01 March 2012

Financial World: Putting pedal to the metal (Graham Bishop article)

This is the first article in a new series by Graham Bishop for Financial World.

The counter-factual for retail financial services in the EU: what if the euro breaks up?

It is now fashionable in the UK media to preface most economic statements by questioning the continued existence of the euro given the alleged fundamental flaws in the design. Were the original terms of the Maastricht Treaty on EMU flawed? They specified tight public finance limits (maximum 3 per cent of GDP deficit and public debt ratios below 60 per cent - or at least heading down toward that ratio at a sufficient rate). If these terms had been enforced, would that have avoided the current problems? This author would say Yes.

But the reality is that the major flaw has turned out to be the weakness of the elected politicians in applying economic policies that are sound in the long run, but uncomfortable ahead of the next election. This is the challenge for 2012: bind into national legislation sensible constraints on elected euro area ministers of finance, or face imminently a future that will probably be very unpleasant. 

Restoring competitiveness

If that “unpleasantness” were manifested as a euro break-up, what consequence might flow for retail financial services? Relative competitiveness would be restored via devaluations, and few observers would doubt that exchange controls would re-appear very quickly in many European countries as currency reserves proved entirely inadequate to buffer capital flows. Such controls would quickly end cross-border retail financial services. Indeed the cross-border financial institutions themselves would find their operations seriously curtailed by demands from national regulators to locate the “production facilities” back in the host country. The concept of the free movement of services and capital - the Single Market - would land on the scrap heap of history remarkably quickly!  The understanding of such dire consequences is a major factor behind the determination of the euro area states to do “whatever is necessary” to keep the euro intact.

Major changes in retail financial services regulations will be debated this year. But the gains in unleashing competition – especially across borders – to benefit consumers will be blunted if the consumers cannot make the payment efficiently!

Original article (FW subscription required)

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