IndyMac, Fannie Mae, Freddie Mae…government seizures, government bailouts, government regulations…can the banking crisis get any worse?  And this was just the last two weeks!   Earlier this year, we witnessed the collapse of Bear Stearns in the US and the nationalization of Northern Rock in the UK.   For each bank who has failed there are five more who have escaped immediate peril but continue to suffer distress from rapidly falling stock prices - Wachovia, Washington Mutual and Lehman just to name a few.

It is difficult to tell whether we are near the end of the subprime mortgage fallout or still in the beginning.   However, one absolute certainty is that 2008 will be recorded in the history books as a period of unprecedented loss and radical transformation the banking industry.  Experts predict that the final tally of losses will reach $1 Trillion.  The banking sector will become even further consolidated as institutions collapse or seek buyouts from healthier firms to survive.  Access to capital will be more challenging to obtain as lending practices become more stringent and tighter regulation emerges. 

Bear Stearns on e-Bay - Found on a Reuters Blog site

The subprime mortgage crisis is not the only source of radical change in the banking industry this year.  A less publicized, but perhaps equally significant transformation is occurring across Europe this year as part of the Single European Payments Area (SEPA).  Much like the credit crisis, SEPA will result in significant losses to banks.  Payment fees collected could decline between 30 to 60%, the equivalent of €13-29B of foregone revenues.  But unlike the credit crisis, SEPA losses will not be the result of a series of unplanned events leading to catastrophe.  Instead SEPA is a deliberate, methodical attempt to evolve the banking system that will provide substantial long term benefits to both consumers and businesses.   SEPA is not a new phenomenon.   Planning for the changes has been occurring within the European banking sector for over a decade now.  However, since the SEPA initiative’s progress has not been well communicated outside of Europe, I thought I would take a few minutes its goals and benefits.

Background to SEPA 

Historically, Europe has been host to a complex set of country-specific pricing, regulation and systems for payment processing.  For example, consumers pay different prices for the same banking services depending upon their country of residence.  Italians and Germans might pay ten times what a Dutch or French citizen is charged for basic retail banking services.  Geographic limitations constrain today’s service offerings.  Many of the banking services consumers purchase are limited to the home country in which the financial institution is based.  For example, when a Belgian citizen travels to another country such as Austria, his debit card from the Belgian bank will most likely not allow him to withdraw funds from a local ATM. 

Corporations suffer many similar challenges to consumers.  The fees assessed by banks for payables and receivables services vary widely based upon country.  A multi-national corporation making a €1000 payment to a supplier might pay €0.75 in Italy; €0.25 in Spain and €0.05 in France.   There is one consistency in payments across all European nations and that is cross-border transactions are expensive regardless of the country of initiation.  For example, before SEPA the €1000 payment explained above would have cost €20 if it were to be made from a payer using a German account to a payee using a foreign bank. 

Single European Payments Area 

Starting in the 1990s, the European Union began the SEPA initiative to harmonize and simplify payments across the 15 countries which have embraced the Euro as the national currency.  Consumers and corporations will enjoy consistent pricing and service levels irrespective of their country of citizenship and the location of their bank account.  Surcharges for cross-border transactions within the Eurozone will effectively be eliminated.  As a result, citizens and corporations will be able to make payments in any Eurozone country as easily and cost-effectively as they could in their home nation. 

SEPA offers numerous benefits to consumers, corporations and financial institutions.  The efficiencies to be gained through SEPA will lead to a 1% increase in GDP for the EU making it more competitive on the world market.  However, the productivity improvements will not come for free.  The gains will be achieved at the expense of the banks.  And they will be substantial.  As I mentioned above, SEPA’s impacts could reduce bank’s payment revenues by 30-60% or €13-29 Billion below 2010 expected results.  One of the greatest areas of impact will be cross-border payment fees which will be reduced from between €16 to €24 per transaction to under €0.50 per transaction.  Another contributor to revenue declines will be the normalization of fees across the EuroZone.  As the region is transformed into a single, common marketplace for retail and corporate payment services, competition will drive prices to their lowest common denominator.

Why are banks willing to participate if they lose so much money? 

While SEPA requires banks to sacrifice short-term payment fee revenue, it offers a promise of much larger long-term revenue and profitability gains.  In today’s model, regulations and requirements for operating a bank vary by country.  As a result, only the largest financial institutions can afford the start up costs to establish operations in multiple countries.  With SEPA the barriers for financial institutions to expand into new markets will be reduced considerably.  As a result, banks can expand their geographic footprint to capture a larger share of the larger EuroZone market and its 300 million citizens.  Furthermore, banks can offer a unified product set across the various countries gaining significant economies of scale in back office operations.

SEPA is, of course, just one part of a broader plan to harmonize the financial systems throughout the European Union.  The EU has similar initiatives completed or underway for invoicing, currency, taxation, securities and financial reporting.  Europe’s success has not gone unnoticed.  The Middle Eastern nations of Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the UAE have already started efforts to unify their economies through the establishment of a common currency by 2010.  2010 is only 18 months away.  And we can only hope that confidence in the banking sector will have been restored by then…