INTEGRATION AND COMPETITION IN THE EUROPEAN FINANCIAL MARKETS * Juan Fernández de Guevara, Joaquín Maudos and Francisco Pérez **

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1 INTEGRATION AN COMPETITION IN THE EUROPEAN FINANCIA MARKETS * Juan Fenández de Guevaa, Joaquín Maudos and Fancisco Péez ** WP-EC Coesponding autho: Joaquín Maudos, Instituto Valenciano de Investigaciones Económicas, Guadia Civil, 22, Esc. 2, 1º, Valencia, Spain, joaquin.maudos@ivie.es. Edito: Instituto Valenciano de Investigaciones Económicas, S.A. Pimea Edición Junio 2003 epósito egal: V IVIE woking papes offe in advance the esults of economic eseach unde way in ode to encouage a discussion pocess befoe sending them to scientific jounals fo thei final publication. * The authos wish to thank the financial suppot of the Ministeio de Ciencia y Tecnología though pojects SEC and SEC Joaquin Maudos also thanks the financial suppot of the BBVA Foundation. ** J. Fenández de Guevaa: Ivie; J. Maudos y F. Péez: Ivie y Univesitat de Valencia.

2 INTEGRATION AN COMPETITION IN THE EUROPEAN FINANCIA MARKETS Juan Fenández de Guevaa, Joaquín Maudos and Fancisco Péez ABSTRACT Financial integation in Euope should affect the competition between makets and intemediaies and geneate a convegence of both inteest ates and magins among the diffeent counties. This pape analyses the evolution of the convegence in inteest ates and the level of competition and its inequalities among the Euopean banking systems fo the peiod 1993 to The inequality index used the Theil index- allows us to beak down the inequalities so that the impotance of eithe a county effect o a specialization effect is quantified. If the fome effect dominates it would mean that the national banking makets ae segmented as a consequence of the existence of obstacles o baies to the integation. On the othe hand, the dominance of the latte effect would be elated to the diffeent level of competition depending on the type of banking specialization. Keywods: integation, competition, Euopean financial makets JE classification: F36, G15 RESUMEN a integación financiea en Euopa debe poduci efectos sobe la competencia ente mecados e intemediaios (educción de pecios, costes de intemediación y mágenes) y genea convegencia en tipos de inteés y mágenes ente países. Este tabajo analiza la evolución de la convegencia en tipos de inteés y el nivel de competencia en los sectoes bancaios euopeos en el peiodo Además, se estudia el gado de desigualdad de los niveles de competencia mediante la aplicación del índice de Theil. Este índice pemite la descomposición de la desigualdad de foma que se cuantifica la impotancia de tanto efectos país como efectos especialización. Si los pimeos dominasen queía deci que los mecados bancaios nacionales estaían segmentados como consecuencia de la existencia de baeas u obstáculos a la integación. Po oto lado, si dominasen los efectos especialización, el nivel de competencia dependeía del tipo de especialización bancaia. Palabas clave: integación, competencia, mecados financieos euopeos. 2

3 1. Intoduction Monetay as well as financial integation ae essential aspects of what is the actual economic integation in Euope and fo the exploitation of its potential advantages. Both ae inteelated a pioi given that the existence of a common cuency should contibute to the integation of the financial makets (banking and capital makets). Similaly, financial integation does not only condition Euopean integation in geneal, it in tun is also conditioned by the pocess of unification in othe economic as well as exta economic aspects (cultual and political). The awaited benefits of integation fo financial sevice consumes have ecently been synthesized fom a maco economic pespective by Heinemann and Joop (2002). Fo the consumes, this ought to mean a boade ange of assets and sevices to choose fom, a eduction in pices esulting fom the intensification of competition, and an impovement in the potfolio composition. At a maco level, in line with othe papes (King and evine (1993), evine (1997), Rajan and Zingales (1998), Beck, evine and oayza (2000), evine, oayza and Beck (2000), evine and Zevos (1998), Cetoelli and Gambea (2001)), the effects of integation ae the cause of developments in the financial makets, stimulating saving and capital accumulation, and impoving the efficiency of the allocation of esouces and the financing of technological innovations which, in the end, boost income and employment gowth. Since the appeaance of the fist evaluations of the potential contibutions of integation to impoving the woking of the Euopean economy and those of its membe counties (fo example, the Cecchini Repot, the Euopean Community Commission, 1988), athe impotant changes have taken place, especially in the monetay and financial sphees, both inside and outside the EU, which allow us to detemine whethe clea pogess is being made in the diection initially tageted 1 : a) Amongst those decisions taken within the EU, the most obvious is the ceation of the single cuency, adopted by eleven counties in 1999 (and Geece in 2001), and put into movement in Also significant ae the fee movement of capital and the second banking diective (1993), and the compomises of nominal convegence that peceded the intoduction of the 1 Moe ecently, in Febuay 2002, a new study commissioned by the Euopean Round Table (Heinemann and Jopp, 2002: Gyllenhamme epot) suggested that potencial fo highe gowth though financial integation could be up to 0.5%-0.7% of GP pe annum. 3

4 Euo (1996). Moe ecently, in 1999, the Euopean Commission appoved the Financial Sevices Action Plan. The FSAP is a set of measues to be developed in the peiod which aims to: a) ceate a single wholesale financial maket, b) open up the etail makets and make them moe secue, and c) seiously evise and homogenize the financial egulations of the membe states. b) With egad to changes in the financial envionment in geneal in which the EU economies have paticipated, it is impotant to emembe that, above all, the nineties witnessed an acceleation of financial integation on a wold scale popelled in pat by the development of infomation and communication technology (ICT). This autonomous facto, independent of the Euopean constuction, is mainly eflected in the integation of the capital makets in tems of both the flow among these and the synchonized evolution of thei stock maket value. One of the expected benefits of integation, on a mico as well as a maco scale, is the cheapening of financial pices esulting fom the intensification of competition. Howeve, it is only when integation esults in a genuine incease in competition that it becomes tangible and can povide all the potential benefits. Fo that eason, it is vey impotant to analyse the evolution of competition in the financial makets to check whethe the pocess of integation is giving the expected esults in tems of welfae. This pape analyses the evolution of the convegence in inteest ates and the level of competition, stating fom the constuction of a synthetic indicato of competition fo the banking fims. The causes of the inequality in the competition levels associated with diffeent types of baies to the integation and competition, which is an impotant issue fo the design of the economic policy, is analysed based on this indicato. Thus, the pesistence of diffeences in the level of competition between counties can be due to the existence of enty baies o obstacles of diffeent type (natual, policy-induced, etc.) that potect banking fims against the foeign competition. By beaking down the inequalities using the Theil index, the impotance of a possible county effect is quantified (which would mean that the national banking makets ae segmented as a consequence of the existence of obstacles to the integation) and also of a specialization effect (elated to diffeent level of competition depending on the type of banking specialization). These diffeent souces of inequality ae elevant to evaluate if the Euopean initiatives aiming to achieve geate financial integation ae esulting in highe levels of competition and lesse diffeences between counties, and also to conside to what extent convegence towads the one pice law can be expected. 4

5 The study is stuctued as follows. Section 2 contains an analysis of the evolution of the inteest ates of the diffeent counties with the aim of evaluating whethe o not thei tajectoies ae conveging at aggegate pice levels distinguishing the behaviou of the wholesale and etail (banking) makets. Section 3 descibes the methodology used fo estimating the level of competition o maket powe of the banking fims, and epots the empiical esults fo the banking sectos of the Euopean Union. Based on the indicato of competition, and using the Theil index, section 4 analyses the oigin of the inequalities in the levels of competition, showing the impotance of a county effect and a specialization effect as poxy s vaiables to the enty baies. Section 5 details the conclusions eached. 2. Integation and convegence in inteest ates The Cecchini Repot (1998) chaacteized a situation of complete financial integation based on the hypothesis of a levelling of asset and financial sevice pices. In a scenaio of pefect mobility of capital, this law of one pice should esult, unde identical conditions of isk and matuity of the opeations, in the levelling of inteest ates, but not so when these conditions ae not the same. Thus, the geate the extent to which such cicumstances ae appoximated, the geate the convegence in the inteest ates, especially in makets whee the homogeneity of the poducts and the opeations is close. Nevetheless, although the majoity of the change factos mentioned peviously may have boosted the conditions that favou inteest ate convegence both at a macoeconomic level and at a micoeconomic level, the cicumstances of the agents may continue to diffe between counties and within each county- and, although the intensification of competition ought to educe magins and pices to a cetain degee, the law of one pice may not be a feasible goal (imie and Sande, 2002). This is even moe likely to be the case if isk diffeences (associated with the chaacteistics of the clients and the opeations) and cultual diffeences emain, not to mention bank-client elationships involving long-tem stategies (based on the infomation impefections typical of banking makets 2. 2 See Scholtens and van Wensveen, 2000; and Cetoelli and Gambea,

6 The empiical evidence on inteest ate convegence pesented hee is based on a dispesion measue populaised by gowth economics, σ-convegence (Bao and Sala-i- Matín, 1992), used to analyse whethe economies appoach the same income pe capita when they each thei steady state. Such gowth models conside that thee may exist cicumstances which popel each economy to convege to its own steady state (conditional convegence) if they diffe in a numbe of fundamental paametes. The analogy fo inteest ate convegence consists of consideing that economies may contain chaacteistics, in thei micoeconomic units that could explain a limited, o conditional, convegence in maket pices. The data used comes fom the statistics of the Euopean Cental Bank. The limitations of the infomation fo this peiod have meant a eduction in the numbe of counties consideed in ode to guaantee the homogeneity of the sample and avoid affecting the significance of the execises 3. The peiod consideed is fom 1993, in which cucial changes occued, to 2001, the last yea available. Seven inteest ates ae consideed: two coesponding to the public debt makets (3-yea govenment debt yield and long-tem govenment debt yield in national makets) and five to the banking makets (time deposits, motgage loans to households, consume loans, shot-tem loans to entepises and long-tem loans to entepises). With egad to the evolution of inteest ates, the fee movement of capital and the implementation of the second banking diective (1993) mak the end of a peiod of geate instability and the beginning of anothe chaacteized by the eduction of nominal inteest ates. Paallel to the fall in inteest ates is a eduction in the dispesion (measued by the standad deviation) of the nominal inteest ates of the diffeent counties (figue 1). Towads the end of the peiod one can obseve that the inequality between the counties is vey much educed in the inteest ates of the public debt makets (wholesale makets) but ae geate in the ates coesponding to the banking makets (etail makets). Within the banking makets, diffeent degees of convegence intensity in the inteest ates ae detected at the end of the peiod: geate convegence occuing 3 In each figue standad deviation is computed only fo those counties with infomation available fo the whole sample peiod. 6

7 Figue 1. s-convegence of selected intees ates. Euopean Union a) Non-weighted standad deviations. Nominal inteest ates b) Non-weighted standad deviations. Real Inteest ates Motgage cedit Shot-tem loans to fims Medium to long tem to entepises Consume loans to households Time deposits ong-tem govenment yields 3-yeas bond yields Motgage cedit Shot-tem loans to fims Medium to long tem to entepises Consume loans to households Time deposits ong-tem govenment yields 3-yeas bond yields c) Weighted standad deviations. Nominal inteest ates d) Weighted standad deviations. Real Inteest ates Motgage cedit Shot-tem loans to fims Medium to long tem to entepises Consume loans to households Time deposits ong-tem govenment yields 3-yeas bond yields Motgage cedit Shot-tem loans to fims Medium to long tem to entepises Consume loans to households Time deposits ong-tem govenment yields 3-yeas bond yields

8 amongst the ates fo poducts with a limited magin fo the diffeentiation of opeation chaacteistics (time deposits and motgage loans to households) and geate inequality in the opeations in which moe poduct diffeentiation exists (consume loans, shottem loans to entepises and long-tem loans to entepises). Given the notable diffeences in size amongst the EU counties, it is not of the same impotance that the lage counties ae the most simila o ae appoximating to a geate extent, as the small counties. When the inteest ates ae weighted fo county size to calculate the dispesion indicatos, it is obseved that the stating inequalities wee less and, above all, thee is a substantial eduction in the inequality of medium and long-tem entepise loan inteest ates. All seems to indicate that it is the small counties which poduce a lage shae of the inequality, paticulaly in entepise loans. The speed of convegence in the smalle counties is geneally slowe, totally disappeaing at the consume loan level. When eal inteest ates ae used, it is obseved that the initial diffeences wee less than they appeaed to be in nominal tems, and the ate at which convegence pogesses is somewhat slowe. This indicates that inteest ate convegence is in pat affected by the pocess of convegence of inflation ates, developed in pepaation fo the adoption of the Euo as the single cuency, making the eal convegence of inteest ates somewhat less than the nominal one. Similaly, when weighted standad deviations ae consideed two things occu: the inequality level is educed, but in two of the etail makets, shot-tem loans to fims and consume loans, thee is no convegence whatsoeve. To summaize, the evidence with espect to inteest ate convegence pesented above povides a numbe of inteesting esults. Fistly, convegence has taken place but this is due to a lage extent to the eduction in the inflation diffeentials and to the geneal dop in nominal inteest ates. Secondly, convegence has been geate in those financial poducts that ae moe homogenous among counties thanks to nominal convegence and the monetay union -such as the public debt makets, time deposits and motgage loans to households-, esulting in thei coesponding makets becoming moe contestable. Thidly, when county size is taken into consideation, it is obseved that the initial inequalities wee geneally smalle because they wee in pat deived fom the dispaities in the small counties, this effect being most noticeable in the case of medium and long-tem loans to entepises that have also clealy conveged. Finally, in cetain etail makets (consume loans and shot-tem loans to entepises) convegence poceeds with much moe difficulty and geate inequalities emain between these inteest ates. This esult suggests two altenative (non exclusive) hypotheses suounding the pesistence of these diffeences in banking activity: that in such 8

9 activities exist maket powe o that they ae deived of a geate heteogeneity of opeations (and clients) that have not been educed, and to which the following section is dedicated. 3. Competition in banking makets The pesistence of a wide ange of inteest ates in seveal of the banking makets may be the esult of a lesse degee of competition in these, due to the existence of obstacles o baies to the financial integation. Fo that eason, this section evaluates whethe the set of cicumstances that have accompanied the libealization measues tending to the ceation of a single maket have caused vaiations in the diffeences in the degee of competition among the diffeent banking industies of the Euopean Union, and fo this pupose ene indices wee calculated fom the estimation of maginal costs and pices The ene index The estimation of ene indices has been widely used in the banking secto as indicatos of degees of maket powe. Some of the most impotant studies in this aea ae Shaffe (1993) fo Canadian banks, Ribon & Yosha (1999) fo the case of Isael, Angelini & Cetoelli (1999) fo Italian banks, Maudos & Péez (2001) fo the Spanish banking secto, and Fenández de Guevaa et al. (2002) fo a sample of counties of the Euopean Union. In the case of banking fims, the model most often used as a efeence fom which a ene index expession is obtained is the Monti-Klein impefect competition model 4. This model examines the behaviou of a monopolistic bank faced with a deposit supply cuve of positive slope ( ) and a loan demand cuve of negative slope ( ). The decision vaiables of the bank ae (volume of deposits) and (volume of loans), and fo simplicity's sake the level of capital is assumed to be given. The bank is assumed to be a pice take in the inte-bank maket (), so that the objective function of pofits to be maximised is as follows: ( ( ) ) + ( ( ) ) C( ) Π = Π(, ) = (1), 4 Monti (1972) and Klein (1971). See a suvey in Feixas and Rochet (1997). 9

10 10 so that pofit is the net inteest income between deposits and loans, afte deducting the tansfomation costs C(,). The fist ode conditions with espect to deposits and loans ae as follows: 0 0 = + = Π = + = Π C C (2) o, e C e C 1 1 * * * * = = (3) e and e being the elasticities of demand fo deposits and loans, espectively. The ene index fo expession (3) epesents the extent to which the monopolist's maket powe allows it to fix a pice above maginal cost, expessed as popotional to the pice (elative magin). In the case of pefect competition, the value of the index is zeo, thee being no monopoly powe. Stating fom this exteme case, the lowe the elasticity of demand, the geate the monopoly powe to fix a pice above the maginal cost. The elative magin (ene index) infoms of the level of efficiency eached in the maket and is theefoe a suitable candidate fo analysing the evolution of competition. The extension of the model to the case of an oligopoly (N banks) povides the following expession of the fist ode conditions: Ne C Ne C 1 1 * * * * = = (4) which diffes fom the case of monopoly only in that the elasticities ae multiplied by the numbe of fims (N). With this simple adaptation, the Monti-Klein model can be

11 eintepeted as a model of impefect competition with two exteme cases: monopoly (N=1) and pefect competition (N=infinity) Empiical appoach: esults The database does not povide sufficiently detailed infomation about the pofit and loss account fo the calculation of sepaate pices fo deposits and loans 5. Consequently, we use a single indicato of banking activity in the empiical model of this study and, as in Shaffe (1993) and Beg and Kim (1994), banking output is poxied by the total assets of each fim. The stating assumption is that the flow of banking goods and sevices poduced by a bank is popotional to its total assets. With this appoximation, an aveage pice (that includes inteest and non-inteest income) and a maginal cost (financial and opeating cost) fo the banking output is computed, estimating the ene accoding to the following expession: [ p MC] p (5) whee p is the aveage output pice and MC is the total maginal cost. The calculation of maginal costs is based on the usual specification of a tanslogaithmic cost function whee as a measue of poduction we use total assets and thee inputs pices (pice of labou, pice of capital and pice of deposits) ae computed. The estimation of the costs function (and hence of the maginal costs) is done sepaately fo each county, allowing the paametes of the cost function to vay fom one county to anothe to eflect diffeent technologies. Fixed effects ae also intoduced in ode to captue the influence of vaiables specific to each fim. Finally, a tend is included to eflect the effect of technical change, which tanslates into movements of the cost function ove time. As usual, the estimation is made unde the imposition of estictions of symmety and of gade one homogeneity in input pices. To estimate ene indices data wee obtained in a standadised fashion fom Bankscope database (Bueau Van ijk). The sample includes the fifteen banking sectos of the Euopean Union fo the peiod The citeion fo banks to be included in the sample is that infomation must be available on all the vaiables necessay fo the 5 In the case of loans, the pofit and loss account does not give the financial income associated with these sepaately, it appeas jointly with othe financial poducts (fixed income investments, fo example). In the case of deposits, the financial costs ae included with those of othe liability poducts. 11

12 estimation of the ene index. In addition, input pice data equied fo the cost function estimation should lie within 2.5 standad eos away fom thei mean values in each yea. Using this data selection citeion, the sample consists of a total of 18,330 obsevations of non-consolidated banking fims (see table 1). Table 1. Numbe of banks by county Austia Belgium Gemany enmak Spain Finland Fance United Kingdom Geece Ieland Italy uxemboug Nethelands Potugal Sweden Euopean Union Souce: BankScope (Bueau Van ijk). Table 2 shows the evolution of the ene index fo the 15 EU counties fom 1993 to Fo the weighted aveage of the EU, the ene index has shown a slight incease o the whole peiod, being the value in 2000 (0.145) 10% geate than the coesponding to 1993 (0.132). By counties, the maket powe has inceased in ten out of the fifteen counties of the EU. In the last yea consideed (2000), the ene index was placed in amounts highe than 20% in Finland, UK, Italy and Spain, placing in the opposite exteme uxemboug, enmak and Gemany as the most competitive banking sectos. The conclusion dawn fom the evolution of the ene index is that, in spite of the deegulating measues implemented in the last yeas, the competitive conditions have not intensified in the majo pat of the banking secto of the EU. This esult agees with the evidence obtained in othe papes. e Bandt and avis (2000) and Covoisie and Gopp (2002) show that in the main Euopean counties and in some banking poducts thee existed situations of monopolistic competition in the 1990s, and the 12

13 Table 2. Evolution of the ene index by county Austia 0,1050 0,1099 0,1176 0,1334 0,1360 0,1460 0,1212 0,1348 Belgium 0,0856 0,0824 0,0959 0,1033 0,1160 0,1424 0,1432 0,1334 Gemany 0,1286 0,1365 0,1275 0,1312 0,1276 0,1192 0,1146 0,1063 enmak 0,1285 0,1585 0,1312 0,1380 0,1305 0,1183 0,1241 0,1006 Spain 0,1596 0,1436 0,1378 0,1454 0,1709 0,1862 0,2117 0,2086 Finland 0,1355 0,1228 0,0993 0,1780 0,2268 0,2416 0,2373 0,2729 Fance 0,1174 0,1081 0,0962 0,1007 0,1063 0,1131 0,1347 0,1287 United Kingdom 0,2025 0,1937 0,1857 0,2151 0,1757 0,1944 0,2273 0,2355 Geece 0,0777 0,1114 0,0763 0,0848 0,1198-0,2180 0,1988 Ieland - - 0,1585 0,1965 0,1677 0,2053 0,1095 0,0889 Italy 0,1443 0,0903 0,1238 0,1329 0,1314 0,1929 0,2034 0,2135 Japan 0,1184 0,1219 0,1793 0,1871 0,1961 0,2258 0,2336 0,2810 uxemboug 0,1198 0,1021 0,1099 0,1188 0,1122 0,1302 0,1116 0,0969 Nethelands 0,0688 0,0802 0,0808 0,0898 0,0949 0,0978 0,1122 0,1120 Potugal 0,1643 0,1400 0,1182 0,1521 0,1755 0,1958 0,2050 0,1809 Sweden 0,1505 0,1523 0,1834 0,1876 0,1534 0,1496 0,1161 0,1145 Euopean Union 0,1322 0,1267 0,1222 0,1310 0,1306 0,1401 0,1466 0,1452 Souce: Own elaboation. monopoly situation was even accepted by banks that acted in small makets. Bikke and Haaf (2002) also offe poof in favou of the existence of monopolistic competition in a wide sample of counties (Euopean and non-euopean), competition being weake in local makets and stonge in intenational makets 6. One of the possible causes of the diffeences in the competition levels obseved between counties is the specialization in a given banking business aea. In as much as the impotance of the baies to the integation and the competition is diffeent depending on the type of banking business (etail banks, univesal banks, investment banks, etc), poductive specialisation could explain the diffeences in competition among counties. In othe wods, the level of competition can diffe among counties on the basis of the elative weight of banks with diffeent poductive specialisation. 6 e Bandt and avis (2000) and Bikke and Haaf (2002) measue competition using the Panza-Rosse model. Covoisie and Gopp (2002) analise whethe the incease in concentation (due to the ecent wave of meges in the euo aea) has offset the incease in competition in Euopean banking though deegulation by estimating a simple Counot model o bank picing. 13

14 The analysis of the impotance of specialisation in the explanation of the diffeences of maket powe between counties equies dividing the sample companies into goups of banks with a simila banking oientation. Using cluste techniques, we identify banking goups of simila specialisation 7. The citeion used to detemine the clustes is to goup fims in accodance with some measuement of thei distance fom cetain individual chaacteistics, each goup being as diffeent as possible fom the othes. The vaiables chosen fo gouping banking fims wee: loans, othe eaning assets, fixed assets, deposits, othe souces of funding and equity, all of them expessed as atios of total assets. The cluste methodology enables us to detect fou poductive specialisation goups 8 (table 3): * Cluste 1: Retail banks. This cluste goups 1,322 fims epesenting 23% of the sample in tems of total assets in This goup, fomed mainly by savings banks and commecial banks, is financed mainly though deposits (81%), distibuting its esouces between, mainly, loans (64%) and othe eaning assets (31%). * Cluste 2: Investment banks. This goup captues the majo pat (73%) of its esouces in the deposit maket, but devotes most of them (68%) to eaning assets othe than loans. 330 banks ae included hee epesenting 22% of the sample. * Cluste 3: Univesal banks. This goup is chaacteised by financing itself mainly by the captuing of deposits (61% of total assets), though they divesify thei asset potfolio to a geate extent between loans (44%) and othe eaning assets (47%). The total numbe of banks contained in C3 is 369, it being the most impotant goup in tems of total assets (43% of the sample). * Cluste 4: Specialised banks. This cluste contains only 82 banks of the sample (mainly eal estate/motgage banks and medium and long-tem cedit banks). It is financed by means of instuments othe than deposits and devotes its esouces to ganting loans (65%) and othe eaning assets (31%). 7 See moe details in Maudos, Pasto and Peez (2002). 8 Fo this pupose we used a non-hieachical method (k-means), though a hieachical one (Wad) was fist used to detemine the numbe of clustes. 14

15 Table 3. Specialization goups in the Euopean Banking sectos Pecentage ove total assets Cluste 1 Cluste 2 Cluste 3 Cluste 4 Total Retail banks Investment banks Univesal banks Specialised banks Sample oans 63,95 25,09 44,08 65,43 46,87 Othe eaning assets 30,70 67,99 47,28 31,33 46,25 Total eaning assets 94,66 93,08 91,35 96,76 93,12 Fixed assets 1,67 0,62 0,68 0,25 0,85 Non eaning assets 3,67 6,30 7,96 2,99 6,03 Total assets 100,00 100,00 100,00 100,00 100,00 Total deposits 80,98 72,68 61,11 21,08 63,65 Total money maket funding 4,37 5,10 8,26 6,16 6,42 Custome and shot tem funding 84,49 76,91 68,86 24,10 69,10 Othe funding 6,67 8,78 14,53 69,16 17,72 Othe (non inteest beaing) 3,54 8,34 9,80 2,87 7,24 oan loss eseves 0,01 0,05 0,06 0,10 0,05 Othe eseves 0,23 2,14 2,15 0,05 1,47 Equity 5,06 3,79 4,59 3,72 4,42 Income statement Inteest income 5,56 5,23 5,25 6,04 5,41 Inteest expense 3,49 4,45 4,04 5,28 4,15 Net inteest income 2,06 0,78 1,21 0,76 1,26 Othe opeating income 0,81 0,93 1,01 0,25 0,86 Goss income 2,87 1,71 2,23 1,00 2,12 Oveheads 1,85 1,10 1,42 0,51 1,35 Pesonnel expenses 1,03 0,58 0,79 0,23 0,73 Othe administative expenses 0,67 0,45 0,54 0,25 0,52 Goodwill wite-off 0,22 0,09 0,11 0,06 0,12 Net income 1,02 0,61 0,80 0,49 0,77 Pofit befoe tax 0,01 0,00 0,01 0,00 0,00 Numbe of fims % total assets 22,96 22,24 43,31 11,49 100,00 Souce: BankScope (Bueau Van ijk) and own elaboation. The calculation of the ene index fo each cluste (table 4) shows that the diffeences between these clustes ae substantial, especially those between etail banks and specialised banks. The aveages of the elative magins between investment banks and specialised banks and between univesal banks and etail banks ae much moe simila, the convegence of the last two clustes being consideable. In geneal tems, the elative magins ae not expeiencing any notable changes, with the exception of the univesal banks whee the ene index has inceased by two pecentage points. Given the specialisation pofile of each cluste, the esults show that the banks in which the taditional deposits-and-loans activity holds geate weight, wok with geate 15

16 magins and these tend to incease in elative tems (especially in etail banks). On the othe hand, in the two goups of banks which ae moe oientated towads the wholesale maket and in the specialised banks (in motgage loans and in public secto financing, makets in which inteest ate convegence was obseved to be geate), the magins ae less and getting smalle. Table 4. Evolution of the ene index by clustes Retail Banks 0,1632 0,1727 0,1652 0,1741 0,1736 0,1649 0,1761 0,1750 Investment Banks 0,1244 0,1056 0,1012 0,1034 0,1036 0,1162 0,1200 0,1191 Univesal Banks 0,1299 0,1191 0,1181 0,1316 0,1351 0,1515 0,1578 0,1558 Specialised Banks 0,1066 0,1099 0,1063 0,1123 0,1125 0,1084 0,1115 0,0961 Souce: BankScope (Bueau Van ijk). 4. Inequalities in the level of competition One of the easons that justify the existence of a low degee of integation in etail banking makets compaed with wholesale makets is the existence of baies o obstacles associated with factos such as the impotance of poximity, the banking elationship, the local aea of infomation, etc. The geate the impotance of these baies, the lesse the pessue of competition on the national makets and, consequently, the moe segmented the makets will be. The esults obtained in the pevious section have evealed the existence of impotant inequalities in the level of competition o maket powe among the banking sectos of the EU. With the pupose of going deeply into the analysis of the inequalities in the competition levels, figue 2 shows the evolution of the standad deviation of the ene index (σ-convegence) calculated at the fim level fo the whole sample. The figue shows that fa fom poducing a σ-convegence phenomenon, the inequalities in maket powe have isen duing the 90 s, inceasing the standad deviation by 9% fom 1993 to With the objective of taking into account the diffeent size of the banking fims and to amend a possible bias in the σ-convegence measuement, figue 2 also contains the evolution of the weighted standad deviation of the ene index, using as weights the total assets of each bank in the sample. The figue shows, once again, an incease in the inequalities in the maket powe within the Euopean Union, aising the standad 16

17 deviation by 36%. Consequently, upon using the weighted standad deviation, the divegence has become even moe maked, existing in the yea 2000 a inequality level supeio to one obtained using the non-weighted standad deviation. Figue 2. s-convegence in ene index. Euopean Union 0,10 0,09 0,09 0,08 0,08 0,07 0,07 0, Non-weighted Weighted Souce: Own elaboation. An impotant issue fo the design of economic policy measues is the analysis of the causes o oigin of the inequality in the competition levels associated with diffeent types of baies to the integation and competition. Thus, the pesistence of diffeences in the level of competition between counties can be due to the existence of natual (diffeences in language, cultue, etc.) and policy-induced (diffeences in tax teatment, potfolio estiction, egulation, etc.) baies and/o, altenatively to these, to the typical cicumstances of banking opeations (banking elationship, the impotance of poximity, infomation and supevision costs, etc.). Empiically, the natual and policy-induced baies ae eflected in the existence of a county effect (the county to which the entity belongs) while the impotance of the baies deived fom the typical cicumstances of banking opeations ae eflected in the existence of a specialisation effect (the cluste to which the entity belongs). To calculate the elative impotance of a possible county effect o specialisation effect in explaining the oigin of the inequalities of magins, a numbe of inequality indices will be used that may be decomposed into two components, one which measues intenal o within-goup inequality (in this case intenal inequality within each county o specialised goup) and anothe which measues between-goup inequality (extenal 17

18 inequality between counties o between specialised goups). The index used will be the Theil index 9, the geneal fomulation of which is defined by: β 1 xi T( β ) = pi 1 (6) β( β 1) i µ whee x i is the study vaiable, µ the weighted aveage of vaiable x i, p i the weight of each individual i in the total sample and β a facto measuing the sensitivity of the index to tansfes between individuals with values in high levels of x i to individuals with low level values. The index will be used in this wok in the case whee β=0 10, so that the pevious expession of the Theil index may be witten as: xi T(0) = pi log i µ (7) et us suppose that the total sample may be sepaated into G goups, that each goup epesents a pecentage p g of the total sample and that the weighted aveage of vaiable x i of each gouping is µ i. Then, the decomposition popety of the family of Theil indices allows us to expess the pevious equation in the following manne: G g g 0 (8) g= 1 T(0) = p T (0) + T (0) whee p i x i Tg (0) = log (9) i n p g g µ g is the intenal inequality (within goups) index of each gouping and (0) log µ g T0 = pg g µ (10) 9 Moe details on diffeent inequality measues and thei popeties may be found in Shoocks (1980) and Shoocks (1984). 10 The Theil index with β=0 is used because in doing so each one of the goups will be weighted by the popotion that the goup epesents of the total numbe of individuals, thus favouing the inequality of those goups which epesent a geate pecentage of the total sample. 18

19 is the extenal inequality (between goups) index between goupings. Thus, the decomposition of the Theil index defined by equations (8)-(10) will be calculated fo the ene index of the banking companies in the sample. The weights to be used (p i and p g ) will be the pecentage in tems of assets that each entity (o goup) epesents of the total sample. To analyse whethe such diffeences exist moe between fims o between counties, a Theil inequality index is calculated fo the ene index (table 5). Its evolution also shows an incease in inequality in ecent yeas. The main pat of the inequality is within counties but the inequality between counties is also elevant and is gowing in impotance, epesenting one thid of the total at the end of the peiod. This esult indicates two things: a) the elimination of diffeences between counties would not eliminate the majo pecentage of inequality in the magins, which is intenal, but b) emoving the baies which geneate the potion of inequality which is extenal would be indeed a elevant objective of political economy. Table 5. ecomposition of the Theil index by county Total Theil index Within county Between county Pecentage ove total Theil index Within Between county county ,103 0,083 0,019 81,16 18, ,117 0,093 0,024 79,38 20, ,105 0,085 0,019 81,46 18, ,121 0,097 0,024 80,09 19, ,107 0,092 0,015 86,15 13, ,100 0,074 0,026 73,99 26, ,116 0,081 0,036 69,43 30, ,143 0,092 0,051 64,40 35,59 Souce: BankScope (Bueau Van ijk). The decomposition of the within-cluste and between-cluste inequality by means of the Theil index (table 6) indicates that both ae gowing, but that the inequality between clustes is inceasing at a faste ate and, consequently, its weight is gowing. This esult is in ageement with the dispaate evolution of the magins of each goup and with the gowth of the ene index in the case of the univesal banks. Nevetheless, the inequality between clustes is smalle than the inequality between counties (table 4), demonstating the impotance that national baies still etain. 19

20 Table 6. ecomposition of Theil index by cluste Theil index Pecentage ove total Theil index Total Within cluste Between cluste Within cluste Between cluste ,103 0,094 0,009 91,56 8, ,117 0,098 0,019 83,91 16, ,105 0,087 0,017 83,45 16, ,121 0,100 0,021 83,20 17, ,107 0,090 0,017 84,27 15, ,100 0,088 0,012 87,89 12, ,116 0,103 0,014 88,24 11, ,143 0,125 0,018 87,43 12,57 Souce: BankScope (Bueau Van ijk). To analyse the elationship between specialisation and belonging to a paticula county even futhe, one last decomposition of intenal and extenal (between counties) inequality has been caied out fo the banks of each cluste (table 7). The inequality between the entities of each cluste is gowing in all the goups and in both indicatos. The goup with the geatest inequality in magins is the investment banks and the one with the least inequality, the etail banks. Futhemoe, the esults einfoce the notion that the diffeences between counties ae indeed elevant in many of the specialisation goupings. The extenal inequalities ae gowing in all the goups with the exception of the investment banks, and ae geatest of all in the case of the univesal banks, whee they epesent two thids of the inequality at the end of the peiod. To summaise, the analysis of banking elative magins and the inequalities to be found in these indicate the following. Fistly, it has been obseved that the elative magin inceases. Secondly, sizable magin inequalities between counties have been veified in the whole goup of entities as well as in each specialisation gouping analysed. These diffeences ae paticulaly high in the case of the univesal banks. Thidly, when the specialisation of the entities is consideed, it is obseved that the magins ae less in those specialisations which ae moe connected with makets in which inteest ates have conveged moe between counties (investment banks and specialised banks), and ae geate in those which ae moe oientated towads deposits and loans makets (etail and univesal banks). 20

21 Table 7. ecomposition of Theil index by cluste and counties. ecomposition by county in each cluste a) Cluste 1. Retail banking b) Cluste 2. Investment banks Theil index Pecentage ove total Theil index Theil index Pecentage ove total Theil index Total Within county Between county Within county Between county Total Within county Between county Within county Between county ,051 0,042 0,010 81,04 18, ,096 0,072 0,024 74,87 25, ,047 0,040 0,007 84,86 15, ,134 0,080 0,053 59,97 40, ,045 0,040 0,005 88,16 11, ,123 0,084 0,040 67,83 32, ,057 0,050 0,007 87,04 12, ,157 0,122 0,035 77,87 22, ,053 0,046 0,008 85,58 14, ,112 0,082 0,030 73,02 26, ,071 0,058 0,013 81,26 18, ,124 0,088 0,036 70,84 29, ,072 0,050 0,022 69,13 30, ,124 0,096 0,028 77,42 22, ,071 0,045 0,026 63,45 36, ,174 0,154 0,021 88,13 11,87 c) Cluste 3. Univesal banks d) Cluste 4. Specialised banks Theil index Pecentage ove total Theil index Theil index Pecentage ove total Theil index Total Within county Between county Within county Between county Total Within county Between county Within county Between county ,121 0,081 0,040 66,91 33, ,084 0,070 0,014 83,04 16, ,115 0,067 0,048 58,40 41, ,071 0,058 0,013 82,04 17, ,092 0,059 0,033 64,14 35, ,074 0,059 0,014 80,56 19, ,091 0,056 0,036 60,91 39, ,082 0,071 0,011 86,55 13, ,101 0,067 0,034 66,40 33, ,068 0,059 0,008 87,51 12, ,075 0,037 0,039 48,94 51, ,084 0,074 0,009 88,79 11, ,106 0,044 0,061 42,04 57, ,098 0,072 0,026 73,92 26, ,133 0,045 0,088 33,75 66, ,110 0,089 0,021 81,04 18,95 Souce: BankScope (Bueau Van ijk).

22 5. Conclusions The pogess of financial integation in Euope is undeniable, but unequal. Some of its moe visible esults can be seen in the eduction of inteest ates -associated with the eduction in inflation and with the est of the nominal convegence objectives with which the oad to monetay union was paved- and in the convegence of the inteest ates in the public debt makets and in the makets of the most standadised banking poducts (time deposits and motgage loans to households). ess conclusive ae the esults in the etail banking makets in which the diect elationships with the client make seveal of the defining chaacteistics of the banking activity moe elevant but also whee the diffeentiation of the sevices and contol of maket powe ae moe easily obtained. The analysis of the elative magins of banking companies also indicates that magins ae highe in etail banking. Given that the magins ae obtained as a diffeential between pices and maginal costs, thee might appea to be geate costs in the magins if the effects on the inteest ates associated with the peculiaities of the banking opeations with clients have not peviously been discounted. If dealing with opeation costs, then this would in fact be the case, and the levels and tajectoies of the magins would confim that maket powe exits and is maintained. Howeve, if we conside it possible that such costs (infomation and supevision costs, idiosyncatic isks of the clients and of the opeations) ae not computed by the estimated cost function and that they will appea as a isk cost ex post, in the last ows of the pofit and loss accounts, the doubts suounding the cause of the behaviou of the magins emain, as an incease of magins does not necessaily imply a eduction in competition. In any case, the fact that magin inequality is due in no small measue to diffeences between counties and that this inequality is even geate within those goups whose specialisation is moe oientated towads etail banking would tend to indicate that enty baies between the diffeent national banking systems continue to exist, deived of egulations, cultual diffeences o of the stengthening of custome elations by means of sentiments of national identity. This implies that in ode fo any potential esults of financial integation to appea it will be necessay not only to pogess in the homogenisation of egulation famewoks but also in othe aeas of integation which ae not stictly speaking economic. 22

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