Financial systems are facing structural changes worldwide. But Europe faces additional challenges, especially the creation - in theory - of a barrier-less market of 350 million people.

Diversity within Europe is reflected by the differing propensities to save and the different methods of saving. This affects the channels through which savings become transformed into investment, which helps determine how corporations finance themselves.

It also determines the nature of the institutions that intermediate between suppliers and the users of savings.


Three sets of contrasting traditions are particularly importance in determining the choices posed by change in Europe and the strategic response to those choices.

The first is the contrast between universal banking - provision of most banking and financial services within a single financial institution - and functional differentiation of financial services.

The universal banking tradition is best exemplified in Germany, France, and Switzerland. The tradition of functional differentiation by the United Kingdom, before the Big Bang.

Next is the distinction of securities markets or stock exchanges between quote-driven and order-driven trading systems. In a system based on market making, the capital of principals is committed to the market, giving it depth and liquidity. The order-driven system, by contrast, is based simply on matching buy and sell orders.

The latter goes naturally with universal banking. Also order-driven are relatively underdeveloped equity markets, which may be linked to a relatively less developed institutional investment market.

Market making, on the other hand, is the principal characteristic of a quote-driven system and is central to the Anglo-Saxon tradition.

The third important contrast is economic and political, loosely defined as a "north-south divide." The banking and financial systems of Spain, Portugal, Greece, and - in this respect at least - Italy have long been less sophisticated and simpler than those of the north.

EC Legislation

European Community legislation designed to bring about a common market in the provision of banking and financial services is based on three basic principles:

* Freedom of capital movements.

* Any entity authorized in its home country to provide banking or financial services should be able to offer such services across borders, or by establishing a branch in any other EC country on the basis of that home-country authorization alone.

* Minimum harmonization of supervisory rules throughout the community.

Freedom of capital movements is already substantially achieved.

The main instruments for the achievement of the other two principles are, in respect to banking, the Second Banking Coordination Directive and ancillary legislation, such as the proposed Large Exposures Directive.

For securities markets, it is the proposed Investment Services Directive and the proposed Capital Adequacy Directive.

With respect to insurance, it is the first and second life insurance and nonlife insurance directives, and the proposed third directives.

The Second Banking Coordination Directive has been passed, effective in 1993. Hopefully, this will happen simultaneously with implementations of the Investment Services Directive, which is currently stalled in the community legislative machinery.

Problems relating to the Investment Services Directive illustrate the difficulties of harmonization: Points of principle, arising from different market philosophies, clash - particularly if overlaid with national rivalry.


The London market, on which much international equity trading takes place, is called SEAQ International. Its depth, liquidity, and user-friendliness for wholesale investors bring it significant amounts of domestic trading of non-U.K. European equities.

Several countries would like to protect their infant domestic equity markets from this powerful foreign rival by insuring that the Investment Services Directive restricts trading and securities to regulated markets. Regulation, in this case, would be defined to exclude SEAQ International.

Aside from rivalries between financial centers such as London and Paris, market rules appropriate to wholesale investors are very different from those appropriate to small retail investors. Because the former predominate in London, the United Kingdom would like to see an investment directive that does not destroy or diminish the service offered to institutional wholesale investors. In Paris, the opposite is true.

If the outcome is agreement on a directive that permits SEAQ International to continue functioning unchanged, SEAQ could well form the embryo of the European securities market.


The first strategic choice is whether to Europeanize at all, or to consolidate and defend within national boundaries against increased competition after 1993.

Defense of domestic market position against newcomers is likely in Spain or Italy, where the banking sector was only recently liberalized.

The main motive for a bank to Europeanize is probably to provide domestic customers with banking services in other EC countries.

Strategies include establishing branches or subsidiaries, acquiring minority holdings in banks, merging with or acquiring a bank, agreeing to cooperate with an EC bank in a specified area of business, or establishing a European joint venture with domestic or foreign banks.

New operating units, or a controlling or minority interest are the most frequent forms of cross-border operation. New units seems to be the preferred option for entering a new market, while the bulk of acquisitions take place in countries where banks already have a presence.

Few Large Takeovers

There have been very few takeovers or mergers of large banks by other large banks. Experience worldwide suggests that cross-border acquisition of retail networks is rarely profitable.

The particularities of domestic systems and traditions dictate local domestic management - so these takeovers obviously have to be friendly.

French and German banks have established alliances aimed at achieving sizable cross-shareholdings.

In significant cross-shareholdings or joint ventures between large banks, the risk is very high that, sooner or later, there will be a conflict of interest in some area of activity. The fate of many consortium banks established in Europe in the 1970s for exploitation of the developing Euromarkets is a clear example.

An additional inhibition to cross-border mergers may well be cost. Capital ratios are under pressure in many, if not most, of the European banking systems.

A change is taking place in savings habits, as a result of the economic growth in Europe that has spread wealth much more widely. The inflation of the 1970s has also had a salutary effect in destroying money illusion in a number of countries. Savers and investors generally have been more concerned by real returns, causing them to widen their horizons beyond bank deposits and fixed-income securities.

The Pension Picture

In the United Kingdom, the United States, and Canada, a sizable part of personal-sector savings and wealth is held in pension funds. End 1988 figures showed private pension fund assets (excluding those held in life insurance companies) to amount to 23% of total personal-sector assets in the United Kingdom, 13% in the United States, and 14% in Canada. The figures for Germany and France were 2.4% and 3.1% respectively.

The principal alternative to private pension plans is the pay-as-you-go system, either with pension liabilities held in the books of the sponsoring firm or through a state social-security pension scheme.

Everybody is concerned about the significant aging of populations over the next 30 years. Governments and commercial firms will take steps to limit their liabilities by reducing benefits or encouraging moves to private schemes.

Pension funds in European countries can be expected to grow in the Anglo-Saxon/Japanese style. This is likely to lead to a spread of securities and equities markets, because experience shows that equity investment is the best return over time of any form of institutional savings.

Intermediators of Funds

Banks would like to regain their market share as intermediators of funds. They will look at the businesses of securities, investment management, and insurance, although equity markets have shown a preference for less risky domestic strategies and have increased the cost of capital for diversifying banks.

Because of the prevalence of universal banking in Europe, many banks have long been involved in their own domestic securities markets, without the need of a specific securities house.

There is a contrast between the highly developed securities market in London and the rest of Europe. When Big Bang happened, many domestic and foreign banks and others sought to acquire U.K. securities houses. In the rest of Europe there has been no great rush to acquire securities houses.

In France, which has gone through its own Big Bang, that situation is changing. All the major French banks - and, indeed, some foreign banks - have acquired securities houses. Apart from France, development of securities markets in other European markets is still relatively backward.

A Bank/Insurance Link

Development of links between banks and insurance companies must be closely watched. In Europe, regulatory inhibitions against such linkages have fallen away, unlike the United States and Japan.

The three most developed insurance markets are Germany, the United Kingdom, and France. Life insurance has done better than household or casualty insurance.

Some European banks have created our purchased their own subsidiaries. Deutsche Bank has set up its own subsidiary.

Many German and French banks have entered alliances with insurance companies, cemented by significant minority shareholdings.

The initiative for this link-up has come mostly from the banking side. Many of these alliances have been defensive.

There is an advantage to joint marketing of products without need for two parallel distribution systems.

These alliances are supposed to provide the individual customer with a complete range of products. But they have also driven some banks into investment banking for corporate customers.

This has been less necessary for the universal banks of continental Europe than the major British clearing banks, which have all acquired merchant banking subsidiaries since the Big Bang.


It's therefore interesting that Deutsche Bank, the most universal of all universal banks, actually acquired a full-fledged merchant bank in London, called Morgan Grenfell & Co. The reasons for this purchase - investment management and MA activities - are to obtain areas in which German banks have been particularly weak.

The trend in Europe is toward universal banking, with a difference. The characteristic of a traditional universal bank was provision of many financial services. That seems no longer compatible with the regulatory climate or complex management problems posed by the increasingly specialized and technical nature of financial services.

The trend is toward bank holding companies with many functions culturally distinct from banking, such as securities, insurance, and investment management.

The daunting task is to maintain appropriate controls among such culturally diversified activities, while obtaining the desired synergies in an increasingly demanding regulatory regime.

Timetable for Changes

If and when the timetable of European monetary union becomes clear further changes may be considered.

And another factor that will stimulate further changes is the way a European stock exchange develops. Other areas of choice likely during the 1990s are how to relate the newly emerging financial systems of Central and Eastern Europe - difficult and chaotic as the prospect is, if one looks eastward at the moment.

To what extent will continued technological revolutions change our habits and outlook on retail banking? Will they bring banking out of the high street, into the home, through computer screens and terminals?

The choices facing European institutions in the 1990s do not look as though they're going to become any fewer or simpler.

Anthony D. Loehnis has been group executive director and vice chairman of S.G. Warburg & Co. Ltd., based in London, since May 31, 1989.

From 1981 until he took on his current duties at Warburg, Mr. Loehnis was executive director for international affairs at the Bank of England. He has also been a member of the Group of Thirty and governor of the Centre for Economic Policy Research since 1986.

Mr. Loehnis was associated with J. Henry Schroder Wagg & Co. Ltd. from 1976 through 1980.

From 1960 through 1966, Mr. Loehnis was in Her Majesty's Diplomatic Service, with assignments in Moscow, 1961-63, and in London, 1963-66, dealing with the U.S.S.R. and East European Communist countries.

Mr. Loehnis was educated at Eton (1948-1954), prior to his national service with the 11th Hussars in Malaysia in 1954-59. He attended New College, Oxford, from 1965 to 1959 and Harvard School of Public Administration in 1959-60.

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