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How much will it cost European banks to adapt to the single currency by 1999? A medium-sized fortune, they are beginning to realize.
Banks in countries due to participate in European economic and monetary union (Emu) will have to convert every domestic account and every product they offer into the new currency. For three years they will have to operate in national currency and in euros, and finally they must make sure they have the systems and logistics to support the withdrawal of old national currency coins and notes. When the UK changed to a decimal currency in 1971, the process of adapting to new coins and notes took two-and-a-half years. It amounts to an overhaul of banks' entire operating systems.
Edouard de Lencquesaing, executive vice- president co-ordinating single currency preparations for Crédit Commercial de France, says the bank's investment will probably be the equivalent to one year's normal spending on systems development. But he admits: "The areas of greatest investment spending are not yet clear. Ideally, we would like to centralize some euro functions." But that may not be possible. "As of today, the project is spreading through and touching all parts of the bank."
The European Banking Federation estimates a bill for Europe's banks of Ecu8 billion to Ecu10 billion, or an additional 1% to 2% of banks' operating costs spread over three or four years. That echoes a British Bankers Association estimate for the cost to the average bank of a big-bang style conversion to the single currency of 2% of annual non-interest expenses spread over two or three years. The phased introduction which is now planned will be less problematic than a sudden big-bang changeover, but possibly more expensive. For example, during the second half of 2002, banks' retail systems must cope with euro and national currency bank notes and coins circulating together.
Generale Bank recently estimated that it would spend Bfr2 billion ($65 million) on the project. Willy Kestens, global treasurer at Kredietbank, agrees that Kredietbank's spending will be of the same order of size, without reaching that high figure: "The situation is different for banks, depending on their previous preparations. As a major dealer in the Ecu we have developed dual and multi-currency systems over many years. A lot of the spending some European banks are now facing, we have already undertaken in the last five years."
Deutsche Bank estimates its conversion costs at around Dm300 million. Other German banks foresee spending on a similar scale. Ernst-Moritz Lipp, deputy managing director and board member of Dresdner Bank, responsible for co-ordinating the bank's preparations for the euro, suggests Dm200 million. He predicts that other large European banks will each have to invest between Dm150 million and Dm250 million, presenting the continent's leading banks with a bill of up to Dm3 billion.
Lipp's information-technology experts calculate that Germany's smaller banks, just to allow data processing in the single currency, will need to invest Dm2 million for each Dm1 billion of balance sheet assets. Other bankers suggest that, of the total cost of the project, two-thirds is likely to go on systems, with the rest on training and marketing.
Peter Wolf-Köppen, director at Commerzbank, says Dm150 million to Dm200 million is a realistic figure for his bank's preparations, though he adds it is hard to isolate Emu-related costs. A huge task for the banks will be to provide advice to their retail and corporate clients on how they might use the single currency, especially during the three-year interim phase when national currencies and the euro will co-exist. "If you add up discussions on the euro with three million retail and corporate customers, that's a huge cost. But Commerzbank would be talking to its customers anyway," says Wolf-Köppen. Similarly, banks would be investing considerable amounts in improving their electronic data-processing systems, even without the single-currency project.
Equally significant will be the loss of revenues. Foreign exchange commission will disappear for transactions between Emu countries, hurting in particular large banks in small countries such as Ireland, Belgium and Austria. Banks are predicting a "5% to 10% hit to the revenue base, according to those we have contacted", says Steven Davis of Davis International Banking Consultants. These banks are searching for new ways to replace their lost earnings, but Davis also warns: "Three years is barely enough time to revise totally their operating systems, much less their strategy."
The political timetable and the lead-time needed for systems development do not necessarily match. "Many people still seem to think we have three years," says Kestens at Kredietbank. "But banks do not. As soon as the new European Central Bank begins operating its monetary policy in euros (from the start of 1999) with all the instruments available to it including repos banks must be ready."
Bankers are wary of discussing their preparations down to the last detail, partly for competitive reasons, partly because they're still waiting for central market authorities to make the decisions that will dictate their own systems changes and partly, one suspects, because banks are not yet fully on top of the project. Those banks which are best prepared for the new currency will enjoy a strong competitive advantage over banks which fumble the challenge.
While the French banks are tending to play a political game, hoping to use the euro project as a means to promote Paris as a financial centre, in Germany some of the technical requirements are becoming clear, and the banks have started filling in the details.
German banks plan their systems
The German bankers' association in Cologne has produced a 600-page book, detailing thousands of individual steps banks should take in the run-up to monetary union. The association produced the book after lengthy consultation with leading German banks. It is being translated into English and other languages so that foreign banks in Germany can show it to their head-office executives. The report contains recommendations on needed changes, from banks' payments systems, to ATMs and even cashiers' equipment.
Showing a commendably entrepreneurial spirit, the association is charging Dm1,000 a time for copies of the book. Even at that hefty cover price, it would have to sell a million copies just to recoup the combined investments of the five leading German private banks. It's not likely to be that kind of best-seller.
The report emphasizes that the Bundesbank will support German banks' efforts to encourage customers to use the euro from the earliest possible date. It is guaranteeing that payment instructions can be delivered in euro, while still carrying Deutschmark amounts, and that Deutschmark sums can still be credited to a customer's account, even on a payment originating in euros. German banks must adapt to a flexible domestic payments and clearing system redesigned for dual-currency use. "We already have an agreement on common data formats for interbank clearing, and that is very important for software development and consultants," says Wilhelm Niehoff, manager at the German bankers' association.
Countries participating in Emu will be chosen as early as possible in 1998, supposedly on the basis of economic data for 1997. Conversion rates for participating currencies into the euro will be fixed some time between then and January 1 1999, when the euro is scheduled to replace them. According to the plan for the introduction of the euro laid down last December at the Madrid summit, corporates and investors will be free, but not obliged, to use the euro during phase B, the transition period from 1999 to 2002. Banks are likely to switch quickly to the euro for their own internal payments and accounts.
The agreement within Germany between domestic banks and the Bundesbank decrees that all domestic interbank clearing systems will operate in euros from the start. But banks must live with the uncertainty of how quickly their customers will follow. This adds to their basic task of converting their millions of bank accounts, loans and savings contracts into the new currency.
Payments systems must be amended so that both national currency and euro denominations can be handled interchangeably through the three-year transition period. That will also require payments' clearing houses to alter their message formats.
Banks outside the euro block will have to handle payments in the euro as another foreign currency. In the long run, banks' customers rightly expect the single-currency project to simplify and reduce the cost of cross-border payments transfers. Once differences between data structures are removed, a mechanism with the characteristics of one large domestic system should emerge.
Some of European banks' greatest efforts will be made in simple domestic retail banking. Kestens says: "Hundreds of thousands of accounts will be changed from January 1 1999. The internal accounts of the bank will be in euro, while many incoming and outgoing payments will be in Belgian francs. Account holders will have the choice of which currency to have their statements in." There are still questions to be decided. Will a customer be able to have all payments in his account stated in national currency and euros, or will one currency be used throughout with just the balance converted? Kestens is not sure. "We still have a lot to do on the domestic side," he says, "and there is still the question of adapting ATMs and introducing coins and banknotes. But mentally we are prepared."
More complex products also demand attention. Banks must decide how to modify OTC derivatives contracts maturing in 1999 and beyond. Europe's derivatives exchanges are grappling with the same problem. The likely solution is to write contracts in all currencies so that they convert unequivocally into euro denomination, if and when the original currency becomes a euro participant.
Banks must decide many questions on standardized terms and conditions for price and interest-rate quotation of securities within the euro bloc. Should interest be calculated on the basis of a 360- or 365-day business year? The question arises because of different calendars of public holidays within the bloc.
Getting the pricing right
Traders in OTC derivatives will have special concerns. As with bond markets, traders need to determine conventions on rounding, and business days used for payment accruals, so that when derivatives are converted from national currencies into the euro there are no remaining mismatches between derivative positions and associated hedges. Banks must also decide whether or not to accept, for example, French franc cash and government bond collateral against euro margin requirements.
Converting future cash flows on swaps and other contracts from national currencies to the euro will be straightforward. More troublesome will be the pricing and valuation of many instruments influenced by a new euro yield curve, which will take time to develop, along with the new euro-denominated government bond and money markets.
Even in countries unlikely to join the euro, bankers are biting the bullet. A major Spanish bank, says Davis, "even if it were convinced that Spain would never join Emu, must be prepared for several hundred branches of Deutsche Bank in Spain to offer euro-denominated loans and deposits to its customers". Many multinational companies, including those headquartered in countries outside Emu, will want euro products. And so expertise in the euro will be a weapon for some banks to attack new markets.
Malcolm Levitt, EU advisor at Barclays Bank, warns: "We believe that we must be ready with our strategies and systems in 1999, even though we cannot be sure the single currency will happen or that the UK will participate." Levitt's rough estimate is that two-thirds of European banks' total spending will be on converting retail banking systems, and Barclays will not begin those investments until the UK is firmly committed to participation. Meanwhile, it sees its task as being "to ensure our wholesale and forex systems have the capacity and functionality to support using the euro as a foreign currency. As to capacity, the euro will replace some other currencies, though we cannot be sure how quickly its use will spread." He is nevertheless confident that, "given the annual IT spend of an institution like Barclays, this project will not break the bank".
As well as individual banks, central authorities for all securities and currency markets must prepare. In August, the London Investment Banking Association published a report on the implications of Emu for various settlement and related facilities for wholesale financial markets in London. It included 63 detailed recommendations for various public authorities, settlement utilities and market participants to tackle. The report produced recommendations for the international central securities depositories, Euroclear and Cedel, which settle much of the international bond trading struck in London. Banks must help drive these developments within market systems and ensure compatibility with their own IT.
A sample of the points made by the report include the following. All market participants must find a way to cope with the question of redenomination of securities from national currencies into the euro. It is inevitable that the conversion rates will change the nominal value of an investor's holding of, say, French franc OATs, from whole numbers of francs into whole numbers plus fractions in euros. These would be incompatible with most trading and clearing systems which simply do not cater for fractions. Various solutions are possible, such as issuers allowing investors the choice of a cash adjustment to bring their holdings back to a whole number or the chance to invest an additional sum. Alternatively, bonds might stay denominated in national currencies with actual payments against delivery made in euros.
Redenomination raises other issues and complexities. For an issuer to revise the amounts of its outstanding security issues might require shareholder meetings and approval or even changes to company law. For discretionary fund managers to accept one or other redenomination option might require them to seek approval from each individual investing client.
The issues multiply. The co-existence of new euro-denominated bonds and old national-currency bonds from the same government or corporate issuer threatens to split the market and reduce liquidity. Price display systems will have to adapt to show national currency and euro pricing for the same bonds.
Banks and clearing systems may receive different currency instructions for two sides of the same trade and will need to develop "intelligent" matching systems to accommodate this.
And there are more mundane questions. Should redenominated securities be issued with new international security identification numbers and other local codes?
Wolf-Köppen at Commerzbank outlines the bank's approach to the bewildering variety of challenges thrown up by Emu. "During the changeover period we have to be prepared to offer all our products, from credit to deposits, in either national currency or euro. That means we have to look at every programme in our systems, decide what about it, if anything, to change, when to change it and how much capacity or manpower it will take." Changing Commerzbank's programmes will take 250 to 350 managers working hundreds of man-years, he says.
Coping with such a massive project will test banks' capabilities and resources to the limit. Lipp at Dresdner Bank admits: "We have found a technical and managerial bottle-neck. To take up such a huge challenge in such a short time exceeds the capability of our in-house IT managers. Their normal task is to develop a system for a particular segment of the bank. They face the difficulty of up-grading across the board. We now must decide how much we can do in-house and how much we should rely on external advisers and implementers." The bank is considering buying in whole systems from outside suppliers.
To boldly expand or specialize
At most large banks, one senior executive responsible for the euro sits atop various committees, usually comprising systems people and a few individuals co-opted from the banks' main operating businesses. These taskforces have been pondering the challenge ahead for months, if not years. Now they face the more difficult task of going back to business heads, explaining what systems changes they must accept and fund, and implementing the changeover. That will be tough.
Lipp maps out the timetable Dresdner Bank has followed in its preparations. Last year was a year for research into the implications of the single currency for clients and for the bank's own products and technology. The conclusion: dramatic changes will affect all parts of the bank from 1999. In 1996 Dresdner Bank began advising clients retail, corporate and institutional about the euro. It ran workshops for corporate clients and devised checklists for them, addressing how far the single currency would affect their industry sector and their generic corporate functions. It also began the huge task of training over 30,000 staff around its own branch network. From 1997 onwards comes the real investment in technology.
The good news, according to Lipp, is that the bank is confident it can identify quite easily the systems changes it needs to make. "We can design a model for the future euro-denominated capital markets and be quite precise about what it means for securities origination and distribution, settlements, custody, private client investment management." Some questions will only be settled gradually and will depend on customer preferences. The bank expects institutional investors in wholesale markets to switch quickly to euro-based documentation. Retail investors may still want to see interest accruing from euro bonds expressed in domestic currency.
Similarly, the bank is clear about the broad implications for its payments business with corporate customers. For three years it must run parallel payments services in domestic currency and the euro. "We need link-ups between our IT and that of our clients, so we can communicate in either one currency or two, with a conversion module," says Lipp. Dresdner is working to identify which companies will be most affected, which will want to convert to euro payments soonest and how other companies will expect the bank to manage their accounts through conversion. Some big companies, like Siemens, have said they do not wish to run two sets of accounts and will switch over to the euro as soon as their financial year permits: for Siemens in October 1999.
It's a big undertaking. Lipp says: "If our clients wanted us to use double-currency information now, it would be far more than we could deliver."
Banks are trying to limit their investments. One way is to be strict about internal information flows. Though customers may receive account information in a choice of currencies, banks' own officers may not enjoy such a luxury. Commerzbank is determined to offer its products in multiple currencies, not just two. But, internally, it will not convert its stores of historical data from Deutschmarks to euros. "If someone inside the bank needs to compare a sequence of payments or results using old data, he must convert those payments himself into euros," says Lipp. "That will save space and time, and instead of producing internal convenience, we can concentrate on providing service to the clients."
Working along a similar timetable, Commerzbank is now entering the final round of planning and specifying requirements for changing programmes. Next year, the implementation begins. That means the banks' planners and systems people must seek agreement from business heads on the necessary technology upgrades, their timing and cost. This means bringing together planners with a three- to five-year time horizon, and business heads, some of whom are concerned with market moves over the next week or the next few hours. It means tackling executives who are far removed from the single-currency project, and who may have thought it would never happen, and persuading them that it will happen, and that they must prepare, whether their own country joins or not.
Perhaps even more daunting are the strategic issues posed by the euro. Fifteen months ago many bankers thought of this as a massive IT conversion, comparable in some ways to the millennium question (banks' computer software was not written to allow for dates ending 00 and must be revised to accept this format), with which it is still sometimes linked. Because IT is not particularly flexible, banks have to develop it with a strategic business view. For the banking industry, the single currency marks the completion of the single European market in a way that it does not for many other industries.
A bank located in one Emu country operating as a foreign bank in a second Emu country will no longer have to tap the comparatively expensive local interbank market to fund local currency loans. Instead, it will be able to use funds raised in its home market to make loans in euros through its branches in other euro countries. Companies are likely to shop around more for banks' services.
The build-up to the single currency forces decisions about which businesses a bank should stay in, and build market share in, and which ones to quit. In many businesses, banks must either expand or specialize. Certain businesses will be affected in obvious ways, such as foreign exchange trading, especially European cross-currency trading. Wolf-Köppen at Commerzbank says: "Obviously six or seven currencies will go and you cannot get that business volume back by dealing in Asian or central European currencies, without having a basic business with those countries."
Operating in other wholesale businesses will become very different. A French bank which is a large trader in OATs, pitching itself against other large French banks, will suddenly find its French franc niche taken away. Instead it will be trading in euros and facing competition from other large European and perhaps American firms. The bank may decide that such a dismantling of barriers presents the opportunity to become a significant player in the global bond markets, or it may look for a new niche.
Cash management for corporate clients, which today is very much a domestic currency business, won't stay that way. A French company may be less inclined to choose a French bank as its cash manager, when its cash flows are largely denominated in euros.
There will be even greater concentration in correspondent banking. Today, a large American or Asian bank might have five correspondent banks in Germany and France, and three in a country like the Netherlands. It's a bread-and-butter business, but one which consumes little capital and provides many banks with a decent return as long as they have good systems and can maintain high volumes. But competition will become fiercer. It may be that non-European banks will reduce the number of correspondents they need inside the euro bloc, perhaps to just one in each country. The pricing for cross-border payments is likely to fall, and banks will have to decide whether they want to remain in that business, how much they can invest to maintain a market position and what is the most efficient way to operate in that market.
Cross-border co-operation
The Target system linking real-time gross settlement systems of participating countries will handle only large-value euro payments for central banks, large private banks and very large companies. Smaller companies will have to go through banks' own payments systems and correspondent networks for so-called low-value payments in euro. There are already signs of banks clubbing together to form alliances to provide basic electronic banking services, including payments, to each others' customers across Europe. Dresdner Bank, Banque Nationale de Paris, Midland, Banque Bruxelles Lambert and BBV, make up one group working together since early last year on co-operation which may extend to some cash management services.
Only large national banks would add anything to such a venture. "You need a partner in each country, which covers the whole of that country, not just with one or a few branches," says Lipp.
Another consortium of banks hoping to use each others' networks to service their own customers around Europe is IBOS, comprising Royal Bank of Scotland, Banco Santander, Banco de Comercio e Industria, Crédit Commercial de France, Kredietbank and Unibank. This allows a customer to access an account from any branch of a consortium member and to execute payments transfers. According to de Lencquesaing: "Our major objective is not to build a payments system that competes with Swift, but to find a way to serve our customers in Europe without buying a bank in each country. We are building a virtual bank to provide a homogeneous service to our clients. It so happens that many of our clients will use that for payments." That imposes several requirements on participating banks, such as producing standardized and simplified remote account-opening procedures and developing multilingual transactions forms.
The broad problem for the banks is that technical preparations will take at least two years. They must begin in 1997 to upgrade technology for the products and markets of 1999. They cannot be certain what the market for banking services will be like then nor be sure that they are modifying their products in the right way.
A related danger for banks is that business managers will try and shape each bank's preparations and investments to protect themselves, and to ensure their product survives in the new single-currency world, even if it has no real place. The track record of the wholesale financial services industry in managing such changes is poor. One European banker says: "I am mindful of Taurus [the failed attempt by the London stock exchange to upgrade its trading and settlement systems], where the stock exchange tried to accommodate interest groups which had no raison d'être in a post-Taurus world. And the whole project failed."
Banks are unsure what products to provide and to whom. Many customers remain reserved on the single-currency project. They are relying on the banks to explain it to them. Banks have to prepare their customers a job some bankers complain belongs to national politicians and the European Commission. It's not just retail and corporate customers who are lagging the banks in their preparation. One banker recalls: "At the Madrid summit [late last year] it became clear to me that while banks had been thinking about technical preparation, wholesale markets, stock exchanges and companies, indeed almost everyone else affected, were miles behind."
Banks are hoping that workshops they run for customers in 1997 will deal with more concrete, specific questions. Banks are striving to train large pools of euro experts to put in front of clients. Some are thinking of ways to recoup their investment. One German bank says it might charge clients Dm1,000 a day to attend a workshop for 10 or more companies. For more detailed advice and support to a single client, it might charge per hour of a banker's time.
The risk for the banks spending most on their preparations is that the project might be derailed, if not by obstinately high budget deficits in 1997, then perhaps by severe social unrest in countries trying to cut social spending, or some unforeseen political upheaval. If the single currency is to be scrapped, banks would much rather it happened in the next three months, not in the last three months before 1999. "From 1997 we'd like to see a more definite political framework, because this is a huge investment," says one German banker. He adds: "In terms of simple return on investment, no sensible banker would actually suggest such a project." |