally, banks run separate applications in each country and suffer the consequences.

Citicorp just recently standardized its retail banking systems for non- New York, non-credit card solutions on tailored software from Sanchez Computer Corp., Malvern, Pa. As cost pressures mount from the global financial crisis, this burden will be attacked relentlessly.

A final major trend is the need to improve securities processing efficiency with straight-through processing. Today an estimated 30% of cross-border trades fail at settlement. Only 30% of Swift's securities transactions were processed straight through in 1996, but it aims to hit 50% by 2001.

U.S. banks are already subject to global credit, market, and liquidity risks. Hedge fund losses derived from non-U.S. equity and bond positions have had well-known effects on U.S. banks' balance sheets.

Thus, an additional major presence by U.S. banks in Europe (and probably Japan) is a likely sequel. To date, few U.S. banks have made major acquisitions in Europe, but inroads have been made by monoline credit card companies like MBNA. Some U.S. banking companies, like BankAmerica, will face constraints on their ability to grow in the United States because of deposit caps.

The net result? The U.S. banking industry must begin to look beyond its borders more than it has. Events in Europe will have substantive effects on U.S. banks, not just in selected businesses like correspondent banking. Technology is tearing down national borders - and the banking systems that are defined by national borders or national currencies.

Europe offers a model and a lesson. U.S. banks should be over there observing and learning.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.