Foreword by Stuart Fraser, Chairman of Policy, City of London and Stuart Popham, Chairman, TheCityUK
The 2007/8 banking crisis, and the subsequent bail-outs and recession, has severely shaken any over-confident belief in the ability of the global banking system and financial markets to readily deliver faster growth with stability. With hindsight, we see the global crisis was a multi-facetted systemic failure – in products, supervision and corporate governance. Solutions to these problems are neither quick nor straightforward and we must recognise that future crises, of a different character from the past, will still occur. However, mitigation of future crises will be better if based on good understanding and engagement with the industry. The norm should be for a well-regulated sector, supporting economic growth in good times, but with built-in support systems that are well designed to resist shocks and contagion in bad times.
The report sets out robust measures of the economic contribution to the EU made by financial services firms operating in its major financial centres. It is illuminated by interviews undertaken with practitioners in different centres and by case studies drawn from EU businesses, the customers and clients of the financial services sector.
It is easy to see the direct benefits of financial services to households in the EU. Many, such as effective and reliable retail banking services are often taken for granted. One evident success of the EU single market is the way EU firms now compete across borders to offer households cheaper and more efficient services. Less easy to explain are the complementary but more complex financial services for businesses, large and small, that in turn bring indirect but substantial benefits to households. These facilitate the efficient allocation of capital through the flow of investment funds from those with available financial resources to those best placed to use these resources productively; they spread the risks of business and innovation to those best placed to bear them; they support business growth and so ultimately improve the wellbeing of EU citizens.
The report shows that firms located in eight major International Financial Centres - Amsterdam, Dublin, Frankfurt, London, Luxemburg, Madrid, Milan and Paris - account for the bulk of financial service provision in the EU. Such concentration in financial centres provides better access to capital, talent and markets, and brings a specialisation in the provision of services to global business. This generates direct economic benefits in the form of lower costs for consumers. This benefit then spills over into higher growth and boosts tax revenues. Location in these centres contributes to economic efficiency and boosts overall EU economic performance. The indirect contribution is that such specialisation and spatial concentration allows complementary specialisation in other business sectors and other geographic regions. This brings lower cost and a competitive dynamic to these other industries and boosts jobs in their domestic markets. This is a general benefit brought about by competition within the single market.
This is a challenging time to be benchmarking. Households, firms and governments are making painful budgetary adjustments in an effort to deal with the overhang of the severe global financial and economic crisis of 2008/9. The EU is restructuring the framework of regulation for financial services and seeking to make more transparent the wholesale markets in derivatives and currency. Governments are progressively reversing the state ownership of those banks rescued during the crisis. Most problematically, governments need markets to deal with the substantial increase in Member State debt and fiscal deficits that were the response to the recent banking crisis – a crisis which also served to expose the underlying unsustainable fiscal position of some EU Member States.
To establish a regulatory framework that can mitigate future crises, while not over-regulating in a way that inhibits growth and innovation, a better understanding is needed of how financial services work and the real impact of regulation on the functioning of business. We welcome the spirit of engagement with the Commission and the Parliament that informs this process. Engaging proactively with business is essential for policymakers looking for effective solutions to the current set of problems, and that of course is a two-way process. These will need to ensure that EU financial services and their financial centres remain an important part of the EU’s offering to global business. We should value the support financial services provide for other sectors of the economy throughout the EU - lowering the costs faced by households, businesses and governments and increasing the potential for trade-led growth and investment. This is in line with the aspirations for the Europe 2020 strategy - both tapping the potential of the Single Market and attracting private capital to finance growth.
There are clear messages in the report for European governments. In a world where capital and talent are increasingly mobile, financial centres need to be deep and concentrated so as to establish regional advantage as business hubs, conduits for capital flows and pools of expertise and innovation. Having such centres embedded in the EU provides substantial direct benefits in terms of tax revenue, export earnings, employment and capital flows.
Conclusions:
1) Financial services are of enormous social value. When Lord Turner and certain economists question whether some components of financial services are “socially useless”, doubtless they mean only to question the value of certain specific complex products, rather than the industry as a whole. But there is a risk that less sophisticated ears gain the impression that the finance sector, overall, is of questionable social value. There should be no such question: it is of huge value.
2) In this report we have rehearsed (and in some areas quantified) a number of its key benefits, in addition to the jobs, value added and tax generated by the sector itself.
3) The payments system and money are, in a modern economy, almost entirely facets of the financial sector. These make the exchange of goods enormously easier and more efficient.
4) Capitalism — the separation between providers of capital and those with entrepreneurial ideas and management acumen — is, in a modern economy, largely a reflection of the financial sector. Capitalism promotes social mobility (allowing those without wealth but with ideas to become wealthier), innovation (allowing new ideas to flourish that would otherwise be lost), and efficiency (allowing those with capital to gain greater returns).
5) Households use the financial sector to save and borrow, allowing them to obtain expensive goods and services that would otherwise be out of reach and to smooth consumption rather than being forced to cut back dramatically with every twist and turn of life. Families also insure themselves against disasters in which, though money may not always solve everything, it very often helps.
6) Businesses use the financial sector to invest (e.g. purchasing new companies), to borrow (e.g. to finance new plant and machinery), to manage cash-flow, and to manage business risks.
7) Governments use the financial sector, especially to borrow to fund public expenditure, keeping things going when tax receipts are temporarily low. Indeed, when the financial sector is more developed, economies grow more rapidly, generating additional tax revenue over-and-above the revenues of finance firms themselves.
8) The financial sector promotes trade in the European Single Market, providing loans, savings products and insurance across borders, bonds and bank loans for businesses in other countries, loans to governments of other Member States, and job opportunities.
9) None of this is to say that there do not need to be changes to regulation and supervision in the financial sector. But in pondering such changes, policymakers should recognise the huge social value of the sector and the danger that mis-regulation might damage it.
Full report