3. Banking Systems = From Regional to National

8/13/2019 3. Banking Systems = From Regional to National

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3.1. The American banking system

The American commercial banking system is known as a dual banking

system because its main feature is side-by-side federal and state chartering(and supervision) of commercial banks. There are federal chartered banks,under the aegis of the Comptroller of the currency, and state-chartered

banks, under the supervision of each of the various states.

A unique feature of the system is that the regulated can choose theirregulator: state banks can shift to national charters and vice versa, statemember banks can shift to non-member status and vice versa13.

The justification for the dual banking system is that it is supposed to fosterchange and innovation by providing alternative routes so that each bank canseek charters and do business. It is claimed that a dual banking system ismore responsive to the evolving banking need of the economy than a single

system would be.

Federal Reserve System

The Fed, as the system is commonly called, is an independent governmental

entity created by Congress in 1913 to serve as a central bank of the UnitedStates, comprising 12 regional Reserve Banks and the Board of Governors

in Washington D.C. The Federal Reserve Bank of New York, one of the 12regional reserve banks is the largest in terms of assets and volume ofactivity. The 12 reserve banks supervise and regulate bank holding

companies as well as chartered banks in their District that are members ofthe Federal Reserve System. Each reserve bank provides services to

13Ligia Georgescu Golosoiu, Business of Banking, Editura ASE, 2002

Banking systems: from regional

to national


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depositary institutions in its respective district and functions as a fiscal agent

of the U.S. government. The regional Federal Reserve Banks, one of eachfederal district, are geographically dispersed throughout the country: NewYork, Boston, St. Louis, San Francisco, Philadelphia, Atlanta, Chicago,

Kansas City, Richmond, Dallas, Minneapolis, Cleveland.

The Federal Reserve System was designated to ensure its politicalindependence and its sensitivity to divergent economic concerns. Thechairman and the six other members of the Board of Governors who

oversee the Federal reserve are nominated by the President of the UnitedStates and are confirmed by the Senate. The President is directed by law to

select governors who provide a fair representation of the financial,agricultural, industrial and geographical divisions of the country. Only one

member of the Board may be selected from any one of the twelve FederalReserve Districts. These aspects of selection are intended to ensurerepresentation of regional interests and the interests of various public

sectors.

The primary responsibility of the Board members is the formulation of

monetary policy. The seven Board members constitute a majority of the 12-member Federal Open Market Committee (FOMC), the group that makes

the key decisions affecting the cost and availability of money and credit in

the economy. The other five members of the FOMC are Reserve Bankpresidents, one of whom is the president of the Federal Reserve Bank of

New York. The other Bank presidents serve one-year terms on a rotatingbasis.

Each Reserve Bank is headed by a president appointed by the Banks nine-member board of directors.

FOMC is the most important monetary policymaking body of the FederalReserve System. It is responsible for formulation of a policy designated to

promote growth, full employment, stable prices and sustainable pattern ofinternational trade and payments. The FOMC makes key decisions

regarding the conduct of open market operations-purchases and sales of USgovernment and federal agency securities-which affect the provision ofreserves to depository institutions and, in turn the cost and availability of

money and credit in the US economy. The FOMC also directs Systemoperations in foreign currencies.


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Reserve Bank boards of directors are divided into three classes of three

persons each.

Class A directors represent the member commercial banks in the District,

and most are bankers. Class B and class C directors are selected to representthe public, with due consideration to the interests of agriculture, commerce,

industry, labor and consumers.

Class A and class B directors are elected by member banks in the District,

while class C directors are appointed by the Systems Board of Governors inWashington.

Similarly, each of the Reserve Banks is supervised by a board of nine

directors who are familiar with conditions in the area encompassed by theBranch.

The responsibilities of directors are broad, ranging from the supervision ofthe Reserve Bank to making recommendations on monetary policy.Directors review their reserve Banks budget and expenditures. They are

also responsible for the internal audit program of the bank. They also haveto set the discount rate every two weeks, subject to approval by the Board of

Governors. The discount rate is the interest rate depository institutions pay

when borrowing from the Reserve Banks. By raising or lowering the rate,the System can influence the cost and availability of money and credit.

The main functions of the Fed

1. Monetary policyThe Fed creates and executes monetary policy to influence monetary and

credit conditions and thereby contributes to the nations economic goal ofnon-inflationary growth. Although the Fed uses three major tools toimplement policy, the most important is open market operations.

Through open market operations, Fed buys and sells US Treasurysecurities in the secondary market in order to produce a desired

level of banks reserves. The Fed adds extra credit to the bankingsystem when it buys Treasury securities from dealers, and drains

credit when it sells to the dealers.

Discount window operations, a second monetary policy tool of the

Fed provides secured short-term loans to depository institutionstemporarily in need of funds. Each of the twelve district reserve


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banks lends to depository institutions in its district, but only after

borrowers have exhausted their market sources of funds. Banksborrow from window at the discount rate that is set by eachreserve bank, but requires the approval of the Board of Governors.

The rate is adjusted occasionally to reflect changes in the marketconditions and monetary policy objectives. Discount window

lending is often referred to as lender of last resort function ofthe central bank.

Reserve requirementsestablish the proportions of demand deposit

(checking) accounts and time deposits that must be held as non-interest bearing reserves at Federal Reserve Banks or as vault

cash. An increase in reserve requirements would be regarded as anattempt to restrict bank credit and restrain economic activity. A

reduction in the reserve ratio would be viewed as a stimulativemonetary policy move.

2. International operationsThe New York Fed, representing the Federal Reserve System and the USTreasury is responsible for intervening in foreign exchange markets to

achieve dollar exchange rate policy objectives and to counter disorderlyconditions in foreign exchange markets. Such transactions are made in close

coordination with the US Treasury and Board of Governors and most often

are coordinated with the foreign exchange operations of other central banks.Dollars are sold in exchange for foreign currency if the goal is to counter

upward pressure on the dollar. If the objective is to counter downwardpressure, dollars are purchased through the sale of foreign currency.

The Federal Reserve Bank of New York serves as fiscal agent in the UnitedStates for foreign central banks and official international financial

organizations. It acts as the primary contact with the foreign central banks.The services provided for these institutions include the receipt and payment

of funds in US dollars, purchase and sale of foreign exchange and Treasurysecurities, the custody of almost $800 billion in currency, securities andgold bullion held for over 200 foreign account holders, and the storage of

over $64 billion in monetary gold for about 60 foreign central banks,governments and official international agencies (about one-third of the

worlds known monetary gold reserves).

3. Supervision and regulation

One of the reasons for the establishment of the Federal Reserve System wasto forestall a repeat of the liquidity crisis and financial panics that occurred


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banks for credit to their reserve accounts. Also Fed serves as a central

check-clearing system, handling almost 18 billion checks a year. It processthese checks, route them to the depository institutions on which they arewritten and transfer payment for the checks through accounts that depository

institutions maintain with the Federal Reserve Banks.

The Fed and about 7,800 institutions are linked electronically through theFederal Reserve Communications System, a network through whichdepository institutions can transfer funds and securities nationwide in a

matter of minutes. In addition, Federal Reserve Banks and their Branchesoperate automated clearinghouses, computerized facilities that allow for the

electronic exchange of payments among participating depositoryinstitutions14.

F inancial institutions

Commercial banks- are the most widely diversified in terms of bothliabilities and assets.

Ranked in terms of assets size, these are the largest financial institutions.Traditionally, their main source of funds has been demand deposits. This

situation has changed over the past twenty-five years; savings and time

deposits have become an even more important source of funds forcommercial banks.

Life insurance companies insure people against the financial consequencesof death, receiving their funds in the form of public payments that are based

on mortality statistics. They consequently purchase longer-term assets, suchas long-term corporate bonds and Lon-term commercial mortgages.

Pension and retirement funds are also concerned with the long rather thanshort run. Their inflow of money comes from working people concerning to

the retirements years. They invest in long-term corporate bonds, high-gradecommon stocks, large-denomination time deposits and long-term mortgages.

Mutual funds are frequently stock market related institutions but there arealso mutual funds specializing in bonds of all kinds.

14The Structure of the Federal Reserve System, www.fed.org


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Savings and loan associationshave acquired almost all their funds through

savings deposits and used them to make mortgage loans.

Sales and consumer finance companies specialize in lending money for

people to buy cars and take vacations and for business firms to finance theirinventories.

Property and casualty insurance companies insure homeowners againstburglary and fire, car owners against theft and collision, business firms

against negligence lawsuits etc.

Credit unions- are organized as co-operatives for people with some sort ofcommon interest, such as employees of a particular company or members of

a labor union. Members buy shares that make them eligible to borrow fromthe credit union.

Mutual savings banks-are practically identical with savings and loanassociations except that there are only about 500 of them.

3.2. EU banking system

The European System of Central Banks (ESCB) is composed of EuropeanCentral Bank (ECB) and the national central banks (NCBs) of all 15 EU

member states. The Eurosystem is the term used to refer to the ECB and theNCBs of the member states, which have adopted the Euro. The NCBs of themember states which do not participate in the Euro area, however are

members of the ESCB with a special status-while they are allowed toconduct their respective national monetary policies, they do not take part in

the decision-making with regard to the single monetary policy for the Euroarea and the implementation of such decisions. In accordance with theTreaty establishing the European Community and the Statute of the

European System of Central Banks and the European Central Bank, theprimary objective of the Eurosystem is to maintain price stability. The basic

tasks to be carried out by the Eurosystem are: to define and implement themonetary policy of the Euro area; to conduct foreign exchange operations;to hold and manage the official foreign reserves of the member states and to

promote the smooth operation of payment systems. In addition, theEurosystem contributes to the smooth conduct of policies pursued by the

competent authorities relating to the prudential supervision of creditinstitutions and the stability of the financial system. The ECB has an


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advisory role vis--vis the Community and national authorities on matters,

which fall within its field of competence, particularly where Community ornational legislation is concerned. Finally, in order to undertake the tasks ofthe ESCB, the ECB, assisted by the NCBs, shall collect the necessary

statistical information either from the competent authorities or directly formeconomic agents.

The process of decision-making in the Eurosystem is centralized through thedecision-making bodies of ECB, namely the Governing Council and the

Executive Board. As long as there are member states, which have not yetadopted the Euro, a third decision-making body, the General Council shall

also exist. The Governing Council comprises all the members of the Executive

Board and the governors of the NCBs of the member states withoutderogation, i.e. those countries, which have adopted the Euro. The mainresponsibilities are:

- to adopt the guidelines and take the decisions necessary to ensure theperformance of the tasks entrusted to the Eurosystem.

- to formulate the monetary policy in the Euro area, including, as

appropriate, decisions related to intermediate monetary objectives, keyinterest rates and the supply of reserves in the Eurosystem

- to establish the necessary guidelines for their implementation.

The Executive Boardcomprises the President, the Vice-President andfour other members, all chosen from among persons of recognized

standing and professional experience in monetary or banking matters.They are appointed by common accord of the governments of themember states at the level of the Heads of State or Government, on a

recommendation from the EU Council after it has consulted theEuropean Parliament and the Governing Council of the ECB. The main

responsibilities of the Executive Board are: to implement monetarypolicy in accordance with the guidelines and decisions laid down by theGoverning Council of the ECB and, in doing so, to give the necessary

instructions to the NCBs; and to execute those powers which have beendelegated to it by the Governing Council of the ECB.

The General Council comprises the President and the Vice-Presidentand the Governors of the NCBs of all 15-member states. The generalCouncil peforms the tasks which the ECB took over from the EMI

(European Monetary Institute) and which, owing to the derogation ofone or more member states, still have to be performed in stage three of

Economic and Monetary Union (EMU). The General Council alsocontributes to the necessary preparations for irrevocably fixing the


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exchange rates of the currencies of the member states with derogation

against the Euro.

The Eurosystem is independent. When performing Eurosystem-related

tasks, neither the ECB, nor an NCB, nor any member of their decision-bodies may seek to take instructions from any external body. The

Community institutions and bodies and the governments of the memberstates may nor seek to influence the members of the decision-making bodiesof the ECB or of the NCBs in the performance of their tasks.

The ECBs capital amounts to EUR 5 billion15. The NCBs are the sole

subscribers to and holders of the capital of the ECB. The subscription of thecapital is based on the basis of the EU member states respective shares in

the GDP and population of the Community. The Euro area NCBs have beenpaid up their respective subscriptions to the ECB capital in full. The NCBsof the non-participating countries have paid up 5% of their respective

subscriptions to the ECBs capital as contribution to the operational costs ofthe ECB. In addition, the NCBs of the member states participating in theEuro area have provided the ECB with foreign reserve assets of up to an

amount equivalent to around EUR 40 billion. The contributions of eachNCB were fixed in proportion to its share in the ECBs subscribed capital,

while in return each NCB was credited by the ECB with a claim in Euro

equivalent to its contribution.

It should be stressed that both Eurosystem and ESCB are not legalpersons16. According to the international public law, ECB is the core of thecomplex structure of the Eurosystem. According to the national legislation,

each central bank of ESCB is a legal person. So each central bank formEurosystem perform the tasks entrusted by the ECB. These central banks

may run any other functions ouside the Eurosystem as long as they are notinterfering with its objectives. Thus, the national cemntral banks performfinancial operations on their name and exercise prudential supervision on

the national credit institutions. The central bank of the EU countries thathave not adopted euro are ESCB members with a special status.

According to the Article 122 of the Treaty, these countries are memberswith derogation which implies that their central banks dont have certain

rights and obligations within the ESCB. The central banks from these

15www.ecb.int, Organisation of the European System of Central Banks16Piata Financiara, No 11/2002


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countries (Denmark, Sweden, Great Britain) may conduct their own

monetary policies; they are not part of the unique monetary policy,concerning its definition and implementation.

Monetary policy instrumentsOpen market operations- are initiated by the ECB, which decides also on

the instrument to be used and the terms and conditions for the executions ofsuch operations, With regard of their aim, regularity and procedures, theESCB open market operations can be divided into the following four

categories:- The main refinancing operations are regular liquidity-providing

reverse transactions with a weekly frequency and maturity of twoweeks. They are executed by the national central banks on the basis

of standard tenders and according to a pre-specified calendar;- The longer-term refinancing operations are liquidity providingreverse transactions with a monthly frequency and a maturity of

three months. They will be executed by the national central banks onthe basis of standard tenders and according to pre-specified calendar;

- Fine-tuning operations can be executed on ad-hoc basis with the aim

both of managing the liquidity situation in the market and of steeringboth interest rates, in particular in order to smooth the effects on

interest rates caused by unexpected liquidity fluctuation;

- In addition, the ESCB may carry out structural operations throughthe issuance of debt certificates, reverse transactions and outright

transactions. The operations will be executed whenever the ECBwishes to adjust the structural position of the ESCB vis--vis thefinancial sector.

Standing facilitiesaim to provide and absorb overnight liquidity, signal the

general stance of monetary policy and bound overnight market interest rates.Two standing facilities, which will be administrated in a decentralizedmanner by the national central banks, are available to eligible counterparts

on their initiative:- counterparts will be able to use the marginal lending facility to

obtain overnight liquidity from the national central banks againsteligible assets. The interest rate on the marginal lending facility willnormally provide a ceiling for the overnight market interest rate;

- Counterparts will be able to use the overnight deposit facility withthe national central banks. The interest rate on the deposit facility

will normally provide a floor for the overnight market interest rate.


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Minimum reserves

Any minimum reserve system would be intended to pursue the aims ofstabilizing money market interest rates, creating (or enlarging) a structuralliquidity shortage and possibly contributing to the control of monetary

expansion. The reserve requirement of each institution would be determinedin relation to elements of its balance sheet. Only institutions subject to

minimum reserves may access the standing facilities and participate in openmarket operations based on standard tenders17.

Economic and monetary union

The first step on the road to European Integration was taken in 1951 withthe signing of theTreaty establishing the Euroepan Coal and Steel

Community. Then, in 1957, Belgium, the Netherlands, Luxembourg,Germany, France and Italy signed the Treaties of Rome. One Treatyintroduced common economic policies, especially on agriculture and, in

1968, a custom union. The other was the Euratom Treaty on nuclear energy.

The Community gradually branched out into other areas. In 1986 the

European Single Act provided for the free movement of people, goods,capital and services and established many new policies. In 1993, the Treaty

on European Union ( Maastricht Treaty) entered into force. It intoduced the

pillar structure: the European Community is the first pillar, foreign policythe second, and justice and home affaires the third.

In 1997, the Treaty establishing the EC was amended once again, this timeat Amsterdam. Consumer policy, employment, growth and free movement

of people were amongst the most important issues dealt with.

Economic and monetary union (EMU) first came to the fore as a primaryobjective of the EC in 1969. Each element in the term has a maximalist anda minimalist meaning. Economic union implies that the member states will,

at most, cease to follow independent economic policies, and at least willfollow co-ordinated policies. Monetary union means, at most the adoption

of a single EU currency, at least the maintenance of fixed exchange ratesbetween the currencies of the member states.

The history of monetary integration began in 1968 with the Werner report,which set out a blueprint for the stage-by-stage realisation of economic and

17Ligia Georgescu-Golosoiu, Business of Banking, Ed. ASE 2002


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monetary union. In 1979 the European Monetary System was established:

bilateral rates were determined between all currencies in the system, whichwere allowed to fluctuate within pre-set margins around these rates. At thecenter of the EMS was the ecu, a basket currency, made up of fixed

percentages of the participating national currencies. In 1989 the Delorsreport laid the foundations for the euro and the Maastricht Treaty of 1992

provided a legal basis for EMU and the single currency.

The Maastricht Treaty provides for EMU in three stages: the first, beginning

on July 1, 1990, is mainly about the free movement of capital; the second,starting on January 1, 1994 is concerned with preparations for the single

currency, including the setting up of the European Monetary Institute, whichis to be dissolved in the third stage, beginning on January 1, 1999. This last

stage will focus on the establishment of the European Central Bank and theintroduction of the single currency.

The European Monetary System (EMS), which began operation in March1979, had a much less ambitious aim: to create a zone of monetary stabilityin Europe. Although it went through several crises, it did eventually prove

to be successful. However, the project for monetary union was revised in thewake of the success of the single market program, and despite opposition

from the British government, and skepticism in several quarters, a single

European currency, the Euro formally came into existence in January199918.

18Stephen George & Ian Bache, Politics in the European Union, Oxford University Press

Inc., New York, 2002


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Stud -case: EURO replaced ECU, as it was easier to pronounc

Set up in 1978, ECU (European Currency Unit) was an abstract currency, a standardlegal tender used by those ones in Brussels, to calculate the budgetary contributions ofeach member state. In fact, it represented a basket of currencies, adjusted periodically toreflect the relative economic power of each state.Over the time, ECU became more important in the international market: non-Europeaninstitutions joint the ECU game in the 80. The outcome: ECU was ranged the fifth inthe top of the most used currencies for international transactions with a 6% marketshare.Used first only for European interbanking operations, ECU became one of the mainreserve currencies in the world; the European Central Banks deposited at the EuropeanCooperation Monetary Fund 20% of their gold and US dollars reserves, in the exchangeof ECU. ECU was easily accepted on international level, even without the help of a

powerful institution as Federal Reserve of USA, Bundesbank or Bank of Japan. Norwaywasnt member of European Economic Community, but decided to relate the value ofits currency to ECU. Far away from Europe, the Japanese, the Americans, and otherimportant players of the economic market used ECU as financial instrument to fightagainst the fluctuations of the yen and dollar. Great performance for a currency thatreally didnt exist!ECU was on its way to achieve the status of a real currency. Luxembourg introducedfor a month ECU as a payment instrument and it was accepted by all the traders of thecountry that used cards as Visa and Eurocard and eurocheques.As a peak of this euphoria, Spain issued a gold currency with the ECU symbol, sold

very quickly when Spanish peseta was officially accepted in the mechanism ofexchange rates.Hotels and restaurants, air companies and even shops started to accept credit cards inECU, paving the way for payments in ECU. A pool made by Ernst&Young among 209European companies and 47 banks showed that ECU would have the chance to becomethe principal currency in the world in 1997.Although the Community does not agree to set up a common currency, ECU will

become a unique currency, said John Heimann, the president of Merrill Lynch Europe.The Maastricht Treaty confirmed the launch of ECU for 1994. It was also a secretcompetition for the name of this currency. Some people spoke about Monnet in thehonor of Jean Monnet which would have been the homonym of the French and Englishterms. Others backed up the term Francfort, with powerful remainder of Carolingian

period and would have the merit to connect the France, Belgium, Luxembourg, andSwitzerland, since their currencies were based on franc, with the German city Frankfurt(in French Francfort), where the Bundesbank and other German private banks arelocated.But ECU, disregarding all this scenario, was liked best by most of the people.Dont forget that ECU is the name given by the French to their golden and silver coinswhile France was the biggest world power. Finally, as ECU was very difficult to be

pronounced in some languages of the Community, it was replaced by EURO. This

decision was taken in December 1995 at the Madrid European Council.


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Convergence criteriaThe main convergence criteria laid down by the Maastricht Treaty are asfollows: an inflation rate not more than 1.5% above the average rate of thethree Member States with the lowest inflation; a public budget deficit not

exceeding 3% of GDP; public debt of not more than 60% of GDP; a long-term interest rate no more than 2 percentage points higher than the averagerate of the three Member States with the lowest inflation; and no currencyfluctuations outside the normal EMS margins for two years and no seriousstains or devaluations.

The secondary convergence criteria are integration of markets, balance ofpayments, labour costs, price indices and ecu trends.

Not all the member states will be taking part in EMU from 1 January 1999but all of them (except Denmark and the United Kingdom) have decided tojoin as soon as possible. It was decided at the Brusells Council on May 1998that Austria, Belgium, Finland, France, Germany, Ireland, Italy,Luxembourg, the Netherlands, Portugal and Spain would participate. The

bilateral exchange rates between their national currencies were set and themembers of the Executive Board of the ECB were appointed. The insconcluded a Pact for Stability and Growth, while pre-ins agreed to workharder towards convergence.

During the transition period (1 January 1999-31 December 2001) the ECBstarted to operate, all new public issues were in euro, the financial markertsand banks, for internal purposes might use euro, business also. In practice itwas possible to use euro for non-cash transactions only, but anyone mightopen a bank account denominated in euro.

The euro was introduced as physical currency on 1 January 2002. Theperiod from 1 Janury 2002 to 30 June 2002 was a dual-circulation period(euro and national currencies).

Stud -case: The futur e tasks of National Bank of Romania withi n the ESCB

The National Bank of Romania will become a member of ESCB at the moment of

accession to the EU. Romania will be in the position to adopt Euro only after it hascomplied with the convergence criteria stated in the Treaty. The task of NBR will differ

from one stage to another. There are to be no essential changes in the NBR activity since

the central bank will be an ESCB member with derogation during the period betweenaccession to EU and acceptance to the Euro area.

Consequently, the NBR governor will not attend the meeting of Governing Council, butonly the General Council, which has a consultative role. The NBR will keep on

maintaining the price stability and will have to look the currency exchange policy as an

issue of general concern. Therefore, Romania will have to participate to the exchange ratemechanism of EU-MCE II. According to the circumstances, this participation may take

place immediately after accession or later.National Bank of Romania will become a full member of ESCB only after Euro will

replace ROL. So NBR will no longer define the monetary policy, as our central bank willimplement the unique monetary policy established by the Governing Council. But the NBR

governor will be a member of this Council, thus being part of the decision-making process

related to the monetary policy. NBR will have the same task of prudential supervision,issuing coins, having and establishing international relations with different institutions and

effecting any financial operations for various entities. NBR will also manage the official

reserves after the transfer of share-quota to the European Central Bank.


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Euro-area banking systemGeneral overview

The structural changes brought about by the adoption of a common currencyand a common monetary policy is exerting a profund impact on the areas

financial sector. Faced with the combined pressures of globalization,disintermediation, new technologies, and increased competition from non-

bank financial intermediaries, banks are designing strategies to thrive in this

new environment.

Altghout it is difficult to characterize the euro-area banking sector, it hasbeen identified some common trends in bank performance, balance sheet

structure, recent capital market developments. The euro areas financial system continues to be bank dominated. The

proportion of financial asstes controlled by the banking systems of the

euro-area countries remain high. Bank loans to to euro-area residentsamount to about 100% of the areas GDP, twice the ratio in the UnitedStates and similar compared to Japan. While euro-area banks continue to

play a dominant role in intermediating saving through traditionalmeans of collecting deposits and extending loans, the use of investment

funds as well as pension and insurance products as savings vehicles is

growing. For instance, assets in investment funds have increased atdouble-digit rates in the recent years in almost all countries19.

Unlike other developed countries, virtually all euro-area countriescontinue to maintain savings banks, and mutual and/or cooperative

banks that gained considerable weight in the local market, particulary at

the retail level. Altghough in the euro-area sector, the largest institutionsin the banking sector are private commercial banks, other types of banks

with different ownership structures continue to play a substantial role inthe banking sector. These institutions can be characterized along thefollowing lines: commercial (private-stock companies), savings banks,

cooperative or mutually owned banks, public banks and a mixture ofother types of banks, usually with special purposes. In several cases, the

savings banks are publicly owned, most often by local or municipalauthorities, and there are still cases of state and central governmentownership of big banking institutions.

19Agnes Belaisch, Laura Kodres, Joaquim Levy and Angel Ubide, Euro Area Banking at

the Crossroads, IMF Working Paper, 2001


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Germany has the largest system in terms of number of credit

institutions-over 3.000-due to its large population and the diverse natureof its banking system. France has fewer than half that many, followed byAustria and Italy (with each containing slightly fewer than 1.000). Spain

ranks sixth after the Netherlands. Each of the remaining countriescontains fewer institutions by far.

To date, consolidation in the euro area is taken mostly two forms, (1)mergers among relatively large private, commercial banks and among

bank and non-bank financial institutions; and (2) mergers within the

savings and cooperative banks, respectively. Consolidation has beenessentially limited, sometimes with implicit government guidance, to

within national borders and within their own type. Some commentatorshave interpreted the governments guidance as an apparent desire to

limit ownership of some influencial institutions and to create a fewnational champions in each country to compete in the European orglobal market place.

Consolidation has accelerated recently at the top: more than half of the30 biggest euro-area banks are the result of recent mergers and theaverage size of the top five has doubled since 1995. Bank of

International Settlements (BIS) data show that some 500 mergers andacquisitions took place in 1991-1992, valued at $17.5 billion, whereas

in 1997-1999 only 200 took place, at a value of about $100 billion-fewer

but of a much larger scale. The degree of concentration at the top is particularly striking in the

smaller euro-area countries, where now just a handful of banks dominatethese banking sectors. Euro-area countries banking systems arecharacterized by relatively few large banks, some of which are

considered global palyers, and an array of medium-sized and smallinstitutions. In almost all smaller countries, the top of five banks hold

more than 50% of the total banking system whether measured by totalassets, total loans, or total deposits. In a few countries, the concentrationis now even more pronounced. For example, in the Netherlands and

Belgium, two large banking groups have more than half of the bankingsector assets, respectively. The four biggest countries have less

concentrated banking sectors, although in France, the five bankinggroups take in nearly 90 percent of all deposits. Notably, Germany hasthe lowest level of concentration in the euro area almost regardlessof

how it is measured. France and Spain are relatively more concentrated.


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Types of Euro Area Banking I nstitutions

1. Private commercial banks. Commercial or private banks are owned bytheir shareholders. Such private-stock companies usually offer equity to the

public, but may be owned by private equity holders. They can distributeprofits to their shareholders, typycally in the form of dividents. These

owners generally have limited liability and exercise control through variousmechanisms, often through board of directors or supervisory bodies. Votingrights, though, may be separable from share ownership.

2. Savings banks. Savings banks often supply credit to local or regional

areas. In many cases, their original purpose was to provide credit tofarmers, artisans, or other underprivileged groups who were unable to

obtain credit elsewhere. Even when not required to do so, savings banksoften focus on individuals and small and medium sized businesses. Whenpartly or entirely owned by state or local governments or municipalities,

these institutions are usually required to allocate part of tehir operatingsurplus to a social fund for use in the local community and the remaining

profit can be either retained or distributed to the government owner.

3. Cooperative/mutual banks. Thsese banks are typically owned by their

depositors and creditors and the services of these banks may be restricted to

those who own them, although recent liberalization has permitted many ofthese institutions to offer their services to others. Ownership shares can be

restricted to ensure broad ownership. In some countries, profits aredistributed as dividents to the mutual owners, sometimes in the form ofhighest interest rates on deposits. In other countries, profits are retained,

adding to reserves and the equity base. Governance is often implementedthrough boards of directors selected from among the members of the

cooperative or mutual institution.

4. Public banks. Public financial institutions are now less prevalent in

Europe and are typically outside the banking system. However, the mostcommon type of public banks remaining in Europe are savings banks,

owned or controlled in part by local or municipal authority. Germany andAustria, with 35 percent and 14 percent of assets in banks either owned orgoverned by the public sector, respectively, constitute the largest public

banking sectors of this type.

5. Others types of banks. Often countries have some specialized lendinginstitutions. For instance, many EU countries contain martgage banks,


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Germany has the largest such sector, whose assets are predominantely

mortgages and their liablities come from either household deposits or theissuance of mortgages-backed securities. In some countries, there areagricultural lending banks, postal savings banks, and other special banks

servicing specific sectors of the economy.

3.3. Shor t comparison between Fed and Eurosystem

The term Eurosystem is not to be found in the legal basis, i.e. the Treaties ofMaastricht and Amsterdam including the protocols which are part of the EU

Treaty. The only reference is to the European System of Central banks(ECSB), which comprises the legally independent national EU central banks

(NCBs) currently 15 and the legally independent European Central Bank(ECB). The ECB was established on June 1st, 1998 as a common subsidiary

of the national central banks located in Frankfurt/Main. The termEurosystem was introduced by the decision-making bodies of the ECB atthe beginning of Stage 3 of EMU (January 1st, 1999) in order to designate

those parts of the European System of Central Banks which are responsiblefor monetary policy in the Euro area. Therefore, in addition to the ECB, theEurosystem only comprises the national central banks of the countries

participating in the monetary union. The Eurosystem bears the exclusiveresponsibility for monetary policy in the EMU and the ECB is the heart of

the Eurosystem. It is responsible for carring out all tasks of the Eurosystem

either through its own activity or through the national central banks. Thismeans that the national central banks are, by function, subordinated to the

ECB to allow the Eurosystem to operate efficiently as a single entity with aview to achieving the objectives of the Treaty. As integral parts of theEurosystem, the national central banks act as operative arms of the ECSB,

carring out the tasks conferred upon the Eurosystem in accordance with therules established by the ECB. Therefore, the basic principle of the

Eurosystem is centralized decision-making, decentralized operations. Thisprinciple of decentralization stipulates that, to the extent deemed possibleand appropriate, the carrying out of the monetary policy operations is the

task of the NCBs. However, decentralization applies to operations only. Themonetary policy decisions and legislative activities remain centralized as

necessary for a common monetary policy. Unlike the ECB, the Eurosystemand the ECSB have neither legal personality nor competence to passdecision on their own. Both are governed by the decision-making bodies of

the ECB the Governing Council, the General Council, and the ExecutiveBoard.


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The Federal Reserve System was set up in 1913. It is comprised of theBoard of Governors and the twelve regional Federal Reserve Banks. Until1935, the decisive role was played by the FRBs. The most important

monetary policy instrument at that time, the discount rate, was decided uponindependently by each FRB. In the 1920s the instrument of open market

operations was discovered. It was used with varying intensity by theindividual FRBs. The FOMC was founded in 1933. At that time it couldonly give recommendations whareas the individual FRBs had the right to

decide. In order to have a common monetary policy, directed to the wholeeconomy, a basic reform of the Fed came up in 1935. Open market policy

was now placed into the responsability of the FOMC and the influence ofthe FRBs in the FOMC was reduced. Consequently, since then the members

of the Board of Governors have had a majority in the FOMC.

The primary objective of the Eurosystem is to maintain price stability. The

EU Treaty does not specify a precise, quantitative definition of pricestability or a time frame within which this objective should be attained.Without prejudice to the primary goal of price stability, the Eurosystem

should support the general economic policy in the EU. Insofar, as thegeneral objective is not to the discretion of the Eurosystem, it is goal

dependent.

On the contrary, the Fed shall pursue several goals. The Federal Reserve Act

states the following: The Board of Governors of the Federal ReserveSystem and the Federal Open Market Committee shall maintain long rungrowth of the monetary and credit aggregates commensurate with the

countrys long run potential to increase production, so as to promoteefficiently the goals of maximum employment, stable prices and moderate

long-term interest rates. Despite this multitude of final objectives, themonetary policy reaction function of the Fed seems to reveal a kind ofimplicit inflation targeting.20

Compared to other central banks, the Eurosystem has the highest degree of

independence. The EU Treaty and the Statutes of the ESCB are the legalbasis. Since this is international law, it can only be modified with unanimityby all EU member states. In this respect, the position of the Fed is by far

weaker. The Federal Reserve System is considered to be an independent

20Gunnar Heinsohn and Otto Steiger, The Eurosystem and the art of central banking,

Center for European Integration Studies, Working Paper, 2002


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central bank. It is so, however, only in the sense that its decisions do not

have to be ratified by the president or anyone else in the executive branch ofgovernment. The entire system is subject to oversight by the US Congress

because the Constitution gives to Congress the power to coin money and set

its value a power that, in the 1913 act, Congress itself delegated to thefederal reserve. The Federal Reserve must work within the framework of the

overall objectives of economic and financial policy established by thegovernment, and thus the description of the System as independent withinthe government is more accurate. Consequently, unlike for the Eurosystem,

the danger exists for the Fed that Congress could change the legal basis.Thus, the ESCB has a more secure institutional foundation than the Fed,

which is a creation of Congress and whose structure can be changed at anytime.

The Eurosystem has three types of instruments at its disposal: minimumreserves, open market operations and so called standing facilities. In the

US, there are minimum reserves, open market operations and so calleddiscount windows. In the Eurosystem, all esential decisions about the useof instruments are made by the Governing Council of the ECB. In the

Federal Reserve System, the FOMC is only responsible for the open marketoperations. Decisions about the use of minimum reserves and the discount

window are made by the Board of Governors.

The design of required reserves is similar in both systems. Credit

institutions are required to hold minimum reserves at their central bankeither as deposits on accounts with the central bank or as vault cash. TheEurosystem only allows the first alternative, whereas credit institutions in

the USA can also fulfil their obligations with vault cash. Credit institutionsare obliged to hold required reserves in relation to specific liabilities of their

balance sheet. The Eurosystem also carries out open market operations,which are undertaken on the initiative of the Eurosystem. Traditionally, theterm open market operations was used for purchase and sale of securities.

The Eurosystem, however, uses this term in an enumerative way. The mostimportant open market operations of the Eurosystem are the so-called main

refinancing operations and the longer-term refinancing operations. Theformer are loans of a two-week term which are offered every week; thelatter are loans with a term of three months. In contrast to the Eurosystem,

the Fed still uses the term open market operations in the traditional way.Open market operations are only purchases and sales of bonds, which could

take place either as outright operations or as repurchase agreements. Finally,the Eurosystem has at its disposal so-called Standing Facilities. These


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operations are carried out on the initiative of the credit institutions. They are

designed simmetrically and provide or absorb liquidity with an overnightmaturity. The marginal lending facility offers the oportunity to creditinstitutions to get liquidity overnight. The amounts are not limited if a credit

institution has enough collateral. On the other hand, there is the depositfacility which enables credit institutions to deposit excess liquidity. The

standing facilities shall facilitate the liquidity management of the creditinstitutions.

Within the discount window, the Fed offers loans to credit institutions.

The interest rate which is charged for this is traditionally called thediscount rate. The discount window is in particular designed for credit

institutions with liquidity problems. The use of the discount credit iscombined with more intensive bank supervision on the part of the Fed.

The central starting point for the instruments of both central banks is themoney market. On the money market, the credit institutions trade funds atthe central bank. Such transactions do not lead to a change of the amount of

existing base money, they only cause a redistribution of the overall volumebetween the credit institutions. From the point of view of an individual

bank, operations with the central bank and in the money market fulfil thesame function. Both support the balancing of changing liquidity needs.

Conclusions

The institutional structure of the two central banks is rather similar but themain tasks and the legal status are different. Whereas the main task of the

Eurosystem is clearly spelled out (price stability), the Fed has several tasksleading to some ambiguity. In this context, it is also important that theindependent status of the Eurosystem is guaranteed by international law (EU

Treaty), whereas the status of the Fed depends on Congress because theConstitution gives to Congress the power to coin money and to set its value.

Regarding the instruments and operating procedures of monetary policy,there are similarities in the design of the minimum reserves and theoperating target. In both cases, the overnight interest rate is the operating

target of monetary policy. Apart from required reserves, the instruments ofmonetary policy are different. The differences in institutional and

instrumental respect can be traced back to historical factors, legal problemsof the change of existing arrangements and a different understanding ofmonetary policy. In this context, the Eurosystem has had the advantage of

introducing all arrangements according to the knowledge of monetary policy


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and theory at the end of the 20th century. In sum, the Eurosystem must be

classified as the superior system under efficiency aspects.21

Summary

Hystory of European integration

- 1951: ECSC- 1957: Treaties of Rome- 1986: Single Act

- 1992: Maastricht Treaty- 1997: Amsterdam Treaty.

Hystory of monetary in tegration

- 1968: Werner Report;- 1979: EMS established;- 1989: Delors report lays foundations for euro;

- 1993: Maastricht Treaty.

Convergence cr i ter ia

- inflation rate: price stability- public finances: budget discipline

max. deficit 3% of GDP

max. debt 60% of GDP

- exchange-rate stability- convergence of interest rate

Stages of integration:

-free trade area

- customs union- common market- economic union

- monetary union.

Decision-bodies of ECB:

- Governing Council- Executive Board

- General Council

21Karlheinz and Franz Seitz, The Euro System and the Federal Reserve System compared:

facts and challenges, Center for European Integration Studies, Working Papers, 2002


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M icroeconomic benefi ts (eur o):

-facilitates cross-border financial transactions- makes travelling easier for consumers- no time wasted changing money

- no more exchange charges- easier to compare prices

Macroeconomic benefi ts (eur o):

- eliminates exchange-rate risk

- strengthens the single market- encourages investment in the euro zone

- promotes convergence of national economies.

Check out questions

1 How is the Federal Reserve System organized?

2 What is the main body of the Fed and how is this elected?

3 What is the FOMC and what is its composition?

4 What is the role of the Federal Reserve?

5 What are the instruments of monetary policy used by the Fed?

6 What kinds of facilities are offered by the Fed to the governmentagencies and to the depository institutions?

7 The regulation and supervision function supposes.

8 Lender of last resort means that:

9 State two benefits of the membership of Fed and/or Eurosystem.

10 Mention the convergence criteria of the EMU.

11 State the difference between the ESCB and the Eurosystem


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12 Specify two common points between the Fed and the EU banking

system.

13 When was the Euro introduced?

14 State two different points between Fed and EU banking system.

15 Mention the stages of integration prior to monetary and economicunion.

16 What are the main features of the EU banking system?

17 What is understood by public finance discipline in case of EMU

convergence criteria?

Choose the right answer(s).

18 Open market operations:a. are the main instrument used by the Fed to implement the

monetary policyb. are foreign exchange operationsc. mean buying and selling US Treasury securities

d. are operations that influence the bank reserves.

19 The role of ECB is:a. to implement the monetary policy in the Eurosystem

b. to implement the monetary policy throughout the EUc. to support the general policies of the EU

d. to hold and manage the official foreign reserves of the memberstates

e. to maintain price stability and sustainable economic growth.

20 The main bodies of the EU banking system are:a. The Governing Council, the Executive Board, the General

Councilb. The Board of Governors, the Board of Directors and the General

Councilc. The Board of Governors, the Executive Board, the General

Councild. The Governing Council, the Executive Board, the Council of

Governors of EU.


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21 The countries that have not yet adopted the Euro are:a. Great Britain, Sweden, Norway

b. Sweden, Denmark, England

c. Denmark, Ireland, Great Britaind. Sweden, Great Britain, Ireland.

22 Convergence is related to:

a. inflation, price stability, long- interest rateb. price stability, budgetary discipline, long-interest rate

stability, exchange rate stabilityc. public deficit, budgetary deficit, public debtd. inflation criteria, interest criteria, public criteria.

References

1. Piata Financiara magazine, 2000-2002

2. Dumitru Miron, The Economics of European Integration, ASEBucharest, 2002

3. Ligia Georgescu-Golosoiu, The Business of Banking, ASE Bucharest2002-12-02

4. www.ecb.org, www.eu.int, www.fed.org

5. Center for European Integration Studies, Working Papers, www.zei.de

6. IMF Working Papers, www.imf.org

3. Banking Systems = From Regional to National

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