Contents

Executive Summary

An Overview of Irish Banking

A. The Structure of Banking in Ireland

History.

Institutions

Ownership of Retail Banks

International Financial Services Centre.

Banking Infrastructure.

Employment.

Bank Networks

B. Banking Services

Deposits

Lending

Payment Systems

Other Services

C. Concentration.

D. Profitability.

A. Main Influences

Globalization and Deregulation

Technological developments

Intensifying Competition

B. Mergers & Acquisitions.

Rationalization

Diversification and growth

C. Retail Payments System

D. Branch Networks

Mergers & Acquisitions Law.

Competition & the Consumer

Retail Payment Systems

Promotion of Electronic Payment Mechanisms

Bank Networks

Irish Financial Services Centre

Appendix One: Membership of the Working Group

Appendix Two: Submissions received by the Working Group.

Appendix Three: Credit Institutions reporting to the Central Bank

Appendix Four: ‘Common Good’ considerations applying to cross border bank mergers and takeovers

Appendix Five: ‘The National Payments Strategy’

Statistical Appendix

1. Bank Assets.

2. Ownership.

3. Other Financial Institutions

4. Employment

5. Bank Branches.

6. Savings

7. Credit.

8. Payments

9. Concentration

10 Profitability.

Figure One: Branches & Sub-Branches of the Clearing Banks

Figure Two: Number of Branches per 1,000 capita - 1997

Figure Three: Breakdown of Deposits by sector

Figure Four: Breakdown of Credit by type of borrowing

Figure Five: Breakdown of Credit by Counterparty

Figure Six: Mortgage Rates 1998-99

Figure Seven: Notes and Coins in Circulation as % of GDP

Figure Eight: Volume of Non-Cash Transactions by type 1990

Figure Nine: Volume of Non-Cash Transactions by type 1998

Figure Ten: Membership of Irish Payments Services Organization Ltd & Clearing Companies

Figure Eleven: Cheques and Credit Transfers as % of cashless transactions

1. The Report first provides an overview of banking in the Irish economy. This is followed by a review of strategic issues facing Irish banking. Finally, the Group makes recommendations in relation to policy issues arising from expected developments.

2. The Report focuses on retail banking; that is the personal sector and the small and medium-sized enterprises (SMEs) sector. More than eighty credit institutions offer banking services in Ireland, of which eleven have a significant involvement in retail banking by operating branch networks. Most Irish banks are publicly quoted companies. The majority of shareholders are private individuals with relatively small holdings although the bulk of the shares are held by institutional investors, including pension funds and insurance companies. An increased proportion of shares in the larger banks are owned abroad. There is a significant foreign presence in Irish banking. The development of the International Financial Services Centre (IFSC) has increased the internationalisation of the Irish banking sector, with IFSC entities operating mainly in the wholesale sector. In terms of employment, Ireland is close to the EU average for numbers working in banking relative to population. There is a comparatively small number of bank branches and Automated Teller Machines (ATMs) per head of population relative to most other countries in Europe.

3. The main services provided by retail banks in Ireland include the traditional intermediation functions (deposit-taking and loan provision), money transmission services through retail payments systems, and, to a growing extent, other services such as providing stockbroking facilities and life assurance products. Increased competition for savings has obliged banks to provide new products which offer higher rates of interest than traditional demand deposits. Interest rates available to savers appear to be competitive by the standards of other euro area countries. The paucity of data, however, prevents firm conclusions being drawn on the cost of loans, especially for the SME sector.

4. The ECB has classified the Irish banking market as one of medium concentration. However, elements of Irish banking, including retail banking, are significantly more concentrated. Irish banks are highly profitable, which partly reflects the country’s strong economic performance in recent years. Cost/income ratios for Irish banks also compare very favorably with those of other countries. Increased competition for traditional bank services has led to a declining trend in net interest margins in recent years and a move towards non-interest sources of income.

5. The Group identified two main factors affecting change in the banking sector. These are (i) globalisation and deregulation and (ii) developments in technology. Both have contributed greatly to increasing the competitive environment in which banks operate. The Group viewed this increase in competition as a welcome development but noted that it also posed certain challenges. The Group identified three strategic areas likely to have policy implications for the banking sector in the next decade. These are: (i) mergers and acquisitions; (ii) retail payments systems; and (iii) bank branch networks.

6. The two main motives for mergers and acquisitions are the rationalisation of costs and the diversification of growth. The Group concludes that a takeover or merger primarily based on rationalising costs is unlikely. It is possible that an Irish bank could be purchased as part of a diversification strategy, based on seeking exposure to the Irish economy or access to the EU. Domestically, mergers or takeovers for cost rationalisation purposes (especially a merger of the two largest banks) could achieve large cost savings but would also raise major issues of excessive concentration.

7. Regarding the implications of developments in information technology (IT), two factors are identified which may have policy implications, namely the type of technology in which banks invest and the timing of the investment. The technical issues have a major competitive significance in that they are relevant to ensuring that Ireland has an open, integrated payments system. The banks are currently engaged in a range of initiatives to develop the retail payments system, sometimes competitively and sometimes cooperatively. These include the development of internet platforms, examining a move to on-line debit card processing and the prospects for ‘electronic purse’ technology.

8. Banking products have traditionally been delivered through an extensive branch structure. However, the role of branches is changing, reflecting the centralisation by banks of the processing of payments and the provision of credit and the emergence of methods of ‘remote’ delivery of banking services. The Group considered it likely that remote delivery will become at least as important as branch based delivery and that organising the transition to this very different approach to the delivery of banking services will increase the pressure for branch consolidation.

9. In light of the expected developments in banking and the policy issues which arise from these, the Group has made a number of recommendations:

10. Appendices One and Two provide information on the work of the Group. Appendix Three lists credit institutions reporting to the Central Bank. Appendix Four considers whether there are special considerations arising in relation to cross border mergers in the banking sector and concludes that there are not. Appendix Five sets out the current position in relation to on-going work between the banks and the State to develop new retail payment options.

1.1 On 4th November, 1999, the Minister for Finance, Mr. Charlie McCreevy T.D., announced that he intended to carry out a strategic review of the future of Irish banking. He invited submissions from the industry (a full list of submissions received is in Appendix 2) and established a group chaired by Mr. Noel O’Gorman, Second Secretary General in the Department of Finance and comprising officials from relevant areas within the Department of Finance and representatives of the Central Bank (hereafter referred to as ‘the Group’ - a full list of the members of the Group is in Appendix 1).

1.2 The terms of reference were to consider:

• possible future developments affecting the structure of banking and related financial services in Ireland;
• their likely implications for the economy and for bank customers generally, particularly from the standpoint of an efficient competitive market for banking services, for the provision of financing for Irish business, and for the quality and quantity of employment in the sector; and
• the need and scope for policy to facilitate change and influence developments.

1.3 The Group has noted the commitment of the Government as set out in An Action Programme for the Millennium to promote competition through technological innovation and regulatory reform. 1

1.4 The Group also noted that the Programme for Prosperity and Fairness, agreed between the social partners, sets out the need to work towards the creation of a society which responds effectively to the constantly evolving requirements of international competitiveness.2

1.5 The Group focussed on the possible impact of a number of developments on the banking sector and the possible policy response to these developments. The developments included the worldwide phenomenon of the rationalization of the financial services industry and consequent mergers and acquisitions, the blurring of the distinction between banks and other financial institutions, and the growth of e-commerce.

1.6 The Group concentrated on the impact of these phenomena on the retail banking sector since it is more sheltered from competition and because international competition should ensure an efficient wholesale banking sector.

1.7 The general policy perspective of the Group was that the economy is best served by having a stable retail banking sector which delivers the highest standard and range of services to customers at competitive prices. This requires a level of profitability and regulation necessary to ensure the prudential soundness of individual institutions and the stability of the banking system, transparency and fairness in the dealings of the banking sector with its customers, and a competitive market place for banking services.

1.8 The Group did not directly examine the consumer protection issues which arise in relation to individual products and services provided by the banking sector. As this has already been addressed by the "McDowell Report"3, consumer protection issues will be dealt with in a coordinated way by the financial services regulatory authority, which is to be established. However, this report is based on acceptance of the position as set down in the Programme for Prosperity and Fairness concerning the interrelationship of the competition reform issues, on which it has focused, and consumer/social inclusion issues.4

1.9 Given that the Group has adopted a retail banking perspective and that there is a comprehensive strategy in place for the International Financial Services Centre (IFSC), the Group did not consider it necessary to explore this aspect of banking in Ireland further.5

1.10 The remainder of the report is organized as follows:

Chapter Two sets out the current structure of banking in Ireland.

Chapter Three identifies the major policy related strategic issues facing banking in Ireland.

Chapter Four makes recommendations in relation to the policy issues arising.

There are also a number of appendices which deal with the following matters:
One: Membership of the Group.
Two: Submissions received and consultations undertaken by the Group.
Three: Credit institutions supervised by the Central Bank of Ireland.
Four: The concept of the ‘common good’ as this applies to cross border bank mergers and acquisitions.
Five: Current position in relation to the ‘National Payments Strategy’.
Statistical Appendix: Statistics on Irish banking from a variety of sources.6

1.3 The Report represents the conclusions of the deliberations of the Group. It has been submitted to the Minister for Finance as an input into the policy making process.

1.4 The Group had two Secretaries - Mr. Richard Shine and Mr. Martin Moloney, both of the Department of Finance. The Group wishes to thank both for their essential contribution to the production of this report. In addition, Mr. Paul McBride and Mr. John McCarthy of the Central Bank provided invaluable assistance with the research for the report and the Group wishes to thank them for their contribution to its work. The members of the Group would also like to thank all the parties who responded to its requests for submissions or who made themselves available for consultations or otherwise provided material or assistance to the Group.

1. see P. 9-11, 25-26, 29-30, An Action Programme for the Millennium

2. P.46-48, Programme for Prosperity and Fairness

3. Report of the Implementation Advisory Group on the establishment of a Single Regulatory Authority for the Financial Services Sector, May, 1999

4. P. 47-48, Programme for Prosperity and Fairness

5. Strategy for the Development of the International Financial Services Industry in Ireland. See also paragraphs 2.23-2.28 and 4.25

6. These statistics were not collected on a harmonised basis and have not been verified or reconciled by the Group.

2.1 The banking sector is a major contributor to the Irish economy. In 1998, banks spent more than IR£1.8 billion [ €2.3 billion] in the economy, paying over IR£640 million [ €813 million] to the Exchequer in taxes. The sector is also one of the largest employers in the State, providing over 30,000 jobs. It is estimated that the contribution of banks to the Irish economy accounted for 3.5 per cent. of GNP in 1998.7

2.2 Without an efficient financial system – comprising banks and non-bank financial institutions and financial markets – no modern economy could prosper. The main function of a financial system is financial intermediation, i.e., facilitating the interaction between those with funds surplus to current requirements (savers) and those in need of funds (borrowers). Banks also contribute to the economy as providers of other financial services, such as money transmission and payment services.

2.3 A distinction may be made between 'retail' banking and 'wholesale’ banking:

Retail banking involves taking deposits and advancing overdrafts and other loans, dealing with the personal, small business, farming, non-profit, corporate and government sectors. It also involves the provision of money transmission services8, with extensive branch and ATM networks and a clearing system for the settlement of non-cash retail payments.

Wholesale banking tends to involve dealing with large corporate and government entities and includes the provision of financial consultancy including advice on dealings with capital markets. In Ireland, there is also a tradition of so-called industrial banks, which focus on instalment credit, leasing facilities and mortgage lending.

2.4 This report focuses on retail banking, especially in relation to customers who deal in low value transactions. In the remainder of this chapter, therefore, the term ‘retail’ refers to business with such customers, e.g., most personal customers, farmers, and small and medium-sized enterprises (SMEs). For larger corporate customers, the degree of competition in the provision of banking services, which is in effect international, is felt to be adequate to safeguard the interests of the customer. Other customers typically have less bargaining power and fewer alternatives.

2.5 Retail banking in Ireland is dominated by the main clearing banks which are examples of the 'universal banking' model. These banks provide a full range of financial services, based on comprehensive nationwide accessibility and the integration of service provision across all sectors (small and large, business and personal, etc.). This contrasts with many countries where there is still a strong segmentation in the banking sector between retail and wholesale banks. In Ireland, a significant number of smaller banks and building societies also compete with the major banks for retail customers.

2.6 A major development affecting the financial sector in recent years, in Ireland and elsewhere, has been the process of financial liberalisation and deregulation. This has enhanced the freedom for financial institutions to increase the range of services they offer, thus blurring the distinctiveness of different types of institutions and removing barriers to competition. In Europe, this process has been accompanied by the creation of a single EU market in financial services. The single market in financial services has involved the harmonisation of regulatory regimes through a number of key EU directives9, and the liberalisation of capital movements with the abolition of exchange controls. Among the directives is the Single Banking Co-ordination Directive (1992), under which a bank authorised in any EU Member State is free to provide banking services in any other Member State without requiring any additional authorisation. This is what is known as the 'single passport' in banking which permits banks in one Member State to offer services in another on a branch or cross-border basis. The introduction of the euro also facilitates the integration of markets for financial services and increases the transparency of pricing across Member States. With technological advances facilitating entry into the Irish banking market, or particularly profitable segments of it, these developments have contributed greatly to increasing the competitive environment in which banks operate.

2.7 The remainder of this chapter looks in more detail at the nature of Irish banking under four headings:
(A) The structure of banking in Ireland;
(B) Banking services;
(C) Concentration; and
(D) Bank profitability.

A. THE STRUCTURE OF BANKING IN IRELAND

2.8 This section provides a description of the structure of the Irish banking system. Following a brief historical background, the main institutional characteristics of the system are outlined, describing first the types of institution and then the ownership pattern, with a separate subsection on the International Financial Services Centre (IFSC). There follows a section on employment and infrastructure.

History

2.9 McGowan10 traces the beginning of Irish banking back to the late 1600s, although branch banking did not appear until the 1820s with the emergence of joint stock banks. The basic structure of Irish banks remained unchanged from the latter part of the 19th century until the 1960s. That decade saw a wave of mergers and acquisitions which McGowan suggests represented part of a process whereby Irish banking sought economies of scale and strengthened itself to cope with the threat of external take-overs and increased competition from abroad. This period of consolidation reduced the number of clearing banks from eight to four.

2.10 The 1960s and 1970s also saw the entry of a number of North American and European banks into the Irish market, increasing competition for non-retail business.

2.11 In the 1970s, the four clearing banks dominated retail banking in Ireland; competition was limited and interest rates were set by arrangement. Competition among these banks was increased in the 1980s by the ending of the interest rate arrangement and, subsequently, by increased competition from other institutions.

Institutions

2.12 In the past, a distinction was made between institutions holding a banking licence issued by the Central Bank under Section 9 of the 1971 Central Bank Act (licensed banks) and other credit institutions. The latter included domestic institutions exempt from the requirement to hold a licence12 and credit institutions operating in Ireland but authorised in another Member State of the EU. Domestic institutions providing banking services but not required to hold a licence included State-owned banks, savings banks, building societies and credit unions. Nowadays, all deposit-taking institutions, with the exception of credit unions, are supervised by the Central Bank and are described by the common rubric 'credit institutions'. All of these are subject to the same supervisory regime. A list of institutions supervised by the Central Bank at end-1999 is set out in Appendix 3.

2.13 More than eighty credit institutions offer banking services in Ireland. Almost sixty of these are incorporated in Ireland, while the remainder are authorised in another EU Member State and operate in Ireland on a branch basis. Excluding institutions with predominantly foreign business and those not engaged in taking deposits from or granting loans to personal or small business customers in Ireland, the number of institutions involved in retail activity is probably around thirty. Of these, eleven have significant involvement in retail banking through branch networks13, and four of those are predominantly involved in mortgage business.

2.14 Apart from retail banks, there are three building societies which also provide retail banking services14. One of these (ICS Building Society) is owned by the Bank of Ireland. Building societies are traditionally specialised mortgage lending institutions, although the Building Societies Act, 1989, allowed them to diversify into other banking activities. The number of building societies in Ireland has declined in recent decades from sixteen in 1980 to three today. This decline has resulted from transfers of engagements (mergers) and demutualisations. Demutualisation has involved the conversion of two institutions into public companies, First National Building Society (now First Active) and Irish Permanent. The main reason for these changes was the restriction which mutual status placed on the ability of these institutions to expand their capital base. In 1999, Irish Permanent merged with the largest life assurance company in the State, Irish Life, to form Irish Life & Permanent, the third largest financial institution in the State in terms of asset size.

2.15 There are also two savings banks in Ireland. The Post Office Savings Bank is owned by the Government and is a deposit-taking institution whose deposits are all loaned to the Government. The other is a trustee savings bank (TSB Bank) and is mainly concerned with retail lending and money transmission.

2.16 In addition, there are two State-owned banks: ACC Bank and ICC Bank (the latter with a subsidiary, ICC Investment Bank). The Minister for Finance has asked both banks to prepare for a change of ownership.

2.17 In addition to the above, there are over 400 credit unions in Ireland, which are co-operatively owned entities15. They report to the Registrar of Friendly Societies. They have traditionally provided savings and loan facilities at local level. The Credit Union Act, 1997, expanded the role of credit unions by permitting them to lend larger amounts for longer periods.

Ownership of Retail Banks

2.18 Ireland is relatively unusual internationally in having such a predominantly commercial banking sector, which is owned mostly by individual and institutional shareholders. In continental Europe, specialised institutions without an exclusively commercial character such as savings banks, mutual societies and State-owned banks still play a more significant, if declining, role. The ownership of US banking is fragmented. Many developing countries have banking systems in which the State is involved to a significant degree. The countries whose banking systems are most like Ireland are the UK, Canada, New Zealand and Australia.

2.19 The two major Irish banks, AIB Bank and Bank of Ireland, are both publicly quoted companies and have raised the bulk of their capital through the Irish Stock Exchange. In each case, ownership is widely diversified, with over 100,000 shareholders, most of whom are private individuals with relatively small holdings.16 In the case of AIB Bank, 41 per cent of shareholders own fewer than 1,000 shares each, while in the case of Bank of Ireland this figure is 54 per cent.17 These small shareholders, however, own just 1 per cent of the total shares. Like similar publicly quoted companies, the bulk of shares in the two largest retail banks are held by institutional investors, including pension funds and assurance companies - 78 per cent of the shares in Bank of Ireland and 65 per cent of the shares in AIB Bank are held in share holdings of more than 100,000 shares.18 An increased portion of the shares in AIB Bank and Bank of Ireland are now owned abroad. At end-1999, a majority of the shares (by value) in AIB Bank were owned abroad.19

2.20 The conversion of two building societies (Irish Permanent and First National) into public companies has further increased the dominance of public companies in the ownership of Irish banking.

2.21 Not all banks operating in the Irish market have been owned in this way. The involvement of banks operating from a base in Belfast in banking activities throughout the island has led to the involvement of major British banks in Irish banking. Ulster Bank became a subsidiary of London County and Westminster Bank in 1917 and as such subsequently became part of the UK National Westminster Bank Group, recently purchased by Royal Bank of Scotland. The Northern Bank (Ireland) Ltd (now National Irish Bank) was acquired by Midland Bank in 1965 and was then sold in 1987 to National Australia Bank Group.

2.22 There has also been a sizeable number of overseas banks operating at the upper end of the Irish corporate market. This element partly dates back to the 1960s and was closely linked to the level of foreign direct investment in Ireland. More recently, the development of the International Financial Services Centre (IFSC) increased the internationalisation of the Irish banking sector.

International Financial Services Centre

2.23 The International Financial Services Centre (IFSC) was established by the Government in 1987 with its principal objective being the creation of a broad-based and well-regulated financial services industry in Ireland which would provide quality, sustainable jobs. The IFSC has since developed into a significant centre for a wide range of internationally traded financial services. The types of activity located there include international banking, corporate treasury, life and non-life insurance business, collective investment schemes, the service providers to such schemes, securities trading, brokerage operations, financial advice and back-office operations.

2.24 Potential IFSC projects were assessed and approved by the Certification Advisory Committee, which made recommendations to the Minister for Finance regarding whether or not a project should be approved for the special tax regime applying in the Centre. This committee is made up of representatives from the Department of Finance, IDA, the Central Bank and the Department of Enterprise, Trade and Employment.

2.25 Changes to the then existing arrangements were put in place in the second half of 1998. These arose from negotiations between the Irish Government and the EU Commission regarding specific tax regimes in Ireland and resulted in the introduction of a quota system for project approval during 1998 and 1999. The IFSC regime does not apply to projects established after 1999.

2.26 Each IFSC project approved had a minimum employment commitment which was determined by the type of project and the nature of proposed activities. At end-December 1999, there were 388 active projects involving direct and back office employment of over 8,500 staff. The IFSC has also made a significant indirect contribution to employment in areas such as accounting, legal, information systems and other general services industries.

2.27 The IFSC banking sector has been at the core of the Centre's development since 1987. Many of the world's major international banks as well as the principal Irish banking institutions have established offices at the IFSC. Almost all credit institutions operating in the State have also been approved to conduct international business from the IFSC.
Approval is conditional on dealing with non-residents.

2.28 The majority of the licensed banks in the IFSC concentrate on granting relatively low-risk, low-margin credit facilities to high-quality international corporate customers, central and regional governments and banks. For the most part, funding is obtained from wholesale sources and from parent banks.


Banking Infrastructure
Employment

2.29 Employment in banking in Ireland has risen consistently for decades and currently stands at around 31,000 which represents 65 per cent. of total financial sector employment.20 Between 1960 and 1990 total employment in the insurance, finance and business sector almost quadrupled.21 Banking employment grew throughout the 1990s, reinforced by the emergence of the IFSC which now employs some 8,500. According to the most recent figures, overall financial sector employment increased by 2,400 between December 1998 and December 1999. Employment in banking increased by 1,600, in the insurance sector by 700 and in the building societies sector by 100. The overall increase is equivalent to a year-on-year growth rate of 5 per cent.

2.30 Figures for 1997 show Ireland as having bank employment per 1,000 population just below the EU average if Luxembourg, with its exceptionally high figure, is excluded.22 Ireland is unusual in that it experienced a large increase in bank employment between 1985 and 1997, whereas most other countries recorded only small increases or declines. This is probably due in part to the development of the IFSC and to the rapid overall growth of the Irish economy over this period. Salaries in the banking sector are, on average, around 144 per cent of the average gross industrial wage (1999) and 118 per cent of total average wages (1996). In Ireland, average banking sector wages as a percentage of total average wages are somewhat below the EU average, with only Greece having a significantly lower figure.23

Branch Network

2.31 Branches have traditionally been the main distribution channel for retail banking services. They continue to be the predominant form of access to banking services, with over 40 per cent of respondents to a recent survey using branches once a week or more, 55 per cent saying they 'mostly use' branches and 93 per cent having visited a bank branch at least once in the previous twelve months.24 The technological changes in the way payments can be organised and the move to remote access to banking services have now begun to change fundamentally the environment in which branches have traditionally operated.

Source: See Table 19

2.32 The number of bank branches and sub-branches in Ireland fluctuated in a range of 700-1,000 for most of the last century.25 At all times, there is an ongoing requirement to adjust this branch network as population moves and economic activity alters. For example, the growth of new suburbs and the emergence of suburban shopping centres has led to the opening of bank branches in or near these centres. Quite independently of the development of e-banking, the profound changes in the Irish economy in recent years mean that this kind of restructuring is happening at the present time. However, there is, to date, little sign that banks have reduced the size of the branch network. While the number of sub-branches26 has been in decline, figures for the period up to end-1999 have continued to show overall branch numbers stable at just under 900. In the ten years to end-1999, the number of branches increased by 39 (5.5 per cent), while the number of sub-branches decreased by 65 (34 per cent).

2.33 One recent international survey has observed that "Ireland...is one of the few countries where the branch network has been maintained, and employment in the banking sector is growing strongly."27 Nevertheless, ECB figures suggest that the number of branches per 1,000 population would be higher in other EU countries by comparison with the U.K. and Ireland. This reflects the pattern of localised banking in those countries.

Source: Statistical Appendix Table 20

2.34 Population coverage, the nature of local demand and the range of services can vary also from branch to branch within the country. For example, an analysis of the spread of bank and building society branches by province and county shows Leinster having the lowest number of branches per population and Ulster28 having the highest. In terms of individual counties, the range goes from Kilkenny with a population of over 3,400 per branch to Leitrim with a population per branch of approximately a third of that figure.29 This kind of pattern reflects the settlement pattern in the country as a whole and the greater level of urbanisation in Leinster. Traditional branch banking in rural areas involved significantly higher branch overheads and there is still an effective cross-subsidisation of rural branch banking by urban concentrations. This is part of a more general pattern whereby branches have characteristic market profiles, in accordance with the patterns of distribution of residence and business activities.

2.35 As already stated, individual banks and building societies are constantly altering their branch networks. A particular phase in the development of branches is currently underway. Smaller banks and building societies, in particular, have begun to restructure branches and the major banks will follow a similar course. The issues arising are discussed in the next chapter.

2.36 The number of ATMs in Ireland increased steadily during the 1990s, but in terms of the total per 1,000 population, Ireland appears at the lower end of the EU spectrum.30 However, the Irish customer is a much heavier user of ATM cards than the average EU citizen/bank customer.

B. BANKING SERVICES

2.37 This section examines the main services provided by retail banks in Ireland, making comparisons, where possible, with other EU countries. First, the traditional intermediation functions (i.e., deposit-taking and loan provision) are looked at in turn. Following that, retail payment systems are discussed. The final division within the section comments on some other services provided by banks.

Deposits

2.38 One of the core banking activities involves the provision of savings products to meet the needs of those who have funds surplus to current requirements which they wish to set aside for the future. Savings by acquisition of financial assets represents part of the wealth of a nation. A 1993 report found that financial assets accounted for an estimated 8 per cent of total wealth in Ireland31 and that two thirds of these financial assets were in the form of bank deposits. Over 56 per cent of Irish households held deposits. Deposits accounted for over three quarters of the financial assets of lower income groups, falling to just over half the financial assets of higher income groups.32

2.39 At end-1999, deposits of non-Government Irish residents with resident credit institutions amounted to about IR£56 billion [ € 71 billion]. Of this, almost IR£28 billion [ € 35 billion] was held by the clearing banks and close to IR£24 billion [ € 30 billion] with other banks operating mainly in the domestic market.

Source : Central Bank Quarterly Bulletin Spring 2000, Table C9

2.40 There has been increasing competition for savings from outside the banking sector. Traditionally, the main competitors for deposits were the banks and the State (in the form of the Post Office Savings Bank and Savings Certificates/Bonds). Investment in assurance savings products has traditionally represented about 30 per cent of annual investment in financial assets. From the 1960s to the 1980s, building societies increased their share of the savings market33 and credit unions have also developed a sizable deposit base.34 Indications are that long term savings through pension schemes and savings products such as single premium bonds and tracker bonds have also proven attractive as has direct stock market investment.35 There has also been a move, more recently, away from low interest demand deposits to term and notice accounts which are less liquid but offer a higher return. The arrival of Northern Rock into the retail funding market, offering a high interest, instant access postal account, has been another element in this increased competition for deposits.

2.41 Banks have responded in three ways:
- by offering a wider range of deposit products, with varying maturity dates,
- by developing assurance subsidiaries, in part to attract long term savings, - by supplementing savings by interbank borrowing and capital markets funding (e.g. bonds and securitisations).

2.42 Closely related to the pressure on the deposit savings market is the issue of pricing. Demand deposits constitute 24 per cent of total deposits in the market.36 The interest rate offered by banks in relation to these products has traditionally been low. Banks have rarely offered a rate over 2 per cent. The relationship between wholesale 'interbank' rates and these demand deposit rates has remained roughly stable over recent years.37

2.43 Term deposit accounts make up 48 per cent of Irish deposits.38 These products offer a higher rate of interest than demand deposits, but with reduced liquidity.39 Rates for term deposits are significantly higher than for demand deposits. Currently, certain term and notice accounts deposits are often available at rates which equal or even exceed the rates available on the interbank market.

2.44 An international comparison shows one month rates in Germany in January 2000 were 2.84 per cent. In Austria, savings deposits with a maturity up to 12 months received a rate of 2.31 per cent. In Portugal, deposits with maturity of 31-90 days received a rate of 2.84 per cent. The average rate throughout the euro area for deposits with agreed maturity up to one year was 2.73 per cent, while the average euro area rate for deposits redeemable at notice of up to 3 months was 2.04 per cent.40 While there is significant variation in the rates offered by individual institutions, the rate for similar products in Ireland has been in the region of 1 per cent higher.

2.45 The overall pattern is that the environment facing banks in the savings market has become increasingly competitive, interest rates have been driven up, but bank deposits continue to constitute a major savings mechanism in the Irish economy.

Lending

2.46 The following two charts show the breakdown of lending by Irish credit institutions at end-1999 by counterparty and by type of credit:

2.47 Of the IR£72 billion [ € 92.2 billion] of private sector credit provided by credit institutions at end-1999, just under IR£26 billion [ € 32.9 billion] was lent to private households. Of this total, mortgage lending was the largest portion at just over IR£19 billion [ € 24.4 billion].

2.48 Definitive comparative data on the overall cost of borrowing in Ireland are not easily available, particularly in relation to loans to small business. The Group concluded that it did not have sufficiently reliable and detailed figures available to it on the basis of which to draw conclusions about the pricing of credit in Ireland. The lack of reliable, internationally comparable figures is undesirable and increases public uncertainty in relation to competitive conditions in the banking sector. The Group addresses this issue in Chapter 4.

Source: See Statistical Appendix Table 30

2.49 A marked fall in the cost of residential mortgages occurred during 1999, in absolute terms and relative both to interbank levels and to rates in other euro area countries.41

2.50 The average standard variable mortgage rate for Irish mortgage lenders was around 6 per cent at end-1998, compared with a euro area average of about 5.3 per cent. By end-1999, it had fallen to 4.19 per cent, below the euro area figure of 5.79 per cent.

2.51 A significant development in the Irish mortgage market relevant to these events has been the emergence of mortgage brokers and the development of telephone banking. In August 1999, the Bank of Scotland entered the Irish mortgage market, depending to a significant extent on these distribution methods and offering a standard variable rate substantially below the rates prevailing in Ireland at that time. Irish institutions reduced their rates, thus demonstrating the importance for effective competition in the Irish banking sector of accessibility to the Irish banking market for EU banks.

2.52 Table 31 in the Statistical Appendix shows rates for unsecured personal loans, for amounts of IR£3,000, comparing the levels in each country to a base rate. On the basis of these data, Irish personal loan rates are relatively high, although lower than in the Netherlands and the UK. In the latter case, this is partly accounted for by the fact that the general level of interest rates is higher in the UK than in the euro area. Adjusting for this by comparing the margins between personal loan rates and a base rate, margins in the UK emerge as higher than in the euro area countries. The authorised overdraft rate for Ireland is also at the higher end of the range.42 Although the UK rate is higher, of the quoted euro area countries, only Portugal has a higher rate than Ireland.

2.53 The pricing structures for credit cards in Ireland are different from those applying in many other European countries, where annual charges normally apply and where credit card use is higher. For this reason, pricing is not strictly comparable. Irish consumers who pay off their bills within the interest free period or who maintain a low average debit balance over the year may tend to pay less for their credit card than many other European credit card holders. On the other hand, those in Ireland who use credit cards as a method of borrowing tend to pay more than they would by using authorized overdraft or personal loan facilities and tend to pay more than counterparts in other European countries also using credit cards as a method of borrowing.

2.54 This is because of the annual charges, but lower interest rates which apply on credit cards in much of Europe. Annual charges do not automatically apply in Ireland and, where they do, apply at a significantly lower rate. But, as one recent survey identified, an average EU credit card interest rate was 12 per cent compared to an Irish average of 19 per cent.43 This matter is further complicated by the varying charging periods applied by different credit card suppliers. Furthermore, there is a belief that competition in the credit card market has put downward pressure in the recent period on the average interest rate on credit cards in Ireland. It is recognized that interest and charges structures for credit cards are complex and the indications from this one survey are not conclusive. These differences in pricing structures require further analysis before a conclusion can be drawn. The requirement for further work is addressed in Chapter 4.

Payment Systems
Payment Patterns

Source: Statistical Appendix Table 34

2.55 As can be seen from Figure 7, Ireland is a below average user of cash, by European standards. Germany is the highest and the Finland is the lowest. The cheque is still the main means of non-cash payment in Ireland. However, its use by volume has declined from 78 per cent. of total non-cash payments in 1990 to 62 per cent in 1998.44 Direct debit and electronic payments have grown by volume in the same period from 11 per cent. of total payments to 34 per cent. Within the EU, Ireland has a level of cheque usage rivaled only by France.45 Even allowing for the fact that some other countries have traditionally depended on credit instructions rather than cheques (which are debit instructions), the Irish position clearly lags behind others in the use of card-based, credit transfer and direct debit transactions.

Source: ECB

2.56 According to research done in 1998, some 53 per cent of Irish adults at that time did not have a bank account with a payments settlement capacity. However, over 90 per cent of adults had either a bank, building society, credit union or post office account. At least 40 per cent of businesses paid wages by cash/cheque. About 75 per cent of all transactions involving cash at banks were done by cashiers. Regular bill payments broke down as follows:

Figure 10
Regular Bill Payments by method of payment

Source: Boston Consulting

2.57 In Ireland payments, clearing and settlement systems are operated by the banks in conjunction with the Central Bank. The main payment instruments are cash, paper (e.g. cheques) and electronic cards. Non-cash payments involve one bank account being debited and another one being credited with the corresponding amount. The process by which the various banks involved settle between themselves for the obligations arising on behalf of their customers issuing/lodging non-cash instruments is through clearing systems. The net aggregate obligations, calculated centrally, arising between the participating banks in the systems are settled across the settlement accounts of these institutions held at the Central Bank.

2.58 Payments systems can be categorised as large value wholesale systems and small value retail systems. (The large value system in Ireland is dominated by the real-time gross settlement system (RTGS) which involves instant electronic payment for banks and their business customers, across banks’ accounts at the Central Bank.) This section, in common with the rest of the report, deals with retail operations.

2.59 Three classes of retail payment, clearing and settlement systems operate in Ireland. These systems are owned and operated by private sector entities established by the credit institutions. The systems provide for cheque settlement, credit settlement and electronic credits/debits settlement.

2.60 The different retail payments systems (electronic, paper debit, and paper credit) are operated through a number of limited companies, the shareholders of which are also represented on the board of an umbrella company which represents the payments industry in Ireland. This is the Irish Payment Services Organisation (IPSO). Any credit institution can become a full member of these systems so long as they comply with technical and volume criteria and are prepared to contribute to the operating costs.

2.61 The various retail payments systems are all overseen by the Central Bank. For paper debit and credit systems, there are seven full members, including the Central Bank, with seven others having an interface via a full member. Other credit institutions which issue cheque books to customers operate through clearing agents which can be any of the banks mentioned in Figure 11. The membership of the electronic system comprises six full members (the Central Bank is not a participant) with currently one other bank having an interface via a full member.
Figure 11
Membership of Retail Clearing Companies

Source: IPSO/Central Bank
*

BNP acts also in an agency capacity for Ansbacher, ABN AMRO, Bank of America, Barclays, Citibank, Guinness & Mahon and HSBC.

2.62 The central office of the clearing companies is used to a very limited extent as the physical location for the central exchange of items collected by participating banks. Its main function is in relation to the calculation of settlement obligations. The vast majority of items are exchanged bilaterally between the clearing departments of the participating banks. The clearing process is effectively, therefore, a formalised series of bilateral exchanges of paper and electronic data which have been established according to commonly agreed documented rules and procedures. Participating banks recover their own clearing department costs. Central costs are recovered from participants based on percentage of transaction volumes. As there is very limited central processing, the latter costs are relatively minor.

2.63 At present, when a cheque is lodged it is delivered back to the branch of the customer against whom it is drawn. This is a costly system involving the transport of cheques throughout the country. A more efficient system would leave the cheques in the branch in which they were lodged and transmit the information relating to the cheques electronically, thus creating an electronic clearing system. This process of leaving cheques in the branch in which they were lodged is called ‘truncation’. The legal provisions to permit this to happen have already been enacted. The system of cheque clearing without truncation has been in place for a long period. It is timely that the Central Bank, as overseer of the payments systems, reviews this process in the context of developing a euro area wide retail payments systems. This is discussed further in Chapter 4.

2.64 In some countries, the equipment for clearing paper and electronic payments is located and operated centrally in what are termed ‘Automated Clearing Houses’ (ACH’s). In Ireland, the equipment is owned and operated by the individual banks and the ‘clearing’ involves bilaterally swapping paper, tapes and, increasingly, electronic data transmission, and calculating centrally the net amount owed to each institution. This is not an arrangement used widely in other countries and the question arises as to whether a central clearing system might be more efficient. This issue is taken up again in Chapter 4.

Other Services

2.65 Apart from the functions described above, banks are increasingly involved in providing a range of other services. These include:
Ÿ mortgages
Ÿ life assurance
Ÿ pensions & long term savings products
Ÿ insurance brokerage
Ÿ stockbroking
Ÿ fund management

2.66 A recent estimate suggested that some 17 per cent of Irish adults now own shares.
The flotation of Telecom Eireann (now Eircom) and the demutualization of Irish Permanent and First Active have contributed to the increased extent of share ownership. There has certainly been significant growth in retail investment into the stockmarket.

2.67 Stockbroking in Ireland is closely integrated with banking. The two major Irish banks now own the two largest stockbroking firms and all four of the major stockbroking firms are part of banking groups.

2.68 It is a notable feature of the Irish stockbroking market that there is, as yet, no Irish-based on-line trading option. These are expected to be developed later this year. Fees per transaction for small retail customers are also somewhat high by comparison with fees in the U.K. or the U.S.

2.69 A trend in Europe, which is also evident in Ireland, is the development of what is termed ‘bancassurance’. This refers to a situation where banking and assurance businesses are combined. The most notable example in Ireland is the merger of Irish Life and Irish Permanent in 1999. One motive for this trend is the maintenance of access to savings which are moving increasingly into long term savings products. Another has been to use bank branches as a supplement to the traditional direct sales force and insurance broker distribution channels.

2.70 Internationally, the development of links between assurance companies and banks is most developed where savers are least inclined to use or have least direct access to equity markets. The assurance arms of the Irish banks have a significant market share in life assurance and, mostly as agents, in property and motor insurance products. It has been estimated that 24 per cent of the life and pensions premiums were distributed through bank branches in 1998.46

C: CONCENTRATION

2.71 Estimates of concentration in the Irish retail banking sector vary. One recent estimate gives the top five Irish banks 90 per cent of the overall domestic retail banking market. Another recent estimate puts this at 82 per cent while a third study suggested lower levels of concentration again.47

2.72 The ECB observes that the degree of concentration varies quite significantly across EU countries, with large countries tending to have less concentrated banking systems than the small ones. The Irish market is classified as one of medium concentration, along with those of Austria, Belgium, Spain and France. The ECB figures show that, taking the five largest institutions for each EU country and expressing their loans as a percentage of total loans in each country, Ireland is ranked eighth in terms of concentration on the basis of 1997 data.

2.73 That is not to say that elements of Irish banking may not be considerably more concentrated. Certainly the physical infrastructure of banking in Ireland is dominated by the five clearing banks which account for about 83 per cent of the employment of licensed banks and 90 per cent of branches and sub-offices. These institutions also accounted for 40 per cent of total resident assets of all credit institutions at end-1999, with the two largest banks accounting for 83 per cent of this. The five largest banks, and especially the biggest two, largely dominate retail banking aided by their role in the money transmission system.

2.74 To the extent that a market is contestable (i.e., if it is relatively easy for new institutions to enter the market) there is an incentive for existing institutions, even in a relatively concentrated market, to remain competitive in order to discourage new entrants from challenging for the more profitable business. Recent developments have tended to increase contestability in banking, making it more difficult, even in a relatively concentrated market, for institutions to exploit market power.

2.75 None the less, a high degree of concentration does increase the danger of uncompetitive practices and possible overcharging of customers with less bargaining power and fewer alternative options (e.g., most personal customers and SMEs). Because of legal, taxation and language barriers to overseas entry into the Irish market, added to customer inertia and information asymmetries, local institutions are likely to retain some degree of market power with respect to these customers. There has been some increase in competition for products aimed at the household sector (e.g. savings, credit cards, residential mortgages). The SME sector is still largely reliant on loan finance supplied by the traditional banking sector. In relation to the SME sector, the requirement for client history and information monitoring are significant ‘natural’ factors discouraging new entrants offering new competition.

2.76 In the context of a single financial market in the EU, the question arises as to whether concentration should be measured on a national or a EU-wide basis. The essential issue is probably one of market power. For banking activities involving very large customers, even if a national market is dominated by a few institutions, the customer can easily deal with institutions in other countries. For such business, the relevant market would extend beyond national boundaries. It is more appropriate to monitor concentration for retail banking at a national level.

Mergers, Takeover and Competition Regulation

2.77 There has been an international trend towards increased financial sector consolidation in recent years, with a notable pick-up in merger and acquisition (M&A) activity. There has been a certain amount of such activity in Ireland in recent years, but the two largest banks have tended to focus on foreign acquisitions. National authorities have an obvious interest in monitoring concentration in their local banking market, especially in retail banking, to guard against a situation where a small number of institutions achieve an overly dominant position. Mergers, takeovers and competition legislation in Ireland provides a role for the Government to ensure that this does not occur.

2.78 The key legislation in this area in Ireland is the Mergers and Takeovers (Controls) Acts, 1978 - 1996. Holders of a banking licence are specifically exempt from the provisions of this legislation. In practice, however, the wording of the legislation gives rise to some uncertainty about the position of banks. Where a proposal for a merger or takeover comes within the scope of the Acts, each of the enterprises involved is required to notify the Minister for Enterprise, Trade and Employment in writing. The Minister has the power to approve the proposal, with or without conditions, or to prohibit it. The Minister may refer a proposal to the Competition Authority if he/she feels that the exigencies of the common good warrant it. The Competition Authority is obliged to investigate every proposal referred to it and report to the Minister. The report must state the Authority's opinion as to whether or not the proposed merger or takeover concerned would be likely to prevent or restrict competition or restrain trade in any goods or services. The report must also give the Authority's view on the likely effect of the proposed merger or takeover on the common good in respect of the criteria laid down in Section 17(4) of the Competition Act, 1991. The Minister must publish the report of the Competition Authority within two months, with due regard to confidentiality.

2.79 As a separate matter, under current law, the Central Bank's approval is required for the acquisition of any holding of more than 10 per cent in a bank. The Central Bank's role in this regard is purely that of prudential regulator and a refusal to approve any takeover bid can only be made on the basis of prudential concerns. The legislation states that the Bank may not refuse approval unless "it is satisfied that the transaction would not be in the interests of the orderly and proper regulation of banking".

2.80 The Minister for Finance also has a role in relation to acquiring transactions concerning banks. Under the Central Bank Act, 1989, any acquiring transaction involving a licence holder which controls 20 per cent or more of the total assets in the State of all licence holders requires the approval of the Minister for Finance. To quote from the Central Bank Act:

"The Minister shall not give his consent unless
(a) he is satisfied that the Bank's proposal to give or refuse to give its approval, as the case may be, would be in the interests of the orderly and proper regulation of banking, and
(b) where the proposed acquiring transaction is of such a nature that the provisions of the Mergers, Takeovers and Monopolies (Control) Act, 1978, apply, he has consulted with

(i) the Minister for Industry and Commerce, and
(ii) such other Minister of the Government appearing to the Minister to be concerned, and he shall refuse to give his consent where he considers that the exigencies of the common good so warrant."

2.81 The extent of the Minister's powers under this section hinge on an interpretation of the terms 'orderly and proper regulation of banking' and 'common good'. The Act provides no guidance as to their meaning. While the Central Bank would tend to interpret these terms using prudential criteria, the Minister could decide that a broader view should be taken.

2..82 Where a proposed merger exceeds the EU thresholds and two thirds of the business of both parties to the merger is not within one State, the relevant authority is the EU Commission. Its investigations are carried out in phases. Phase One involves an initial examination to establish whether there are any issues. At this stage national authorities may provide views to the Commission. If the Commission does not identify any issues which may justify rejection of the proposal, an 'Article 6.1.b.' decision to approve the proposal is issued.

2.83 Phase Two involves the initiation of proceedings which involve more detailed investigation and consultation with the Advisory Committee, made up of representatives of Member States. Ireland is represented on this Committee by the Department of Enterprise, Trade & Employment. Following the Phase Two investigation a 'Section 8' decision to approve or prohibit the proposed merger is made.

2.84 The highest level of concentration of general significance which has been allowed by an EU decision arose from the merger of Fortis AG/Generale Bank in Belgium, which created concentrations in various banking sectors ranging up to 39 per cent of branches in one geographic region and a 38 per cent concentration in corporate loans.

2.85 A key factor in the Commission's decisions has tended to be its assessment of effective access to competitors. In the past, the Commission has taken the view that retail banking is a separate market segment and that retail markets are national markets. Accordingly, for retail banking, concentration levels within individual Member States have been considered. If that approach were not taken, i.e. if the banks were considered as operating in a larger market, concentration at the national level would be significantly less of an obstacle to mergers or takeovers within a Member State. It remains open to the Commission to change its approach as the market develops. The Commission has indicated that differing competitive conditions in different national areas are the key consideration in this regard.

D: BANK PROFIT

2.86 Internationally, bank profitability varies widely. There are a variety of reasons for this:
particular characteristics of economic development
regulatory and taxation environment
structure of the financial sector in general and banking in particular

2.87 One study has found that where banks play a larger role in the economy and concentration is lower, margins and profits tend to be lower. This study also found that foreign banks tend to have lower margins than domestic banks in developed countries.48 In the Irish case, there is a relatively high level of concentration in the domestic banking market and a large role for banks in the economy. These factors are associated with a relatively high level of profitability.

2.88 A recent analysis of profitability in European banking has found a strong trend towards the growth in non-interest income linked to the broadening of the range of products offered by banks. In Ireland, non-interest income as a percentage of operating income increased by 80 per cent between 1985 and 1995. Traditionally, in Ireland, the main source of banking profits has been ‘net interest income’ (i.e., the difference between interest paid to depositors and that earned from borrowers). In recent years, however, net interest margins have been falling. Irish banks’ net interest margins49 fell from 2.4 per cent. (1996-97) to 1.7 per cent (1998-99), despite a growing economy. The fall in interest margins is a trend which is also evident across Europe, reflecting increased competition for traditional bank intermediation services.

2.89 Banks have introduced a range of charges on payments services which were previously cross-subsidised by lending margins. This is by far the most important component of the non-interest income mix in the Irish banking sector. Fees and commissions accounted for 68 per cent of non-interest income for the Irish banking industry for the period 1995-1998.50 Such charges are subject to approval by the Director of Consumer Affairs.

2.90 Institutions have also sought to diversify their operations and to increase their product range, offering investment funds and assurance or pensions products as alternatives and as complements to traditional deposits. Banks have also developed their financial product trading activities and securitization operations leading to a further shift in the source of bank income towards non-interest income. The major Irish banks now have sophisticated treasury operations which are a significant source of income. The two largest Irish banks have also become involved very substantially in ownership of banks in other countries and this is a major determinant of their overall profitability.

2.91 The fall in domestic interest margins is clearly being driven by competitive pressure. But it is also facilitated by the introduction of such transaction charges for payment transactions over recent years, a development which undermines the cross-subsidisation of payment systems by other banking activities and makes the pricing of credit more transparent.

2.92 In addition to the level of concentration and the development of non-interest income, the third major influence on the profitability of Irish banks is the substantial growth in credit in the Irish economy with the result that bank profitability is benefiting simply from the increased volume of lending and deposit activity in recent years. This is a cyclical feature. Any downturn in the economy would be reflected in profits, just as lower profits in earlier periods reflected the condition of the economy at those times. Bank profitability is particularly susceptible to cyclical movements and international comparisons of profitability which measure banks operating in economies at differing points in the economic cycle are not comparisons of like with like.

2.93 All international comparisons need to keep this in mind. Average figures for the 1990s show Irish banks having the highest return on assets of all EU countries (1.77 per cent).51 Looking further back, figures for 1985 suggest that at that time the return on assets and the return on equity in Ireland fell below profitability in various other European countries, having been higher in 1980. In the 1990s, the profitability of Irish banks again rose well above European levels, including the U.K. which would be the most similar banking market. Thus, while the profitability of Irish banks can fall below that in other countries, due probably to varying economic cycles, Irish banks tend to be among the more profitable banks internationally.

2.94 Historically, the reason for this appears to have been that Ireland has tended to have one of the higher interest margins (3.2 per cent). That drives the high overall income margin of Irish banks (4.6 per cent). Irish banks profit performance is therefore similar to Denmark, which also has a higher interest margin (3.5 per cent) and a higher contribution from non-interest income. Denmark’s overall return on assets of 1.55 per cent is somewhat lower than Ireland’s and may reflect its higher operating costs. The profitability of U.K. banks is also similar to Ireland. However, operating expenses are higher, interest margins are lower, while the contribution from non-interest income is greater. The biggest contrast within the EU is with French banks, which have a return on assets of only 0.16 per cent and interest margins of only 1.3 per cent.52

2.95 If we look at the performance of the top commercial banks in each country, the performance of the main banks is significantly better than the country average. In Ireland’s case, the top commercial banks were earning an interest margin, on average, over 1990-98 of 4.1. per cent. Non-interest income pushed the total income margin up to 6 per cent creating a return on assets of 1.3 per cent.

2.96 It is difficult to make generalisations from these figures. However, taking the historical trend into account it is still reasonable to view Ireland as tending to have one of the more profitable banking systems not merely on a cyclical but also on a long term basis.

2.97 For a given volume of activity, high profitability can result from higher charges, higher interest margins, or a higher level of efficiency through a lower cost base. A tendency to somewhat higher margins is one factor in explaining the profitability of Irish banks. The cost base is also a factor. Currently, Irish banks' cost/income ratios compare very favourably with other countries, averaging around 58 per cent over the past few years compared with an EU average of over 65 per cent. In 1997, of the EU countries, only Luxembourg had lower cost/income ratios than Ireland.53 In Ireland's case, the recent exceptional rate of growth in economic activity has generated a large increase in bank income and this has played a large part in reducing cost/income ratios.

2.98 Whether this level of profitability will be sustained is not clear. Interest margins in banking in Ireland have been falling quickly in recent years. It might be reasonable to expect them to converge towards rates in other euro countries, however the pace of change is uncertain. With an international trend towards consolidation in banking, high levels of profitability and limited scope for further economies in Irish banking would tend to reduce the vulnerability of Irish banks to takeover by ensuring that they would be relatively expensive acquisitions with virtually no economies to be made. What is clear is that as well as diversifying into new activities and developing new products and delivery channels, Irish banks will need to focus on maximising efficiency in order to ensure a continued strong profitability performance in an increasingly competitive market.

CONCLUSION

2.99 Banks continue to play an important role in the Irish financial sector and the economy as a whole. The nature of that role is continuing to evolve, with banks offering an expanded range of products, developing new delivery channels, and generally operating in an increasingly competitive environment. Banks face greater competition on both the asset and liabilities side from banks in other countries, from non-bank institutions and even from entities, such as retailing outlets, which did not previously offer financial services. Financial liberalisation and technological advances are amongst the main developments generating new competitive pressures for banks in Ireland as elsewhere. Both factors facilitate entry into the market, possibly in a niche capacity targeting particularly profitable types of business ('cherry-picking'). This has the effect of reducing the scope for cross-subsidisation, with banks increasingly forced to price their products according to cost, including risk.

7 Figures taken from the Irish Bankers Federation Factfile, May, 2000

8. In Ireland, the retail clearing system is operated by the five clearing banks, i.e. Bank of Ireland, AIB Bank, National Irish Bank, Ulster Bank and TSB Bank. See Paragraphs 2.62-2.63

9. These directives apply to ll the countries of the European Economic Area, i.e. the 15 members of the EU and also Norway, Iceland and Lichtenstein

10. Money and banking in Ireland, P.MacGowan, Institute of Public Administration, 1990

11. Since that period, the clearing arrangements have been revised and other banks have become involved either directly or indirectly - see the section on payments.

12. Under Section 7 of the Central Bank Act, 1971, as amended by Section 30 of the Central Bank Act, 1989

13. Bank of Ireland,  AIB Bank, National Irish Bank, Ulster Bank, TSB Bank, Irish Life and Permanent, First Active, EBS, ICS Building Society, Irish Nationwide Building Society and ACC Bank.

14. EBS Building Society, Irish Nationwide Building Society and ICS Building Society. See Statistical Appendix Table 11.

15. See Statistical Appendix Table 10.

16. IBF Factfile, op cit.

17. See Statistical Appendix Table 6

18. See Statistical Appendix Table 7. By one estimate, Irish institutions held between 32-36% of the shares in these banks in 1998, see Table 8.

19. See Statistical Appendix Table 5 and also Table 8.

20. See Statistical Appendix Table 12

21. The Association between Economic Growth and Employment Growth in Ireland, NESC, December, 1992

22. See Statistical Appendix Table 15

23. See Statistical Appendix Tables 13 & 16

24. Internet - Irish Financials, Goodbodys Stockbrokers, April 2000

25. The situation is somewhat complicated by the use of agencies and sub branches. Some banking services are also provided by post office, credit union and building society branches. Consequently, the branch network for banking services is considerably larger than the network of bank branches. See Statistical Appendix Table 17.

26. A sub-branch is a banking outlet which is not a bank branch in its own right. Opening hours will vary and can range from one or two hours per week up to a full five day service. Normally, a full banking service is not available in a sub-banch and more complex services are provided only in the parent branch and all cheques etc. issued will bear the sort code and name of the parent branch.

27. Europe's New Banks: The 'non-bank phenomenon, David Lascelles, Centre for the Study of Financial Innovation, 1999

28. Cavan, Donegal, Monaghan.

29. Using 1996 population data and 1998 bank/building society branches data.

30. See Statistical Appendix Table 35

31. Land and buildings make up the bulk of wealth

32. See The Financial Assets of Households in Ireland, P. Honohan, B Nolan, ESRI, General Research Series No 162, Dec. 1993

33. See T. O'Connell, Journal of Statistical and Social Inquiry Society of Ireland, 1986

34. See Statistical Appendix Tables 10, 11 and 23

35. See Statistical Appendix Table 23

36. See Table C3, Central Bank of Ireland Quarterly Bulletin

37 See Table 26

38. See Table C3, Central Bank of Ireland Quarterly Bulletin: this includes Agreed Maturity, Special Savings and other agreed notice accounts but not overnight deposits

39 According to www.ndb.ie/main.html there are over 1,500 different deposit account options.

40. ECB figures

41. The position is complicated by the wide variety of mortgage products offered - some 250 by one estimate, see www.ndb.ie/main.html. Developments in the mortgage market which have complicated the choice available to customers have been the emergence of fixed rate mortgage products and the emergence of discounted variable rates for new customers

42 See Statistical Appendix Table32

43. See Statistical Appendix Table 33

44. See figures 8 and 9 below

45 See Statistical Appendix Table 36

46. P 112. Financial Services in Ireland, DataMonitor, 2000

47. See Statistical Appendix Table 40-46

48. See Determinants of Commercial Bank Interest Margins and Profitability: Some International Evidence,, Asli Demiguc-Knut and Harry Huizinga, World Bank, January 1998

49. Net Interest Income/Gross Assets for all Irish credit institutions

50 Source: based on OECD data

51. See Statistical Appendix Table 52

52. See Statistical Appendix Table 52

53. See Statistical Appendix Table 53

Chapter 3

Strategic Issues facing Banking in Ireland

3.1 The Group identified two main factors influencing change in banking generally and the increasing competition in the banking sector in particular:

                Globalisation and deregulation;
                Developments in technology.

Chapter 4 will examine the policy issues raised by the developments in these areas.

A: Main Influences
Globalisation and deregulation

3.2 Recent decades have seen a strong trend towards increasing international integration of trade and investment, facilitated by strengthening of international trade agreements. Investment strategies by institutional investors have also become increasingly global over recent decades and this has been reflected in the share-ownership of the two major Irish banks. The introduction of the euro and the development of the single market in Europe have led to further international integration of financial services in Europe. The establishment of the euro, in particular, has eliminated a very significant exchange rate risk in relation to cross border banking within the euro area. The future is likely to see a continued consolidation in banking at the level of individual countries and there is also likely to be consolidation at a regional level - such as among banks in the euro countries.

3.3 The Irish economy itself has experienced very significant growth and development in the last decade, and this has also affected the Irish financial sector. Because of this economic development, banks find themselves faced with increased demand for mortgages, long term savings products (including pensions) and development finance.

3.4 Internationally, barriers between the provision of different financial services have been greatly reduced and the various financial institutions can now provide a broader range of financial products. This has led to the growth of financial conglomerates worldwide. In Ireland the major banks now provide this broad range of services. Moreover, the single market operates for financial products and particularly for banking so that there are no regulatory barriers to banks from other EU countries competing in Ireland or to Irish banks competing in any other EU country.54

Technological Developments

3.5 The recent period of investment in developing the architecture for internet commerce in most retail sectors both nationally and internationally has also been in evidence in the financial sector. Banks are investing heavily in the development of internet access points for individual and corporate customers. The Irish banks are currently in the middle of the process of enhancing their internet platforms and making them more widely available.

Intensified Competition

3.6 The ability of institutions to access local markets and to offer a multiplicity of products under one brand, along with the use of technology, is calling into question the way banks have operated traditionally, and lowers the barrier to new entrants which previously existed as a result of the need to set up a branch network. The Internet, in particular, presents the banks with a significant challenge. New entrants can now enter the banking sector to ‘cherry pick’ new customers and existing customers willing to move away from the branch network.

3.7 There are four types of operators likely to make use of the Internet to compete in the Irish banking market:
banks already established here
internet banks
established banks from other markets
retailers from other sectors (utilities/supermarkets)

3.8 The potential role for new players is strongly reinforced by the possibility of agency arrangements where retailers (bank or non-bank) sell the banking products of other banks, either branding them as their own or branding in a way which highlights the agency arrangement.

3.9 The potentially low cost base for such new entrants and the ability to attract customers previously subjected to pricing partially determined by cross subsidisation is compelling all banks to develop an internet banking service, to restructure pricing and to control costs in the branch network in order to remain competitive .

3.10 The Group recognized that this increase in competition is a welcome development and is likely to bring long term benefits to bank customers and to the economy generally. However, the changes involved also present certain challenges. The Group sought to identify the key strategic issues in the banking sector over the next decade which are likely to have policy implications.

3.11 Three key areas have been identified:
Mergers and acquisitions
Retail Payments Systems
Branch Networks

B. Mergers and Acquisitions

3.12 Mergers and acquisitions and the emergence of large financial conglomerates have proven to be a key developments in recent decades. One may loosely differentiate two reasons for mergers or bank purchases:55

- Rationalization
- Diversification and growth

Rationalization

3.13 A strong motive - though not the only one - for mergers and takeovers in retail banking is to achieve more cost-effective operations. Mergers and acquisitions are often seen as an effective response to a requirement for cost rationalization because economies of scale and scope56 at head-office and, sometimes, rationalization of branches can be used in order to eliminate perceived surplus capacity.

3.14 Cost-driven mergers are subject to uncertainty arising from the risk of failing to meet the cost savings targets underpinning the financing of the merger/acquisition. There is a significant record of bank mergers failing to meet cost savings targets.

3.15 If cost savings are uncertain in domestic mergers, they are even more problematic in cross border mergers. Internationally, a number of major banks are thought to be examining substantial cross-border mergers or purchases. But it is not clear that cost-rationalisation is a significant motive for such mergers and acquisitions.

3.16 A significant aspect of the pattern of mergers to-date is that where these do occur, 57they tend to be concentrated in culturally, geographically or legally similar regions - for example the Benelux region, Iberian Peninsula/Latin America, Scandinavia, Ireland/UK. This probably reflects the absence of some of the cultural or legal obstacles to effective rationalization in cross-border mergers which otherwise restrict the ability of banks to increase synergies and reduce unit costs.

3.17 Rationalization can also be closely related to issues arising from the need to manage resources effectively by having the appropriate technical and general management skills in place. A perceived requirement to improve management by importing expertise can be the motive for a change of ownership of a bank, whether because of poor operational performance, historical strategic misjudgment or perceived strategic misjudgment for the period ahead. Given the corporate structure of publicly quoted companies this can sometimes be seen by institutional investors as the only way to change management culture, especially when the market sees a requirement for cost rationalization of which management are not convinced.58

3.18 Increased international integration and competition among banks also creates a requirement for similar technical skill levels in banks in different countries. Consequently, transfer of technical skills can be a significant factor in international mergers and acquisitions. In such circumstances, there may few overlapping functions, and thus limited potential for cost savings through staff reductions (some H.Q. functions), but there is a potential for the transfer of management and technical skills in order to develop new products or procedures in a less developed market.

3.19 It is reasonably clear that there is very limited potential for significant inward technical skills transfer to Irish banking from other banking markets. The skills level of Irish banking is generally similar to that of the most developed banking systems in the world, although there may be differences in practices and strategic choices which create marginal skill variations in certain areas.

3.23 Mergers or acquisitions based on diversification will tend to be defensive, providing a geographic spread of a bank’s exposure across different economic regions and thus reducing the tendency to a cyclical pattern in financial performance.

3.24 Banks may also purchase operations in different countries to which they require access as part of a wider market. For example, there is a view that the period ahead will see some of the larger banks in individual EU countries develop by acquisition into regional banks covering the whole or a large part of the EU. 59Any bank wishing to take on this mantle might wish to purchase banks in various EU countries in order to provide local services across the EU, although remote/internet access is also increasingly feasible. As indicated above, this kind of diversification appears to be a significant consideration in Europe at the present time.60 Also, banks from outside the EU may purchase a bank within a Member State to expand without having to apply directly for a bank licence.

Cross-Shareholdings

3.25 An alternative to a full-blown merger or acquisition is the strategic partnership. Strategic partnerships across industry sectors within national economies have been a sustained feature of continental national economies, although they have come under strain in the changed legislative and regulatory context of the last two decades. The German insurance company Allianz and the Spanish bank Banco Santander Central Hispano, for example, have both adopted cross share holding strategies as a response to the current situation. Strategic alliances have also been a characteristic response on the part of retailers in various sectors to the emergence of the Internet as a viable retailing option. This ‘third way’ strategy has been recognized as appropriate for banks which are unable or unwilling to pursue a trans-European universal bank strategy, while being too diversified to focus on niche areas.

3.26 There are elements of skill transfer in such arrangements and other elements of cost saving. The importance of developing internet banking capacity may encourage such alliances. There are also elements of risk diversification involved. However, many analysts remain unconvinced of the contribution to profitability from such relationships.

3.27 Such alliances will also tend to be defensive, creating large shareholders likely to take a long-term strategic view, rather than seeking profit maximization over a medium-term horizon. For example, the $155 billion in cross-shareholdings between German banks, insurers and utilities, of which Allianz is the largest with cross-shareholdings valued at $51 billion, has been described as having "thwarted market discipline".61Whether or not that is true, the role of Allianz in the recent abortive Deutsche-Dresdner merger proposal indicates that such cross-shareholdings are not always an obstacle to mergers and acquisitions but may instead affect the terms on which such mergers and acquisitions take place.

Conclusion.

3.29 Developments in information technology ("IT") (i.e. information collection, storage, processing, transmission and distribution) and their impact on the banking industry is expected to continue and will require continued substantial investment in IT by banks. There are two factors which may have policy implications. These are:

- the type of technology in which the banks invest

- the timing of investment in that technology

Type of technology

3.30 Any period, such as the current one, in which there is rapid technological innovation throws up a range of technical options which compete to be adopted. Depending on factors such as the function of the technologies, the process of competition can lead to the emergence of one dominant technical standard (at either a national or international level) or alternative technical arrangements can continue to compete over the longer term. The current period is no different. There are a range of technical issues arising in relation to various aspects of e-banking.

3.31 The technical issues involved are significant for competition in that they are relevant to ensuring that Ireland has an open, integrated payments system. These technical issues are not examined further in this report. It would be appropriate for the review of the payments system recommended in Chapter Four to consider how best to ensure that these issues are taken fully into account in the process of determining which technologies to use.

The timing of investment in technology

3.32 It is clear from the pattern of investment to date that there is wide scope for differences in the pace at which technological changes are introduced in different countries, particularly in the retail banking market, and such differences will constitute a strategic choice which will influence competition between participants in the marketplace.

3.33 Banks cannot be expected automatically to invest in technological innovation as soon as it becomes available. The timing of their investments will, instead, be dictated primarily by competitive advantage in the banking sector. Competitive advantage does not necessarily accrue to the early adopters of new technologies. The pattern of competitive advantage in the banking sector from technological innovation is more complex.62

3.34 In other areas of retailing, much of the recent investment in internet retailing has depended on a concept of ‘early mover advantage’, which, in summary, is that the first participants in internet retailing in a sector will quickly build market share and brand image which will count as substantial competitive advantages later on. Arguably, this is quite the opposite of the pattern that has dominated banking investment in technology in the past, namely that early movers were in danger of being at a disadvantage because the cost of technological innovations is highest when they first emerge, as is the threat of incorrect choice of technology. Competitive advantage probably tended to lie with the bank which invested in technology after the cost began to fall but before other banks had delivered a difference in quality of service that the customer could discern or that affected operating costs. The current situation is unclear, but it is fair to say, that as more banks have begun to roll out their internet platforms, there is increased scepticism about the extent of the advantage which has accrued to those who sought early mover advantage.

3.35 The current position with regard to technological innovation in Ireland is that each major bank is competitively developing its internet platform. The banks are understood to be cooperatively examining when to move to on-line debit card processing. The prospects for the use of ‘electronic purse’ technology are being examined by banks on a competitive basis. The development of certification procedures for on-line electronic transactions and the possibility of an Automated Clearing House (ACH) to centralize the bilateral arrangements for electronic transactions are being developed cooperatively. The banks have indicated a willingness to develop an automated bill payment system on the basis of cooperation between the banks and the State, while at the same time developing bill payment options on a competitive basis for their internet services. In Chapter 4, the issue of what initiatives should be taken at the policy level in response to these developments is examined.

D. Branch Networks

3.36 As set out in Chapter 2, banking products have traditionally been delivered through an extensive branch structure. Originally, such branches would have worked as almost autonomous business units. In recent decades, and particularly over the last ten years, the processing of payments and the provision of credit has been increasingly integrated and centralized. That development is ongoing.

3.37 Changes in the role of branches in the period ahead are likely to be closely linked to the emergence of other methods for the ‘remote’ delivery of banking services. The most significant fact already evident is that, in some form, many banking transactions such as the arranging of loans, receipt of cash, bill payments, card-based purchase transactions, payment of wages, are already, to a large degree, centralized away from branches.

3.38 The likely scenario is that remote electronic delivery will become at least as important as branch based delivery over the period ahead, but that branches will continue to play a key role in the distribution of banking products. The Group’s own consultations suggested a view among industry sources that this development will involve as many as 50 per cent of bank personal customers using on-line financial services in five years and that almost all business customers will be using on-line banking services. It is likely that organizing the transition to this very different approach to the delivery of banking services will increase the pressure for branch rationalisation and consolidation. The geographical spread of branches has been changing in any event against the background of a shifting pattern of population and economic growth.

3.39 All this suggests that it is likely that over the next five years the significance of the branch for the bank-customer relationship will be uncertain and changing.

3.40 Various options are open to the banks with regard to managing their branch networks during this period. Much will depend on the degree to which special arrangements can be made with other credit institutions, the credit unions, the Post Office or even with other retailers to provide services. The degree to which ATM systems can be upgraded and remote banking options successfully exploited are also important factors. All these routes for the provision of financial services would need to be tested in practice, but it is clear that at the present time the development of electronic service delivery still has some way to go before a full range of branch services could be delivered in a customer-friendly way using these substitutes for bank branches.

3.41 In deciding between the options, banks will also undoubtedly be influenced by their relationship with their own customers and investors, with their staff and by their own strengths and areas of specialization. For example, certain banks with particular strengths in cross-selling other financial products are likely to see greater potential in focusing branches on marketing a broader range of financial products.

3.42 The situation may be further complicated by the competitive responses of certain banks and other financial service providers, such as credit unions, to the approach taken by their competitors. In so far as there is branch rationalization, an opportunity arises for selective opening of branches where other credit institutions believe they have a more appropriate range of specialisations to run a branch in a particular location, or where they believe a competitor has pursued an incorrect strategy.

3.43 While some banks may adopt a conservative approach to branch rationalization, it cannot be excluded that one or other of the major banks would take a radical view and move to a policy of significant branch consolidation sooner rather than later.63 These two possibilities raise the issue of whether a policy response is required at this time to the possibility of major branch rationalization. These issues are considered in Chapter 4.

54. For an overview of planned initiatives in this area see Financial Services: Implementing the Framework for Financial Markets: An Action Plan, Communication of the Commission, COM (1999)232, 11.05.99. Regulatory issues arising from technological developments are discussed in The Effects  of Technology on the EU Banking Systems, European Central Bank, July 1999.

55. This report considers banking mergers: many of the considerations will also apply to bank/insurance company mergers or acquisitions which are also an option in the current market. Large European assurance companies have recently been involved in a significant number of cross border  acquisitions within the assurance sector to build 'global brands'.

56. The ability to offer a range of products by one entity

57. For example, bewtween 1995 and the first quarter of 1998, there were 402 domestic mergers/acquisitions in the EU and 86 cross border mergers/acquisitions. The latter were almost all acquisitions rather than mergers. See Annex One, Section EIght, Possible Effects of EMU on the EU Banking System, ECB, February, 1999.

58. By the same token management issues can also improve important in preventing mergers taking place. See for example, P.III Portugese Banking & Finance Supplement, Financial TImes, 17/4/2000, in relation to the role of management differences in the abandonment of a proposed merger of two large Portugese banks.

59. Consolidation within the EU in the insurance sector has been motivated bu such considerations. National management structures have tended to remain in place. There is little statistical evidence to date of significantly increased profitability associated with this consolidation. See Financial Times World Insurance Industry Supplement, 28/4/00

60. One recent survey has found that 'For those banks with cross-border expansion plans, the prime motivation is to tap an enlarged geographical market and therefore customer base. Generation of critical mass in order to be able to utilise economies of scale and the opportunity tp leverag know-how between markets are of secondary importance at best. Diversification of risk does not seem to have had any influence whatsoever on the decision to expand abroad.' P25 The Strategic Impact of the Euro on European Retail Banks, Price Waterhouse/European Financial Management and Marketing Institute, 2000

61 P46 Institutional Investor, March 2000

62 A recent report from the Bank for the International Settlement concluded: '... the development of new payment products might open up new possibilities, but also carries the risk that a specific technology in which considerable investments were made could be rapidly rendered obsolete by new developments. Linked to this are the sometimes large investments needed for a large-scale rollout, whether at national or regional level. At the same time, the current rapid innovation of new payments products and quickly evolving technology has delayed an industry consensus in many other countries on standards or interoperability. Underlying these complex investment decisions is the uncertainty regarding consumer demand for new payment products.' P.20, Retail Payments in Selected Countries, Bank for International Settlement, September, 1999

63. It has been suggested to the Group that if one of the major banks were foreign-owned, that a more radical option might be more likely to be taken. It is difficult to assess this proposition. However, see Appendix Four for related points.

4.1 In this chapter the following policy areas are examined in which issues arise in relation to the likely pattern of developments in banking:

§ Mergers and Takeovers Law
§ Competition & the Consumer
§ Retail Payment System
§ Promotion of Electronic Payment Mechanisms
§ Bank branches
§ International Financial Services Centre

Mergers and Takeovers Law

4.2 Given the prospect of increased merger and acquisitions activity in Ireland and in Europe generally, it is desirable that the legislation governing such changes in ownership should operate efficiently and should clearly reflect the policy goals of the Government.

4.3 The Group identified two provisions of the existing legislation governing changes of ownership within the banking sector in relation to which there is a case for change. These are

- Section 1, MERGERS, TAKEOVERS AND MONOPOLIES (CONTROL) ACT, 1978: No. 17/1978;

- Chapter VI, CENTRAL BANK ACT, 1989 No. 16/1989.

Arising out of the changes which are proposed to these two pieces of legislation, the Group has also identified a requirement for consultation between the regulatory authority for the financial sector and the Minister for Enterprise, Trade & Employment. The reasoning for this is also set out below.

Mergers, Takeovers and Monopolies (Control) Act, 1978

4.4 There is currently an exemption from the Mergers, Takeovers and Monopolies (Control) Act, 1978 in relation to any service provided by the holder of a banking licence under section 9 of the Central Bank Act, 1971. In practice, despite this explicit exemption, there is some uncertainty surrounding the position of banks because of the wording of the legislation. It is quite likely that any banks intending to engage in a merger to which the Act would otherwise apply would comply with the provisions of the Act, for the avoidance of doubt. The Group could see no reason why banks should be exempt from merger legislation as it considers that this sector should be subject to the same scrutiny in relation to ownership as applies to other sectors of the economy.64 However, the Group did see a need for provision to be made to ensure that ‘fast-track’ approval of changes of ownership can be provided by the Minister for Enterprise, Trade and Employment where the regulatory authority considers that this would be appropriate. Also, provision should be made for consultation with the regulatory authority for the financial sector so as to ensure appropriate liaison in relation to the banking sector.

Central Bank Act, 1989

4.5 Under Section 77 of the Central Bank Act, 1989, the approval of the Minister for Finance is required for any mergers involving more than 20 per cent of the banking sector. This legislation functions as an alternative to regulation of banking sector mergers and takeovers under the general mergers legislation. In practice, the existence of this provision means that any major merger could be subject to two independent decisions by two Ministers. This creates uncertainty. In the view of the Group, legislation should provide for a single decision-making process in relation to banking mergers.

4.6 Neither of these changes would affect the requirement for the regulatory authority for the financial sector to exercise a supervisory role in relation to prudential issues arising from any proposed change of ownership of a bank involving more than 10 per cent of its shares. Nor would it affect the role of the Minister for Finance as the responsible Minister in relation to the regulatory authority for the financial sector.

4.7 In summary, the Group’s view is that,

a) with the prospect of increased mergers and acquisitions activity in Ireland and in Europe generally, it is appropriate that the exemption of licensed credit institutions from the provisions of the Mergers, Takeovers and Monopolies (Control) Act, 1978 should be removed. In that event, proposed mergers should be assessed by the Minister for Enterprise, Trade and Employment, and, where appropriate, the Competition Authority, in consultation with the regulatory authority to ensure compliance with competition laws and so that they are in the best interests of bank customers and the economy generally;

b) Section 77 of the Central Bank Act, 1989, which gives the Minister for Finance a role in the supervision of acquisitions of bank assets, should be deleted.

‘Common Good’ Considerations

4.8 Both the Mergers, Takeovers and Monopolies (Control) Act, 1978, as amended, and the Central Bank Act, 1989, make use of a concept of the common good. The legislation provides some guidance as to the application of this concept generally. However, the guidance provided within the legislation is not exhaustive. Indeed, it implies that there may be common good considerations other than those referred to in the legislation.65 The Group reviewed the application of the concept of common good considerations to cross border banking sector mergers and its consideration of this point is attached in Appendix 4. The main conclusion is that the criteria applying to mergers generally are appropriate for the financial sector, including cross border mergers in the financial sector, and do not need to be supplemented. (This conclusion is based on recognizing that prudential issues are dealt with by the regulatory authority for the financial sector as a separate matter.)

Competition & the Consumer

4.9 It is the view of the Group that an efficient and competitive banking system is in the best interests of individual bank customers and the national economy as a whole. As set out in Chapter 2, the indications from the available evidence are that, as regards personal lending and savings products, banks in Ireland provide a generally competitive service to their customers. The Group was not satisfied that it had sufficient information available to it on the cost of borrowing for small business to draw a conclusion on the competitiveness of the cost of this type of financing. The Group also recognized that it will be important to ensure that small business in particular and bank customers generally are receiving an internationally competitive banking service in the period ahead during which the banking sector itself will be changing substantially and during which the overall prosperity of the Irish economy will depend on its competitiveness. Appropriate arrangements need to be made to ensure that the regulatory regime for the banking sector gives a high priority to regular monitoring and evaluation of the competitiveness of the banking sector as it affects customers.

4.10 As part of its general reporting responsibilities, the regulatory authority for the financial sector should be mandated to monitor and report on competitiveness in the financial sector as it affects bank customers. It is envisaged that such a report would provide data and analysis, including internationally comparative analysis, on particular product segments of the banking market (Mortgages, Overdrafts, SME lending, credit cards, etc.).

Retail Payment Systems

4.11 As shown in Chapters 2 and 3, until relatively recent times the bulk of banking business has been transacted on paper-based systems which are costly for banks and for their customers. The rapid development of technology has already changed this dramatically and future developments will lead to an acceleration in the process of change.

4.12 The key to change in the retail payments system is the development of an electronic payment option for the bulk of commercial transactions - business to business, business to customer, large and small value - and all State payments. Banks are currently developing internet-based banking services and developing the debit and credit card service they offer retailers. They are also examining ‘electronic purse’ technology options. Through the payments system, operated jointly by the banks, they are working together on examining the feasibility of setting up an automated clearing house (ACH) and certification for electronic payments. In addition, they have made proposals to the State in relation to aspects of the development of electronic payment mechanisms. The current position in relation to this is set out in Appendix Five.

4.13 The Group is supportive of initiatives to make the entire payments system more efficient and believes it is important that they are progressed with all possible speed. Bank customers (business and personal), the banks and the banking system can achieve significant benefits from such development.

4.14 The Group did not become aware of any restrictive practices significantly impeding access by providers of banking services to the payments system. Nevertheless, it recognized that it will be important that access to the payments system should not constitute an obstacle to competition in the provision of banking services, and that there is a potential for technological developments to create barriers to competition, depending on how they are developed. Given the clear prospect of very significant change in the pattern of retail payments, it was the view of the Group that this is a matter which requires closer examination (and more extensive consultation with the industry) in order that a robust conclusion can be drawn.

4.15 The Central Bank should carry out a full review of the organization of the retail payments system and its report on this matter should be provided to the Minister for Finance and published. Among the issues to be considered would be the promotion of efficiency in payment cycles, the issue of whether there should be greater transparency in the activities of the retail payments systems and the role that the Central Bank should play. The priorities in an Irish context are to ensure that appropriate investment continues to be made in updating the system and that the level of access available to the payments system does not constitute an impediment to new competitors moving into the provision of financial services.

Promotion of Electronic Retail Payment Mechanisms

4.16 It was submitted to the Group that the structure of the stamp duty on cards and cheques issued by banks is not consistent with a policy of promoting electronic payments.

4.17 There is currently a IR£5 stamp duty charge on cash (ATM) cards. This charge was introduced in 1992 at a rate of IR£2 per card and was increased to the current rate in 1996. The duty is payable by the bank or building society in respect of each cash card which is valid during their accounting period. They may pass on the charge to customers. In addition there is a stamp duty charge of IR£15 on credit and charge cards. This charge was introduced in 1981 at a rate of IR£5 per card and reached its current level of IR£15 in 1992. There is also a stamp duty on cheques of 7p per cheque. The stamp duty on cheques was last increased in 1984.

4.18 The yield from these taxes is as follows in 1999:
Cheques: IR£8.58 million[ € 10.89 million]
Credit Cards: IR£12.12 million [ € 15.39 million]
ATM Cards: IR£8.31 million [ € 10.55 million]
It should be noted that these products are not subject to Value Added Tax (VAT). Discussions on applying VAT to financial services are ongoing at EU level.

4.19 However, there are two sets of charges applying to consumers making use of payment mechanisms. Tax charges are one, but charges imposed by banks are a second and more substantial set of charges. For personal customers, paper transaction charges applied by banks are generally between 20p and 25p per transaction, although in some cases exemptions apply. Leaving aside the various exemptions, ATM and Laser transaction charges are somewhat lower in a range of 17p to 22p per transaction. The stamp duty on credit cards is the main initial cost in relation to credit cards because, as discussed in Chapter 2, most of the banks and building societies do not systematically charge annual fees. However, some annual fees are charged under certain conditions and the main disincentive to the use of credit cards is arguably the higher rate of interest which applies to credit card borrowing than applies to overdraft borrowing.

4.20 The Group took the view that the gap between the charges applied by banks for electronic and paper transactions could be the most significant feature of the current charges regime in influencing customer preferences. The differentials currently applied by banks do not appear sufficiently wide and are not universal.

4.21 The Group noted that Corporation Tax rates have already been reduced substantially and it is intended that they will be reduced further to 12.5 per cent. This is leading to a substantial reduction in taxes paid by banks which provides the banks with an opportunity, in their own commercial best interests, to restructure charges to provide a better service to customers.

4.22 Part of the savings to banks from the restructuring of Corporation Tax should be used to make electronic/automated banking transactions more attractive to a wider range of customers while maintaining appropriate charges for paper-based transactions. In the context of the banks having implemented proposals on this, the Group recommends that the Department of Finance should then consider the restructuring of taxation arrangements for payment mechanisms with a view to promoting the move to more efficient (e.g. electronic) payment systems without reducing the overall yield.

Bank Networks

4.23 As discussed in Chapter 3, the Group has concluded that there may be significant rationalization of branches, involving consolidation, in the period ahead. The Group considered that this phenomenon has significant public policy implications. However, the Group also recognizes that long term commercially viable solutions need to be found. If branches are losing their position as the predominant access point for retail customers, their numbers will be reduced. In a situation in which new access points for the payments system are emerging, in the interests of securing long term customer loyalty, banks will have to manage change in such a way that access to the payments system is not significantly reduced either in the long term or during the period of transition to new access mechanisms. Short term expediency, which could lead to the permanent withdrawal of the quantity and quality of services from geographic areas leading to the long term loss of customers should be avoided. Once banks are committed to that goal, they should be free to restructure and reorganize branches and replace branches by other access methods in a manner which is consistent with running efficient and up-to-date banking and payments systems.

4.24 The banking industry needs to develop a strategy (whether involving agency arrangements with other non-bank retail outlets, electronic arrangements or otherwise) to address the issue of maintaining appropriate mechanisms for and levels of access (in all regions and by the different social groups) to banking services in the context of possible future developments such as internet banking, closure of branches and rationalization in the branch banking system. The regulatory authority for the financial sector should monitor and report on this from a customer perspective.

International Financial Services Centre

4.25 The Group reviewed the strategy outlined in the document Strategy for the Development of the International Financial Services Industry in Ireland. The strategy is based on the achievement of a set of specific priority objectives, work on which is well in hand. The Group was satisfied that no fundamental review of the strategy is required at this time. The Group was also satisfied that the IFSC Clearing House Group structure which is currently in place provides an adequate framework for the ongoing partnership process which is required to ensure that the IFSC continues to function as a vibrant part of the wider financial services sector in Ireland.

64. A similar view has been taken in the recent report of the Competition and Mergers Review Group. See Paragraphs 6.2.15 - 6.2.17, The Final Report of the Competition and Mergers Review Group.

65. This matter is discussed in Section 6.4 of the Final Report of the Competition and Mergers Review Group, May, 20000

Noel O’Gorman (Chairman) [Second Secretary General, Finance Division, Department of Finance]

David Doyle [Assistant Secretary, Finance Division, Department of Finance]

Ann Nolan [Principal Officer, IFSC Section, Department of Finance]

Liam O’Reilly [Assistant Director General, Central Bank]

Tom O’Connell [Head of Function, Central Bank]

Secretary: Richard Shine (November, 1999 - January, 2000)

[Assistant Principal, Finance Division, Department of Finance]

Martin Moloney (January, 2000 - July 2000)

[Assistant Principal, Finance Division, Department of Finance]

Submissions were received from the following:

Where the Group considered it appropriate to explore issues further, discussions were held with some of the above and with the following:

.

The total number of financial entities for which the Central Bank has supervisory responsibility is of the order of 1,040, comprising:

Credit Institutions : 82

IFSC entities: 257

FINEX related entities: 81

(including 2 exchanges)

The Irish Stock Exchange: 1

Stockbrokers: 14

Investment intermediaries: 592

Moneybrokers: 6

Approved Professional Bodies: 5

In addition, at end-1999, collective investment schemes authorized by the Central Bank numbered 784 (1,966 including sub-funds).

The following is a list of institutions which currently submit returns to the Central Bank in relation to banking activities in Ireland.

[as at 31/12/99: Deposits from Non Government/Non Financial Irish Residents: IR£27.7 billion

Credit to Non Government/Non Financial Irish Residents: IR£30.6 billion]

*Allied Irish Banks plc

*The Governor and Company of the Bank of Ireland

#National Irish Bank Limited

*TSB Bank

#Ulster Bank Limited

[as at 31/12/99: Deposits from Non Government/Non Financial Irish Residents: IR£23.9 billion

Credit to Non Government/Non Financial Irish Residents: IR£31.0 billion]

#ABN AMRO Bank N.V.

*ACC Bank plc

*AIB Capital Markets plc

*AIB Finance Limited

*Anglo Irish Bank Corporation plc

*Anglo Irish Corporate Bank Limited

*Ansbacher Bankers Limited

#Associates Capital Corporation plc

#Bankers Trust International plc (BTI)

#Bank of America NT & SA

*Bank of Ireland Finance Limited

#Banque National de Paris S.A.

#Citibank N.A.

*EBS Building Society

#Equity Bank limited

#FCE Bank plc

*First Active plc

*Guinness & Mahon (Ireland) Limited

#HFC Bank plc

*ICC Bank plc

*ICC Investment Bank Limited

*ICS Building Society

#IIB Bank Limited

#Investec Bank (UK) Limited

*Investment Bank of Ireland Limited

*Irish Life & Permanent plc

*Irish Nationwide Building Society

#Lombard & Ulster Banking Limited

#Marks & Spencer Financial Services Limited (MSFS)

#MBNA International Bank Limited

#National Irish Investment Bank Limited

#Northern Rock plc

#Ulster Bank Markets Limited

[as at 31/12/99: Deposits from Non Government/Non Financial Irish Residents: IR£4.6 billion

Credit to Non Government/Non Financial Irish Residents: IR£7.5 billion]

#Artesia Banking Corporation

#Banca Commerciale Italiana (Ireland) plc

#Banque Bruxelles Lambert

#Bankinter S.A.

#Banque Internationale a Luxembourg

#Bank of Montreal Ireland plc

#Bankgesellschaft Berlin (Ireland) plc

#Barclays Bank plc

#Bear Stearns Bank plc

#BW Bank Ireland plc

#Caja de Ahorros y Monte de Piedad de Madrid

#Chase Manhattan Bank (Ireland) plc

#Citco Bank Nederland N.V.

#Commerzbank Europe (Ireland)

#Commerzbank International (Ireland)

#Credit Local de France

#Daiwa Europe Bank plc

#DePfa-Bank Europe plc

#DePfa-Bank AG/ Bauboden

#Deutsche Bank/DB Ireland plc

#Dresdner Bank (Ireland) plc

#Eurohypo European Mortgage Bank plc

#Europaische Hypothekenbank S.A.

#Fimat International Banque

#Garras Bank - Naspa Dublin

#Helaba Dublin Landesbank Hessen-Thuringen International

#Hewlett-Packard International Bank Limited

#HSBC Bank plc

#Hypovereinsbank Ireland

#ING Bank N.V.

#KBC Bank N.V.

#KB Luxembourg Finance Dublin

#LGT Bank in Liechtenstein (Ireland) Limited

#Merrill Lynch Capital Markets Bank Limited

#Pfizer International Bank Europe

#Rabobank Ireland plc

#Rheinhyp Bank Europe plc

#Sanpaolo Bank Ireland plc

#Scotiabank (Ireland) Limited

#SGZ-Bank Ireland plc

#Societe Generale SA

#Unicredito Italiano Bank (Ireland) plc

#Westdeutsche Landesbank (Ireland) plc

#WGZ-Bank Ireland plc

A4.1 Mergers legislation envisages that there are ‘common good’considerations which may be taken into account in assessing whether a proposed merger or takeover should be permitted. The Act lists such factors and the matter has been discussed by the Competition and Mergers Review Group. 66

A4.2 In general the factors which apply in relation to banking will be the same as those which apply to other sectors. This Appendix considers whether cross border mergers and takeovers raise particular issues which require special attention.

A4.3 Some banks operating in Ireland are already foreign owned. The transfer of ownership of, for example, another 10 per cent of the Irish banking market out of the country would not have any immediate or direct consequences for concentration in the Irish banking market. The main issue would be how the management of that bank was organized.

A4.4 There was a view among many of those consulted by the Group that the maintenance of headquarters decision-making functions by banks within Ireland was a common good consideration which should be taken into account, where appropriate, in considering proposals for change of ownership of major banks.

A4.5 In particular, there appear to be four areas where a change of ownership from domestic to foreign could lead to a review of policy by the purchaser:

- provision of payment services to a broad range of customers, not all of whom are profitable when considered individually

- location of specialized staff, particularly in treasury and centralized support systems for retail banking,

- the approach to be taken to cooperation by the bank with the State where this would facilitate overall management of the Irish economy,

- involvement in co-operation with the State in industrial development promotion.

A4.6 The likely outcome of reviews of these issues by management in the event of a cross border merger or takeover cannot be predicted. Management, based outside Ireland, may well draw the same conclusions that have been drawn by current bank management based in Ireland as to the balance of the best interests in Ireland of their shareholders. Even where an Irish bank is taken over by a foreign bank, structures may be put in place, such as a local board and a substantial policy-making function at national level, which would facilitate the formulation of policies sensitive to specific characteristics of the Irish economy. On the other hand, it is possible for international banks to take the opposite view and seek to operate a single business model across national borders. Such a model may involve a significant change in aspects of the approach of banks to the marketplace in Ireland and, consequently, to a reduction in the availability of banking services in Ireland.

A4.7 A proposed purchase of a domestic bank by a foreign bank, therefore, creates a risk of negative consequences for the Irish economy overall. This risk may never be realized. However, on the grounds that unnecessary risks should not be taken on, it could be argued that the existence of this risk would suggest that there may be some justification for a public policy of discouraging such takeovers. There are two problems with that view:

firstly, what price is Ireland willing to pay in order to avoid such an unquantifiable risk that foreign takeovers might lead to negative results for the domestic economy overall ?

secondly, can such an approach be reconciled with the wider policy framework for the development of the Irish economy ?

A4.8 Taking the first point, a concomitant of discouraging foreign takeovers of Irish banks would be a greater willingness to facilitate mergers between domestic banks. One argument for allowing increased concentration in the Irish banking sector might be that the Irish economy needs domestically headquartered banks and that the only way to ensure that is to allow a single dominant domestic bank to emerge.

A4.9 The Group was generally sceptical of the advantages of a public policy of promoting or facilitating the emergence of a single dominant domestic bank. The Group did not identify any sustained long term benefit, in the current environment, for the Irish economy from the emergence of such a bank. In particular, it noted that a merger of two major domestic banks would almost certainly not act as an obstacle to a takeover of a major Irish bank by a foreign bank because of the small relative size of all the participants in the Irish banking market, even if merged.67

A4.10 Secondly, as outlined in Chapter 2, Ireland’s approach to the ownership of banks is subject to the EU single market regulatory framework. Significant mergers or acquisitions of Irish banks will fall under the relevant EU Directive and will be considered by the EU Commission, rather than by national authorities. This reflects the fact that a merger or acquisition of the larger participants in the Irish banking market could exceed the thresholds set down in the EU directive, while any transaction involving either of the two main banks would be unlikely to benefit from the exception for mergers and acquisitions where two thirds of the business activity is concentrated in one member country.68

A4.11 This situation in which mergers involving major domestic banks are subject to supranational rather than national regulation reflects the fact that Ireland is committed to the policy of the promotion of the development of the Irish economy within a single European market. Ireland’s commitment to the development of the single European market is consistent with a calculation that the disadvantages which may arise from foreign ownership of, for example, banks trading in Ireland will be more than offset by the benefits arising from the integration of the European economy on the basis of efficiencies achieved on a Europe-wide basis.

A4.12 In addition, a cross-border merger or takeover would be likely to be part of the modernization and development of the banking sector. In many cases, improved efficiency, a broader range or improved quality of financial services could well be created by such a cross-border merger or acquisition. These benefits for customers are an important consideration.

A4.13 All these considerations mean that ‘common good’ considerations arising in relation to foreign ownership of Irish banks should only be reflected in a manner consistent with the wider policy goals and commitments of Ireland and in line with overall competition policy.

A4.14 That suggests that where the domestic regulatory framework applies, common good considerations as they apply generally should be considered by the Minister for Enterprise, Trade and Employment. Where the EU regulatory framework applies, a structure should be put in place now for consultation between the Department of Enterprise, Trade & Employment, the Competition Authority and the regulatory authority for the financial services sector to establish how such proposals will be handled domestically, including the Irish input to the EU Commission decision-making process.

66. See P.42, Mergers Discussion Document, July 1998 and P.223-224, The Final Report of the Competition and Mergers Review Group, May, 2000

67. See Statistical Appendix Table 1.

68. The large and increasing proportion of the activity of the two main banks carried out abroad would be relevant in this regard.

A5.1 In July, 1998, AIB Bank and Bank of Ireland proposed the establishment of a group to examine the payments system. The banks stated that in relation to payments, "Ireland is out of line and lagging behind". The banks argued that "The dynamics of the payments system are such that the banks alone cannot bring about the conditions necessary for change. The banks can create the core infrastructure of an electronic payments system, but a successful National Payments Strategy can only be successfully implemented through cooperation of all the key players, with government playing a significant leadership role."

A5.2 Section 30 of the Government Action Plan Implementing the Information Society in Ireland requested the financial institutions to prepare proposals for appropriate systems to facilitate further development of electronic payments in the economy.

A5.3 The Irish Payment Services Organization (IPSO) formally made proposals to the Taoiseach and the Minister for Finance in October 1999. They proposed an approach in which "the banks and other financial institutions would have a shared vision, shared standards, shared infrastructures, shared processes".

A5.4 The proposed ‘National Payments Strategy’ includes:
- electronic regular bill payments
- a ‘universal’ payments account

Electronic Regular Bill Payment Service

A5.5 The proposed utility bill payment initiative has three main goals:

Ÿ to truncate the bill payment process by eliminating the requirement on those not using direct debit instructions to use cash or cheques to make bill payments
Ÿ to make it possible to send bills to customers by E.mail who have an E.Mail facility.

Ÿ to produce aggregate bills thus saving on postage and administration.

Pilot schemes are being developed to push this project forward.

Universal Account.

A5.6 The second proposal is for the establishment of a ‘universal account’ to make it possible for each adult to make use of electronic payments technology. Access to this account would be card-based, with access through Automated Teller Machines and retailers. The ‘universal account’ would be made available on a non-competitive basis to each adult. These accounts would be managed centrally by an arm of the State or by the central payments system companies on a not-for-profit basis. They would be financed by charges levied for social welfare and salary payments made to the accounts.

A5.7 A Group based in the Department of the Taoiseach is currently in discussions with the Irish Payment Services Organization to develop greater clarity as to how the proposals would operate and with a view to identifying the full range of issues which arise.

A5.8 Amongst the issues identified to date are:

the need for easy access to and participation in any such "universal account" type of arrangement by citizens;

cultural and societal acceptability of the proposals;

the right of all financial institutions to participate in electronic payment systems;

the need for the financial institutions to cooperate more closely in the area of electronic payments and clearing systems;

the role of An Post in any new arrangements;

the extent of support among the utilities for the proposed central billing arrangements;

the administrative costs associated with the proposed arrangements (and how they are to be met);

transitional arrangements (including possibility of dual systems being needed and cost implications);

the need to establish a "critical mass" of participation before the proposals become viable;

identifying the range of options regarding a gradual move to electronic payment of Government payments;

the need for discussion with the social partners, particularly regarding salary payments;

It is expected that these issues will be addressed in the group's report, along with such other issues as arise during the course of the group's work.

A5.9 The recently concluded Programme for Prosperity and Fairness includes a commitment that a group which includes representatives of the social partners will examine means of facilitating greater use of electronic payments.

Source: Banking Federation of the European Union/Banking Business:Abstract of Statistics, Vol.16, 1999, British Bankers’ Association.

1. Separate figures for commercial banks not available. 2. Banking sector as a whole. 3. Banks with a working capital above DKK100m, excluding Faroese banks and branches of foreign banks. 4. Domestic Operations only. 5. Private commercial banks excluding mortgage banks and home loan and savings associations. 6. Commercial banks and savings banks, excluding rural and artisanal banks and central institutions. 7. Consolidated figures, including foreign operations. 8. Banking sector as a whole. 9. Also includes Finland, Greece, Iceland, Luxemburg, Norway, Portugal, Switzerland.