Introduction
This Handbook aims to offer a broad overview of key issues in European banking, taking stock of its performance after the recent crises and looking forward to challenges ahead. The European banking landscape has profoundly changed since the mid-2000s, partly driven by the regulatory response to the 2007ā8 global financial crisis and subsequent sovereign debt crisis in the eurozone. Even after substantial regulatory reforms, debates on further steps needed to strengthen the EU regulatory framework to limit future risks arising from the banking system are ongoing. A distinct political debate on the benefits of increased integration has moved to the forefront of the political agenda in light of the results of the Brexit referendum, which might end the āpassporting rightsā of UK based financial institutions. This historic choice is already having a profound impact on financial markets. For many economists and policy makers the key aim is now to ensure that the eurozone is resilient to potential negative shocks, possibly encouraging further reform and increasing integration.
To this end, the European Commission (EC) pursued a number of initiatives, including stronger prudential requirements for banks, improved depositor protection and common rules for managing bank failures. An important step in the direction of increased integration was the creation of a Single Rulebook, applicable to all financial institutions in the EU and foundation for the Banking Union (BU), which is currently made up of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) and applies to countries in the eurozone, though with the option of other countries opting into it.
Although the new regulatory architecture is now in place, its successful implementation depends crucially on how the eurozone deals with the legacy of the financial crises and it is here that the USA and the eurozone seem to have taken divergent paths after 2008 (Hoshi and Kashyap 2015). The eurozoneās banking industries appear increasingly segmented, with an overexposure to domestic risks. The persistent weakness of some eurozone banking systems puts the implementation of the newly agreed rules to the test, as the discussions in 2016 on the recapitalization of Italian banks through the bail-in of retail investors holding junior debt instruments show.
Beyond the banking system, regulatory reforms have covered an array of other segments of Europeās financial system, ranging from insurers to equity funds. The Banking Union initiative has recently been complemented with a Capital Market Union (CMU) initiative. Unlike the Banking Union, this initiative relates to the whole European Union and not only the eurozone. Unlike the Banking Union initiative, the CMU contains a series of different initiatives in the regulatory, legal and infrastructure frameworks of financial markets. The Banking Union and CMU initiatives also complement each other, however, in that they constitute efforts to move away from a bank-bias in most European financial system towards more market- and equity-based systems.
It is against this background that this Handbook aims to provide an understanding of the key issues facing European banks. The Handbook is composed of five main parts. Part I, European Banking: Through the Crisis and Beyond, offers an overview of the European banking sector in terms of financial structure, ownership and business models and corporate governance, as well as the payment system. Part II, Performance and Innovation in European Banking discusses the key themes of bank competition, efficiency and performance. In addition, it looks at the impact of technological development on the banking sectors and how banks are embracing the opportunities it offers. Finally, it explores the issues of bank diversification and the relevance of small business lending.
Part III, Financial Stability and Regulation, addresses the key issues of financial reforms and the increasing complexity of financial regulation. It also looks at the impact of state aid and the impact of monetary policy. Finally, it considers the increasing interactions between banks and markets. Part IV, Cross-Border Banking, looks at recent trends in cross-border banking in Europe and evaluates the establishment of the Banking Union. Finally, Part V, European Banking Systems, offers a detailed analysis of the main issues facing national banking system in key European banking markets.
The reminder of this chapter offers a summary of the key issues discussed in the Handbook as well as an overview of European banking.
The EU Single Market for Financial Services
The European Union (EU) was formally established in 1993 by the Maastricht Treaty; although its history dates back to the post-war period.1 The signing of the Maastricht Treaty also marks the official start of the EU single market project, leading to the establishment of the single currency, the euro, and of the European Central Bank (ECB) in 1999. The current constitutional basis of the EU is the Lisbon Treaty, which came into force in 2009. Membership of the EU has grown through a number of enlargements.2 Today, the EU is the largest integrated economic area in the world, accounting for more than 20 % of the worldās gross domestic product (GDP). Campos et al. (2014) and Campos et al. (2016) show that the economic benefits from EU membership are large and substantially outweigh the costs. Using a methodology known as SCM (synthetic counterfactuals method) to provide an estimate of per capita GDP if a given country had not become a member of the EU, the authors suggest substantial and permanent benefits, concluding that there are positive pay-offs of EU membership, clearly above the direct costs.
Since the introduction of the First Banking Co-ordination Directive in 1977 (77/780/EEC), the deregulation of financial services, the establishment of the Economic and Monetary Union (EMU) and the introduction of the euro have helped create the Single Market for financial services. European authorities consider financial integration one of the key issues for making Europe more efficient and competitive and, ultimately, for contributing to sustainable economic growth.
Until the 1980s the EU financial and banking sectors were mainly domestically oriented. National governments regularly acted as protectors of their banks and state ownership was still prevalent in some EU countries. Interest rate restrictions and capital controls were common, and branching restrictions existed. The First Banking Co-ordination Directive in 1977 started a legislative process directed towards creating an integrated and competitive European banking system. These objectives reflected wider changes in the domains of economic policy, internationalization, technological advances and globalization. Possibly the most far reaching legislation in the harmonization of EU banking, the 1989 Second Banking Co-ordination Directive (89/646/EEC), sought to enhance competition by establishing EU-wide recognition of single banking āpassportsā issued in any member state as well as the principle of home-country supervision with minimum standards (includin...