Industry gets set for advent of a currency revolution

Date: 28/03/1996

By Tim Jones

FOR Europe's banking industry, the advent of monetary union has little to do with grand notions of bringing an end to wars on the old continent or binding together the single market.

To the financial sector and its three million employees, the Euro will bring about a revolution as profound as that wrought on the music industry by the arrival of the compact disc.

In the early Eighties, vinyl was still king and record-players dominated audio hardware production. Within ten years, only CD players could be found in the shops and singles were a blast from the past.

The prospect of a single currency in at least six European countries within less than three years will dramatically alter the way banks work, affecting the whole range of their activities from services in trading government bonds right down to the operation of cash counters.

When the world's leading cash-machine manufacturers assembled for their annual fair in Hannover last week to display their wares, they were already talking about the change in demand from banks.

To De La Rue and Brandt from the UK, Japan's Glory and Laurel and Magner and Bilcon from the US, what happens on 1 January 1999 is of more than academic interest. They will be making the new coin-wrappers and currency converters that Europe's banks will need.

EU banks have calculated that they will have to spend billions of ecu on making the transition to the Euro to cover the cost of staff retraining and re-equipping branches with new information systems and adapted machines.

For the biggest banks, the single currency means something more. The creation of the Euro will cost them business as a handful of heavily-traded European currencies bite the dust. Trade between the deutschemark and other EU currencies accounts for 9&percent; of the daily 360-billion-ecu turnover of the London foreign exchange market. While business concerning the dollar, mark and yen alone accounts for the lion's share of daily trade, the prospect of losing nearly a tenth of the market in the wake of economic and monetary union is not to be dismissed lightly.

Some banks are already drawing up strategies for coping with this loss of business, redirecting their activities away from trading marks for francs and looking instead at the opportunities in euro-dollar and euro-yen trading.

Internal Market Commissioner Mario Monti addressed banks' fears in a speech last year in the City of London, a small area of the UK capital which is host to the biggest currency market in the world.

For Monti, the benefits far outweigh the loss of markets. “Dealing with money, banks will take advantage of the increase in credit demand due to the impulse to economic activity resulting from monetary union,” he told the assembled bankers. “While there will undoubtedly be some loss of income, I have no doubt that banks will find substitute business.”

For a start, banks will be able to expand their activities in other member states without increasing the size of their capital base to cover against currency risk, while capital markets will grow in size and liquidity, so boosting potential bank profits.

The elimination of exchange rate risk will encourage large corporate customers to tap into the German, French, Austrian, Dutch and other EU capital markets to raise funds for investment. At the same time, banks' mergers and acquisitions business should accelerate as a major disincentive to cross-border take-overs disappears.

While their specialist mark-franc traders may be less than convinced of the benefits of a single currency, leading bankers are essentially in favour of EMU. Their main worry now is getting from here to there.

For them, it is absolutely vital that the transition to a single currency from January 1998 (when the short-list of countries able to take part is drawn up) to July 2002 (when Euro notes and coins appear in people's purses) is structured and orderly.

Throughout last year, the banks argued with member states and the European Commission that the transition should be as fast as possible, so ensuring it was simple and cheap.

They wanted 1 January 1999 to be more than just the day when exchange rates were irrevocably fixed. Instead, from that day, all money market and foreign exchange operations, interbank business and all government bonds (old and new) should be converted to euros. This, they argued, would ensure a rapid switch of corporate bonds and equities to the new currency.

For a while, the German government demanded that national bonds should be denominated in the old currencies until the Euro became the only legal tender in the monetary union.

But at last December's Madrid summit, as part of the trade-off for getting the support of other EU leaders for the name Euro, Bonn finally met the needs of the banks by promising to convert new and old tradeable bonds into euros during the three-year transition period.

Since it is the banks' capital market activities which will bear the brunt of the transition at the beginning, it is their scepticism that the Commission wants to dispel first, particularly because this will have an indirect influence on the attitudes of ordinary people.

As Graham Bishop, the leading European analyst at Salomon Brothers in London, told the single currency round table: “Capital markets have a relatively small direct impact on citizens, but they are important because they are the repository of much of citizens' savings.”

New legislation designed to fill in the gaps left by the Maastricht Treaty will define the status of the Euro while it remains a quasi-currency without a physical cash presence before 2002. To address this, the Commission could specify that the Euro is the only true currency, of which national units are sub-denominations.

One of the biggest problems for banks during the transition will be how to keep their payments systems - the mechanism by which banks settle claims on each other - separate. In several countries, the wholesale payments system (which deals with corporate business) and the retail system (which deals with personal everyday banking business) are separate.

During the three-year transition, when the national currencies are the only legal tender in the EU, banks will want to ensure that there is no leakage between the two systems.

This is particularly exercising the minds of British and Danish bankers in the run-up to the single currency deadline. Both countries have an opt-out from, or an opt-in to, monetary union and their bankers are unsure how to prepare for the Euro.

However, it is almost inevitable that their big and profitable clients - major companies and other financial institutions - will want to do as much of their business as possible in the new currency. “Ideally, we would like clarity on the position, but we recognise that this is a political decision which is out of our hands,” said a spokesman for the British Banking Association. “We have to work on the assumption that it will happen, whether or not the UK is in a single currency scheme, because markets and large customers would want to trade in it.”

On 12 March, the board of the Danish Bankers' Association gave the go-ahead for a work programme looking into how its members should prepare for monetary union. “At the moment, we don't know how we will be connected to the Euro,” said Lars Barfoed, the association's managing director. “However, whether or not we participate in the EMU, it is a fact that the Euro is something we will have to deal with.”

He admits the possibility that this kind of development could well lead to a rupture between the wholesale and retail payment systems, as two wholly different settlement regimes emerge for companies and people.

“The scale of the problem will obviously depend on how many countries take part in the Euro,” says Barfoed.