Payments in the euro zone. Stick beats carrot

Gentle persuasion may not be enough to create a single payments area

THIS week 59 banks put their name to a project to enable direct debits across European borders by 2008. It is but a small step on a slow journey. Seven years after the birth of the euro and four years after notes and coins made their appearance, the euro zone still has a patchwork of incompatible systems for transferring money between member countries. If an estimate by the European Central Bank is to be believed, European businesses might be euro50 billion-100 billion ($60 billion-120 billion) a year better off were the euro zone covered by just one or two interoperable payment systems.

No wonder Charlie McCreevy, the European commissioner for the internal market, has become increasingly strident about the importance of a single European payments area (SEPA). In December the commission published a proposal for a directive that will clear legal obstacles to seamless cross-border payments. It is now preparing a list of "incentives", probably a combination of sticks and carrots, to encourage banks and their customers to switch to a pan-European system.

One reason for the banks' inertia and that of most of their customers (besides the biggest companies) is that national payment systems work well, by and large. They were also costly to build; and small cross-border payments--ie, of less than euro50,000--account for only 3% of overall volume. Some bankers think that building a single pan-European system makes about as much sense as buying a Rolls-Royce for monthly visits to the hairdresser.

So far, the only big steps towards SEPA have been forced by the commission. In July 2003 its Regulation 2560/2001 came into force, requiring cross-border transfers in euros below euro12,500 to cost no more than domestic ones. Because banks in some countries do not charge for domestic transfers, the regulation has simply landed them with extra expense. And since the start of the year it has applied to payments of up to euro50,000.

The proposed new directive requires that by 2010 transfers of up to euro50,000, both domestic and cross-border, must be settled by the end of the next working day. At the moment international payments can take up to ten days and domestic ones four. The cost to the customer must be clear and no intermediary may take a cut on the way, a practice that is endemic today. The draft directive would also like payments to be opened to non-bank competition. But the commission does not specify how the SEPA is technically to be achieved. As far as possible it would like the market to sort that out.

This is laudable, but the market has been slow. The SEPA project is being led by the European Payments Council (EPC), a group of private-sector institutions, mostly banks. Some of these banks are also shareholders in EBA Clearing, which already operates systems for three types of cross-border payments, although with modest volumes. Because banks are reluctant to replace expensive national systems, not many are keen to switch to EBA Clearing. That said, in October Luxembourg's banks decided to shift their domestic and cross-border transfers to EBA Clearing's system for low-value payments, known as STEP 2. Some big Italian banks are expected to follow suit soon. EBA Clearing is also behind the new direct-debit project.

The EPC appears incapable of reaching a consensus. The only real pressure for change is coming from big companies. Some, such as Royal Dutch Shell, Hewlett-Packard, General Electric and IBM, are acting through a group called TWIST (for Treasury Workstation Integrated Standards Team) but aim to standardise big companies' connections to banks and each other worldwide, rather than just in Europe. The European Associations of Corporate Treasurers are a wider group somewhat at odds with TWIST. Many smaller members simply do not want the cost and interruption that change might bring.

As with Regulation 2560/2001, if the European Commission is serious about SEPA it may find that it has to wield the stick again. Yet the commission itself is divided: the internal market directorate is pushing for a pan-European system, while the competition directorate might find the solution anti-competitive. Eric Sepses, a payments veteran at Citigroup, sees the use of the stick as inevitable. "It's one thing to build a system, another to get people to use it." He cites the example of euro bank accounts. Banks offered these accounts from 1999, but almost no one bothered to open one until 2002, when marks, francs and so forth were forcibly converted into the new money. Dirigisme can sometimes be more effective than laisser-faire.

Gentle persuasion may not be enough to create a single payments area in the euro area