On the optimal size of the financial sector

Speech by Benoît Cœuré, Member of the Executive Board of the ECB,at the ECB Conference “The optimal size of the financial sector”
Frankfurt, 2 September 2014

Ladies and gentlemen ,
Thank you very much for giving me the opportunity to speak here today.
The recent global financial crisis has made us rethink the contribution of the financial sector to the real economy. Today, I will talk about how our understanding of the finance and growth nexus has changed over the past years, and how policy-makers in Europe ‒ in particular, here at the European Central Bank (ECB) ‒ have used this knowledge.

Introduction

In the years prior to the financial crisis, the empirical literature on finance and growth accumulated a substantial body of evidence suggesting that financial sector deepening is a key component of the economic development process. This appeared to be true, both in respect of emerging markets and industrialised economies.  Encouraged by such evidence, policy-makers did not question the ability of the financial sector to innovate and channel funds to their most socially productive uses. In the words of the Federal Reserve’s then Chairman Alan Greenspan: “[…] our financial system, whose job it is to ensure the productive use of physical capital, has been such a crucial part of our overall economy, especially over the past two decades. It is the signals reflected in financial asset prices, interest rates, and risk spreads that have altered the structure of our output in recent decades towards a different view of what consumers judge as value.”
Yet, economies with large, dynamic, and complex financial sectors are not immune to severe macroeconomic contractions. In fact, the banking crises literature provided some evidence on a causal link between rapid credit growth and systemic banking distress long before the emergence of the global financial crisis . Furthermore, the output costs of severe banking crises have been found to be of a large magnitude. 
Are these two observations contradictory? Not necessarily ‒ both are related to well-understood economic mechanisms. On the one hand, mature financial industries ensure the efficient allocation of productive resources, supporting long-term growth. On the other hand, excessive leverage can throw the financial system into a crisis resulting in deep and abrupt economic downturns. 
The crisis has made us understand that the size of the financial sector can exacerbate the trade-off between economic efficiency and financial stability. While finance per se is necessary for growth, an oversized financial industry can be detrimental to real economic activity. Of course, the question of what constitutes an “oversized” financial sector is a complex one, and the collection of papers on the programme of this conference makes great progress towards providing an answer.
Recent changes to the global regulatory architecture, particularly regarding the banking union in Europe, are in part aimed at mitigating the negative effects that a large and complex modern financial industry can have. These changes should be implemented in a way that avoids eliminating the positive impact of financial services on growth and tackling financial complexity with overly complicated and excessive regulatory interventions. In addition, policy-makers should be increasingly aware of the importance of overcoming fragmentation in European capital markets and of achieving a single market for capital.

Identifying the problem

As regards the link between finance and growth, for a long time, it was common to say that finance affects growth in a positive, monotonic way, as if more is always better. Recent empirical evidence, however, has qualified this conventional wisdom. The analysis has now been refined to show that, beyond a threshold size, the effect of finance on long-term economic growth can weaken and even become negative.
Why is the effect of finance on growth non-linear? Recent academic research puts forward at least five possible explanations.
First, the financial sector has gradually extended its scope beyond the traditional activity of intermediation towards so-called “non-intermediation” financial activities, such as trading. The evidence strongly suggests that banking strategies which are heavily geared towards generating non-interest income are riskier. This change in focus is naturally associated with a higher potential for systemic crisis. Moreover, as a result, it has become increasingly more difficult to come up with empirical measures of financial services that are consistent with what modern-day finance actually does. This is especially true for high-income economies whose financial sectors are particularly sophisticated.
Second, the financial system can grow too large relative to the real economy because it can extract excessively high informational rents and pay excessively high wages. For example, while in the wake of World War II the financial sector accounted for less than 2.5% of total labour income, in 2006, this share was 8.3%. As a result, too much young talent can be reallocated towards the financial industry. To put it more bluntly: the world before the crisis was one where there were too many bankers and too few engineers. This particular type of “brain drain” can harm the overall productivity of the real economy. It can be highly inefficient if the social returns to financial services are lower than their private returns, which is probably the case when the financial sector is very large to begin with.
Third, an expansion in the financial sector can signal a misallocation of credit to less productive economic activities. Textbook models of financial intermediation usually assume the mobilisation of savings for entrepreneurial credit. However, much of the spike in financial intermediation before the crisis was associated with household credit, and mostly with mortgage credit. In fact, in a number of countries (e.g. Canada, Denmark and the Netherlands), loans to households accounted for more than 80% of overall bank lending. In most cases, an additional euro of mortgage lending contributes less to overall economic growth than an additional euro of credit to a young innovative company.
Fourth, an oversized financial sector can reflect increased risk-taking. For example, it has been argued that increased bank competition can erode individual banks’ franchise values. This, in turn, can encourage banks to engage in imprudent behaviour. Competitive behaviour can increase the resilience of the system, while a competitive market structure can weaken it.  A similar logic applies to an environment where liquidity is abundant. This can result from a very accommodative monetary policy (as outlined in the “risk-taking” view of monetary policy transmission  from a leveraged financial system with high inside money creation , or from a combination of both. Such an environment exacerbates moral hazard problems in the banking sector, increasing banks’ appetite for risk. Meanwhile, increased risk-taking makes both individual banks and the banking sector as a whole more fragile, increasing the probability of a systemic meltdown and thereby harming long-term growth.
Last but not least, there is a link between the size of the financial sector and its complexity. It is likely that the complexity and interconnectedness of financial institutions increases (presumably in a non-linear way) with the size of the overall financial system, making it more difficult for regulators to understand what is going on within its bounds. Policy-makers have allowed the financial system to balloon without availing themselves of the instruments to understand its complexity and monitor the propagations of shocks . We cannot afford to be caught off guard again, simply guessing where the real problems may lie.

The policy response

Now that we have identified the problem, what is the solution? In the wake of the financial crisis, the global regulatory architecture has evolved to meet the challenge posed by the financial sector’s potential to generate economic distress. For one, we have proceeded towards a more integrated governance of the banking sector in Europe. The first components of a genuine banking union – the Single Supervisory Mechanism and the Single Resolution Mechanism – are already being implemented. By aiming to make the banking activities conducted in Europe safer, the banking union implicitly touches on some of the aspects of “oversized finance” in general, and “overbanking” in particular.
We need to be mindful of the fact that the macro problem (the financial sector being “too big”) and the micro problem (individual financial institutions being “too big”) are not necessarily identical. Even if the financial sector is small relative to the real economy, it may be comprised of banks whose incentives are misaligned due to “too big to fail” considerations. This can lead to excessive risk-taking and inefficient credit growth and has inspired recent changes to regulation and prudential policy. For example, Basel III includes a revised leverage ratio framework that has the goal of preventing banks from operating with excessive leverage. This should reduce the discrepancy between social and private returns in banking and limit the rents extracted by the financial sector. A similar role is envisaged for recent rules on liquidity coverage. The size of individual banks is also a relevant consideration (albeit not the primary one) when it comes to measuring their importance in terms of systemic risk and determining their contribution to the Single Resolution Fund. Finally, some recent suggestions for regulatory reform propose separating activities that are currently implemented by commercial banks under “one roof”, limiting the size of individual banks and at the same time increasing the relative importance of traditional financial intermediation activities.
Timely data reporting is another critical issue because policy-makers need to know in real time what is going on inside the system. The Financial Stability Board’s work on data harmonisation and on filling data gaps is critical in this respect.
Finally, Europe needs to move towards the re-creation of a genuine single market for capital. By this, I do not mean the convergence of prices for euro-denominated financial assets. The crisis provided a painful reminder of the limitations of such measures of financial integration. What I have in mind instead is “genuine” integration, whereby financial resources are allocated with reference to the risk-return relationship and not to location ‒ a process which would improve economic diversification in that it would cushion both entrepreneurs and households against local shocks ^. This should naturally reduce the negative impact of an overextended financial sector by decreasing the probability of inefficient booms and severe busts.
How can a single market for capital be realised? In addition to the better integration of governance that I have just talked about, the process rests on the improved integration of retail banking and capital markets. As regards retail banking, even before the crisis, we at the ECB acknowledged that this is one of the least integrated markets in the euro area . The crisis undermined the process of integration by prompting a further retrenching of retail banking services within national borders. The new regulatory and supervisory framework has the potential to steer us towards deeper cross-border integration, and, in the process, to address Europe’s over-reliance on large banks. Evidence before the crisis suggested that the integration of retail lending markets may be a more efficient mechanism for cross-border risk-sharing than secured or unsecured interbank markets. It is important that the banking union and the regulation against the “too big to fail” problem effectively encourage banks to reach an optimal size relative to the European market – that is, large enough to operate across borders and diversify risks, but small enough to be resolved with the resources of the Single Resolution Fund. This would be Europe's best contribution in terms of improving the trade-off between financial stability and economic efficiency.
Regarding capital market integration, things can only improve in the future, given Europe’s high reliance on bank funding. It is likely that the ongoing deleveraging of the global banking sector will stimulate the development of non-bank financial intermediation in Europe. As a sign of things to come, the decline in bank credit is already to some extent compensated for by an increased issuance of corporate bonds. And the recent initiatives to create an active market for high-quality securitisation  will help further in this direction.

Conclusion

Let me conclude.
The global financial crisis was, to a large extent, driven by an oversized and overleveraged financial sector whose risk-creating capacity was left unchecked by regulators and supervisors. We believe that we have learned our lesson and the recent flurry of policy initiatives reflect, in large measure, our new understanding of the destabilizing role of an oversized financial sector.
The academic literature, as well as our own experience in the crisis, has proven that the size of the financial sector can exacerbate the trade-off between economic efficiency and financial stability. I hope that the regulatory reforms that are now being enacted and the recent changes in the European supervisory architecture, combined with the renewed push for a single market for capital in Europe, will go some way in addressing this trade-off.
Thank you very much for your kind attention.

Making foreign direct investment beneficial for job creation

Making foreign direct investment beneficial for job creation

The MENA region benefits from a substantial and growing inflow of foreign direct invest­ment (FDI). In principle, such investment should provide support for stronger growth and employment creation, both directly and indirectly, by spurring structural transformation and sectoral reallocation of jobs into higher value added industries. So far, however, there is little evidence that FDI has led to such changes in the region. This section discusses some of the recent trends and the reasons for the limited effects FDI had on employment creation in the region.

FDI into the MENA region has increased substantially over the past decade (from US$8.7 billion in 2001 to US$94 billion in 2008). However, these inflows were directed to only a few sectors, such as construction, telecommunications and mining, while the manufac­turing and agriculture sectors were neglected (figure 32). In addition, high-technology services sectors have received very little FDI inflows, limiting positive spill-overs onto productivity growth in the region. Moreover, FDI inflows have been highly concentrated in resource-rich countries, with Saudi Arabia receiving the lion’s share (around 44 per cent; OECD and WEF, 2011). More importantly, with the onset of the Arab Spring and the rise of social protest, which has affected the political stability of the region, FDI inflows have declined by 13 per cent, in particular in Egypt and Tunisia.17 So far, FDI in the MENA region has not had the broad-based effect on economic development that was seen in Eastern Europe and Asia over the same period.

         FDI inflows in the MENA region by sector,2003-10(%)

In principle, FDI inflows can promote employment creation through two channels:

*When FDI comes as greenfield investments, new employment opportunities are generated immediately, especially if these investments are directed into labour-intensive sectors such as agriculture, manufacturing, tourism and wholesale and retail trade. Greenfield invest­ment is expected to have a positive impact on employment and to generate positive spillo­vers to the whole economy. Over the past five years, around 90 per cent of FDI in the MENA region was in greenfield operations.

*Alternatively, FDI can flow in through mergers and acquisitions. These typically do not create new job vacancies, and in the short term they might lead to job destruction. In the longer run, this type of investment is expected to increase productivity, which could enhance employment creation through sectoral reallocation of jobs.

So far, neither type of foreign investment has had a significant positive impact on employment in the MENA region. To a large extent, this can be explained by the very limited number of sectors that have benefited from FDI inflows and the fact that they were not labour-intensive sectors. Most FDI has been directed to the hydrocarbons sector, which is capital-intensive. For instance, in Algeria and Tunisia, 50 per cent and 61 per cent, respectively, of FDI inflows were oriented towards the energy sector. In Egypt, 45 per cent of total FDI inflows were directed to the petroleum sector. Not only are these sectors capital-intensive, they offer job oppor­tunities for a very limited number of occupations, such as petroleum engineers, which many MENA countries lack in a sufficient number and so need to import. In countries that are not oil exporters, FDI inflows often went into other capital-intensive sectors, such as telecommu­nications, again creating only limited new jobs. For example, in Tunisia and Morocco, 35 per cent and 33 per cent, respectively, of the FDI received between 2000 and 2007 went to the telecommunications sector.

In addition, where investment went into labour-intensive sectors, such as construction, the native population often benefited very little from new job openings, which were quickly filled with migrants from countries outside the region. Indeed, in the Gulf countries in par­ticular, wage premiums for native workers lead employers to hire migrant workers at lower wages, often with working conditions that would not be accepted by native workers (see also the discussion in ILO, 2013c). Moreover, cultural barriers often prevent women from working in some male-dominated industries.

To ensure that labour markets receive more benefit from FDI, countries in the MENA region need to make substantial efforts to diversify the sectoral allocation of FDI inflows. Often, high barriers to market entry, a low level of perceived governance quality and a lack of proper infrastructure create substantial obstacles for foreign investors who wish to enter new markets. Also, in some countries in the region there seems to be a first-mover bias, where sub­stantial protection from further competition is granted for the first investor in any particular sector, thereby limiting the possibility of a much broader positive employment effect from FDI.

 Conservation Agriculture

Facing climate change and nine billion mouths to feed by 2050, Conservation Agriculture is key to the future of food security

30 Jul 2014 - In the face of changing weather driven by climate change and the increasing demand for food, Conservation Agriculture (CA) aims to achieve sustainable and profitable agriculture and improve farmers’ livelihoods. Here are five things you need to know.

1. CA observes three main principles that you should remember

• Direct seeding involves growing crops without mechanical seedbed preparation and with minimal soil disturbance since the harvest of the previous crop.
• A permanent soil cover is important to: protect the soil against the deleterious effects of exposure to rain and sun; provide the micro and macro organisms in the soil with a constant supply of "food"; and alter the microclimate in the soil for optimal growth and development of soil organisms, including plant roots.
• The rotation of crops is not only necessary to offer a diverse "diet" to the soil micro organisms, but as they root at different soil depths, they are capable of exploring different soil layers for nutrients.

2. CA helps fight climate change 
Only because the effects of climate change are being felt more and more, it does not mean we should give up on efforts to reduce greenhouse gas emissions (GHG). With the increasing soil organic matter, the soils under Conservation Agriculture can retain carbon from carbon dioxide and store it safely for long periods of time.
The consumption of fossil fuel for agricultural production is also significantly reduced under CA and burning of crop residues is completely eliminated, which also contributes to a reduction of GHG release.

3. CA provides small-scale farmers with diversification opportunities
CA has direct impacts which have the potential to turn around the daily and seasonal calendar and in the long term change the rhythm of farmers’ family because of the reduced labour requirements for tillage, land preparation and weeding. More time availability offers real opportunities for diversification options such as for example poultry farming or on-farm sales of produce, or other off-farm small enterprise developments.
FAO argues that support should be given to smallholders to scale-up production. This support should include legal land tenure, global policies for a level playing field, access to capital and markets, structured training, and investment in technology and infrastructure.
4. CA helps lower farm power and reduces labour
One of the most noticeable changes for the farmer is the reduced requirement for farm power and labour. CA helps lower the overall requirement for farm power and energy for field production by up to 60 % compared to conventional farming.

This is due to the fact that the most power intensive operations, such as tillage, are eliminated. Additionally equipment investment, particularly the number and size of tractors, is significantly reduced. This effect applies equally to small-scale farmers using only hand labour or animal traction.
5. Everyone has a role to play
Maintaining the momentum of growth in agricultural productivity will remain crucial in the coming decades as production of basic staple foods needs to increase by 60 percent if it is to meet expected demand growth.
Food is one of our most basic needs, so be it reducing food loss and waste, eating lower-impact diets or investing in sustainable agriculture  such as conservation agriculture - countries, companies, and consumers can make a difference

Unemployment in the euro area

Speech by Mario Draghi, President of the ECB,
Annual central bank symposium in Jackson Hole,
22 August 2014

No one in society remains untouched by a situation of high unemployment. For the unemployed themselves, it is often a tragedy which has lasting effects on their lifetime income. For those in work, it raises job insecurity and undermines social cohesion. For governments, it weighs on public finances and harms election prospects. And unemployment is at the heart of the macro dynamics that shape short- and medium-term inflation, meaning it also affects central banks. Indeed, even when there are no risks to price stability, but unemployment is high and social cohesion at threat, pressure on the central bank to respond invariably increases.

1. The causes of unemployment in the euro area

The key issue, however, is how much we can really sustainably affect unemployment, which in turn is a question – as has been much discussed at this conference – of whether the drivers are predominantly cyclical or structural. As we are an 18 country monetary union this is necessarily a complex question in the euro area, but let me nonetheless give a brief overview of how the ECB currently assesses the situation.
Figure 1: Change in the unemployment rate since 2008 – the euro area and the US

The long recession in the euro area

The first point to make is that the euro area has suffered a large and particularly sustained negative shock to GDP, with serious consequences for employment. This is visible in Figure 1, which shows the evolution of unemployment in the euro area and the US since 2008. Whereas the US experienced a sharp and immediate rise in unemployment in the aftermath of the Great Recession, the euro area has endured two rises in unemployment associated with two sequential recessions.
From the start of 2008 to early 2011 the picture in both regions is similar: unemployment rates increase steeply, level off and then begin to gradually fall. This reflects the common sources of the shock: the synchronisation of the financial cycle across advanced economies, the contraction in global trade following the Lehman failure, coupled with a strong correction of asset prices – notably houses – in certain jurisdictions.
From 2011 onwards, however, developments in the two regions diverge. Unemployment in the US continues to fall at more or less the same rate. ^[1] In the euro area, on the other hand, it begins a second rise that does not peak until April 2013. This divergence reflects a second, euro area-specific shock emanating from the sovereign debt crisis, which resulted in a six quarter recession for the euro area economy. Unlike the post-Lehman shock, however, which affected all euro area economies, virtually all of the job losses observed in this second period were concentrated in countries that were adversely affected by government bond market tensions (Figure 2).
Figure 2: Relationship between financial stress and unemployment

The sovereign debt crisis operated through various channels, but one of its most important effects was to disable in part the tools of macroeconomic stabilisation.
On the fiscal side, non-market services – including public administration, education and healthcare – had contributed positively to employment in virtually all countries during the first phase of the crisis, thus somewhat cushioning the shock. In the second phase, however, fiscal policy was constrained by concerns over debt sustainability and the lack of a common backstop, especially as discussions related to sovereign debt restructuring began. The necessary fiscal consolidation had to be frontloaded to restore investor confidence, creating a fiscal drag and a downturn in public sector employment which added to the ongoing contraction in employment in other sectors.
Sovereign pressures also interrupted the homogenous transmission of monetary policy across the euro area. Despite very low policy rates, the cost of capital actually rose in stressed countries in this period, meaning monetary and fiscal policy effectively tightened in tandem. Hence, an important focus of our monetary policy in this period was – and still is – to repair the monetary transmission mechanism. Establishing a precise link between these impairments and unemployment performance is not straightforward. However, ECB staff estimates of the “credit gap” for stressed countries – the difference between the actual and normal volumes of credit in the absence of crisis effects – suggest that that credit supply conditions are exerting a significant drag on economic activity. ^[2]

Cyclical and structural factors

Cyclical factors have therefore certainly contributed to the rise in unemployment. And the economic situation in the euro area suggests they are still playing a role. The most recent GDP data confirm that the recovery in the euro area remains uniformly weak, with subdued wage growth even in non-stressed countries suggesting lacklustre demand. In these circumstances, it seems likely that uncertainty over the strength of the recovery is weighing on business investment and slowing the rate at which workers are being rehired.
That being said, there are signs that, in some countries at least, a significant share of unemployment is also structural.
For example, the euro area Beveridge curve – which summarises unemployment developments at a given level of labour demand (or vacancies) – suggests the emergence of a structural mismatch across euro area labour markets (Figure 3). In the first phase of the crisis strong declines in labour demand resulted in a steep rise in euro area unemployment, with a movement down along the Beveridge curve. The second recessionary episode, however, led to a further strong increase in the unemployment rate even though aggregate vacancy rates showed marked signs of improvement. This may imply a more permanent outward shift.
Figure 3: Evolution of the euro area Beveridge curve over the crisis

Part of the explanation for the movement of the Beveridge curve seems to be the sheer magnitude of the job destruction in some countries, which has led to reduced job-finding rates, extended durations of unemployment spells and a higher share of long-term unemployment. This reflects, in particular, the strong sectoral downsizing of the previously overblown construction sector (Figure 4), which, consistent with experience in the US, tends to lower match efficiency. ^[3] By the end of 2013, the stock of long-term unemployed (those unemployed for a year or more) accounted for over 6% of the total euro area labour force – more than double the pre-crisis level.
Figure 4: Evolution of euro area employment by sector and educational level

Another important explanation seems to be a lack of redeployment opportunities for displaced low-skilled workers, as evidenced by the growing disparity between the skills of the labour force and the skills required by employers. Analysis of the evolution of skill mismatch ^[4] suggests a notable increase in mismatch at regional, country and euro area level (Figure 5). As the previous figure shows, employment losses in the euro area are strongly concentrated among low skilled workers
Figure 5: Skill mismatch indices for the euro area

All in all, estimates provided by international organisations – in particular, the European Commission, the OECD and the IMF – suggest that the crisis has resulted in an increase in structural unemployment across the euro area, rising from an average (across the three institutions) of 8.8% in 2008 to 10.3% by 2013. ^[5]

Nuancing the picture

There are nevertheless two important qualifications to make here.
The first is that estimates of structural unemployment are surrounded by considerable uncertainty, in particular in real time. For example, research by the European Commission suggests that estimates of the Non-Accelerating Wage Rate of Unemployment (NAWRU) in the current situation are likely to overstate the magnitude of unemployment linked to structural factors, notably in the countries most severely hit by the crisis. ^[6]
The second qualification is that behind the aggregate data lies a very heterogeneous picture. The current unemployment rate in the euro area of 11.5% is the (weighted) average of unemployment rates close to 5% in Germany and 25% in Spain. Structural developments also differ: analysis of the Beveridge curve at the country level reveals, for example, a pronounced inward shift in Germany, whereas in France, Italy and in particular Spain, the curves move outward.
This heterogeneity reflects different initial conditions, such as varying sectoral compositions of employment (in particular the share employed in construction), as well as the fact that unemployment rates have historically been persistently higher in some euro area countries than others. ^[7] But it also reflects the relationship between labour market institutions and the impact of shocks on employment. ^[8] The economies that have weathered the crisis best in terms of employment tend also to be those with more flexibility in the labour market to adjust to economic conditions.
In Germany, for example, the inward shift in the Beveridge curve seen over the course of the crisis follows a trend that began in the mid-2000s after the introduction of the Hartz labour market reforms. Its relatively stronger employment performance was also linked to the fact that German firms had instruments available to reduce employees’ working time at reasonable costs – i.e. the intensive margin – including reducing overtime hours, greater working time flexibility at the firm level, and extensive use of short-time work schemes. ^[9]
Even within the group of countries that experienced the sovereign debt crisis most acutely, we can see a differential impact of labour market institutions on employment. Ireland and Spain, for example, both experienced a large destruction of employment in the construction sector after the Lehman shock, but fared quite differently during the sovereign debt crisis. Unemployment in Ireland stabilised and then fell, whereas in Spain it increased until January 2013 (Figure 6). From 2011 to 2013 structural unemployment is estimated to have risen by around 0.5 percentages points in Ireland, whereas it increased by more than 2.5 percentages points in Spain. ^[10]
This diverging performance can in part be accounted for by emigration, especially of foreign-born labour ^[11], which was much higher in Ireland. But it also reflects the fact that Ireland entered the crisis with a relatively flexible labour market and adopted further labour market reforms under its EU-IMF programme beginning in November 2010. Spain, on the other hand, entered the crisis with strong labour market rigidities and reform only started meaningfully in 2012.
Importantly, until then, the capacity of firms to adjust to the new economic conditions was hampered in Spain by sectoral and regional collective bargaining agreements and wage indexation. Survey evidence indicates that Spain was among the countries where indexation was more frequent – covering about 70% of firms. ^[12] As a result, as Figure 6 shows, nominal compensation per employee continued to rise in Spain until the third quarter of 2011, despite a more than 12 percentage point increase in unemployment in that time. In Ireland, by contrast, downward wage adjustment began already in the fourth quarter of 2008 and proceeded more quickly.
The upshot was that, whereas the Irish labour market facilitated some adjustment through prices, the Spanish labour market adjusted primarily through quantities: firms were forced to reduce labour costs by reducing employment. And due to a high degree of duality in the Spanish labour market, this burden of adjustment was concentrated in particular on a less protected group – those on temporary contracts. These had been particularly prevalent in Spain in advance of the crisis, accounting for around one third of all employment contracts. ^[13]
In Spain, as in other stressed countries, a number of these labour market rigidities have since been addressed through structural reforms with positive effects. For example, the OECD estimates that the 2012 labour market reform in Spain has improved transitions out of unemployment and into employment at all unemployment durations. ^[14]
Figure 6: Unemployment and nominal compensation developments in Ireland and Spain

To sum up, unemployment in the euro area is characterised by relatively complex interactions. There have been differentiated demand shocks across countries. These shocks have interacted with initial conditions and national labour market institutions in different ways – and the interactions have changed as new reforms have been adopted. Consequently, estimates of the degree of cyclical and structural unemployment have to be made with quite some caution. But it is clear that such heterogeneity in labour market institutions is a source of fragility for the monetary union.

2. Responding to high unemployment

So what conclusions can we draw from this as policymakers? The only conclusion we can safely draw, in my view, is that we need action on both sides of the economy: aggregate demand policies have to be accompanied by national structural policies.
Demand side policies are not only justified by the significant cyclical component in unemployment. They are also relevant because, given prevailing uncertainty, they help insure against the risk that a weak economy is contributing to hysteresis effects. Indeed, while in normal conditions uncertainty would imply a higher degree of caution for fear of over-shooting, at present the situation is different. The risks of “doing too little” – i.e. that cyclical unemployment becomes structural – outweigh those of “doing too much” – that is, excessive upward wage and price pressures.
At the same time, such aggregate demand policies will ultimately not be effective without action in parallel on the supply side. Like all advanced economies, we are operating in a set of initial conditions determined by the last financial cycle, which include low inflation, low interest rates and a large debt overhang in the private and public sectors. In such circumstances, due to the zero lower bound constraint, there is a real risk that monetary policy loses some effectiveness in generating aggregate demand. The debt overhang also inevitably reduces fiscal space.
In this context, engineering a higher level and trend of potential growth – and thereby also government income – can help recover a margin for manoeuvre and allow both policies regain traction over the economic cycle. Reducing structural unemployment and raising labour participation is a key part of that. This is also particularly relevant for the euro area as, to list just one channel, higher unemployment in certain countries could lead to elevated loan losses, less resilient banks and hence a more fragmented transmission of monetary policy.

Boosting aggregate demand

On the demand side, monetary policy can and should play a central role, which currently means an accommodative monetary policy for an extended period of time. I am confident that the package of measures we announced in June will indeed provide the intended boost to demand, and we stand ready to adjust our policy stance further.
We have already seen exchange rate movements that should support both aggregate demand and inflation, which we expect to be sustained by the diverging expected paths of policy in the US and the euro area (Figure 7). We will launch our first Targeted Long-Term Refinancing Operation in September, which has so far garnered significant interest from banks. And our preparation for outright purchases in asset-backed security (ABS) markets is fast moving forward and we expect that it should contribute to further credit easing. Indeed, such outright purchases would meaningfully contribute to diversifying the channels for us to generate liquidity.
Figure 7: Expected real interest rate path in the euro area and the US

Inflation has been on a downward path from around 2.5% in the summer of 2012 to 0.4% most recently. Acknowledging this, the Governing Council would use also unconventional instruments to safeguard the firm anchoring of inflation expectations over the medium- to long -term.
Turning to fiscal policy, since 2010 the euro area has suffered from fiscal policy being less available and effective, especially compared with other large advanced economies. This is not so much a consequence of high initial debt ratios – public debt is in aggregate not higher in the euro area than in the US or Japan. It reflects the fact that the central bank in those countries could act and has acted as a backstop for government funding. This is an important reason why markets spared their fiscal authorities the loss of confidence that constrained many euro area governments’ market access. This has in turn allowed fiscal consolidation in the US and Japan to be more backloaded.
Thus, it would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this, while taking into account our specific initial conditions and legal constraints. These initial conditions include levels of government expenditure and taxation in the euro area that are, in relation to GDP, already among the highest in the world. And we are operating within a set of fiscal rules – the Stability and Growth Pact – which acts as an anchor for confidence and that would be self-defeating to break.
Let me in this context emphasise four elements.
First, the existing flexibility within the rules could be used to better address the weak recovery and to make room for the cost of needed structural reforms.
Second, there is leeway to achieve a more growth-friendly composition of fiscal policies. As a start, it should be possible to lower the tax burden in a budget-neutral way. ^[15] This strategy could have positive effects even in the short-term if taxes are lowered in those areas where the short-term fiscal multiplier is higher, and expenditures cut in unproductive areas where the multiplier is lower. Research suggests positive second-round effects on business confidence and private investment could also be achieved in the short-term. ^[16]
Third, in parallel it may be useful to have a discussion on the overall fiscal stance of the euro area. Unlike in other major advanced economies, our fiscal stance is not based on a single budget voted for by a single parliament, but on the aggregation of eighteen national budgets and the EU budget. Stronger coordination among the different national fiscal stances should in principle allow us to achieve a more growth-friendly overall fiscal stance for the euro area.
Fourth, complementary action at the EU level would also seem to be necessary to ensure both an appropriate aggregate position and a large public investment programme – which is consistent with proposals by the incoming President of the European Commission. ^[17]

Reforming structural policies

No amount of fiscal or monetary accommodation, however, can compensate for the necessary structural reforms in the euro area. As I said, structural unemployment was already estimated to be very high coming into the crisis (around 9%). Indeed, some research suggests it has been high since the 1970s. ^[18] And given the interactions I described, there are important reasons why national structural reforms that tackle this problem can no longer be delayed.
This reform agenda spans labour markets, product markets and actions to improve the business environment. I will however focus here on labour markets, where there are two cross-cutting themes that I see as a priority.
The first is policies that allow workers to redeploy quickly to new job opportunities and hence lower unemployment duration. Such policies include enabling firm-level agreements that allow wages to better reflect local labour market conditions and productivity developments; allowing for greater wage differentiation across workers and between sectors; reductions in employment adjustment rigidities and especially labour market dualities; and product market reforms which help to speed up the reallocation of resources and employment to more productive sectors.
The second theme is raising the skill intensity of the workforce. We have already seen the disproportionate effect of the crisis on low skilled workers, which implies a period of re-skilling will be necessary to get people back into work. The longer-term effects of high youth unemployment also point to this conclusion. The number of unemployed aged between 15 and 24, relative to the labour force of the same age group, increased from an already high level of around 15% in 2007 to 24% in 2013. This has most likely left significant “scarring” as the young have lost access to a crucial step of on-the-job training.
The issue of skill intensity is also very relevant for potential growth. While raising labour participation is crucial, demographic prospects imply that it will provide a diminishing contribution to future potential. Lifting trend growth will have to come mainly through raising labour productivity. Thus, we need to ensure that, to the extent possible, employment is concentrated in high-value added, high-productivity sectors, which in turn is a function of skills.
What is more, in the global economy the euro area cannot compete on costs alone with emerging countries, if only because of our social model. Our comparative advantage therefore has to come from combining cost competitiveness with specialisation in high-value added activities – a business model that countries such as Germany have successfully demonstrated. Seen from this perspective, insufficient skill levels will effectively raise the non-accelerating inflation rate of unemployment (NAIRU) by causing more workers to drop out of the ‘competitiveness zone’ and become unemployable.
Raising skills is clearly first and foremost about education, where there is much that could still be done. The percentage of the working age population that has completed upper secondary or tertiary education in the euro area ranges from a high of more than 90% in some countries to a low of around 40% in others. But there is also an important role for active labour market policies, such as lifelong learning, and for eradicating distortions such labour market duality. The latter would, among other things, help reduce inefficient worker turnover and increase incentives for employers and employees to invest in developing job-specific skills.

3. Conclusion

Let me conclude.
Unemployment in the euro area is a complex phenomenon, but the solution is not overly complicated to understand. A coherent strategy to reduce unemployment has to involve both demand and supply side policies, at both the euro area and the national levels. And only if the strategy is truly coherent can it be successful.
Without higher aggregate demand, we risk higher structural unemployment, and governments that introduce structural reforms could end up running just to stand still. But without determined structural reforms, aggregate demand measures will quickly run out of steam and may ultimately become less effective. The way back to higher employment, in other words, is a policy mix that combines monetary, fiscal and structural measures at the union level and at the national level. This will allow each member of our union to achieve a sustainably high level of employment.
We should not forget that the stakes for our monetary union are high. It is not unusual to have regional disparities in unemployment within countries, but the euro area is not a formal political union and hence does not have permanent mechanisms to share risk, namely through fiscal transfers. ^[19] Cross-country migration flows are relatively small and are unlikely to ever become a key driver of labour market adjustment after large shocks. ^[20]
Thus, the long-term cohesion of the euro area depends on each country in the union achieving a sustainably high level of employment. And given the very high costs if the cohesion of the union is threatened, all countries should have an interest in achieving this.

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^[1]It is important to note, however, that the difference in euro area unemployment developments relative to the US also reflects very different developments in labour market participation. Over the period 2010-12, the decline in the participation rate contributed significantly to the fall in the unemployment rate in the US. At the same time, the rising participation rate in the euro area explains part of the rise in the unemployment rate. Assuming that, in both the US and the euro area, the labour force participation ratios had remained unchanged compared with 2007 and that the difference to the actual ratios had been fully reflected in the number of unemployed, the US unemployment rate in 2012 would have been higher than that of the euro area. For more information see Box 7 in the ECB Monthly Bulletin, August 2013.

^[2]The “credit gap” is computed as the difference between the actual and the counterfactual path of the total credit to non-financial corporations simulated by using the multi-country BVAR of Altavilla et al. (2014). More precisely, the counterfactual path has been obtained by measuring the stock of loans consistent with pre-crisis past business cycle regularities in absence of financial friction for the banking system. For further details see Altavilla, Carlo, Domenico Giannone and Michele Lenza (2014). "The Financial and Macroeconomic Effects of the OMT Announcements," ECB Working Paper No.1707.

^[3]U.S. industry-level studies find that a large part of the decline in match efficiency is driven by the low level of job openings and hires per vacancy in the construction sector—see e.g. Barnichon, Regis, Michael W. L. Elsby, Bart Hobijn and Ayșegül Șahin (2012) “Which Industries are Shifting the Beveridge Curve?" Monthly Labor Review, June 2012, 25-37; Davis, Steven J., R. Jason Faberman, and John C. Haltiwanger (2012) “Recruiting Intensity during and after the Great Recession: National and Industry Evidence,” American Economic Review: Papers and Proceedings.

^[4]Based on skill mismatch indexes computed as the difference between skill demand (proxied by educational attainments of the employed) and skill supply (proxied by the educational attainments of the labour force or unemployed, respectively). See (forthcoming) ECB Occasional Paper entitled “Comparisons and contrasts of the impact of the crisis on euro area labour markets’’.

^[5]In terms of calculating structural unemployment, the European Commission estimates a NAWRU while OECD estimates the NAIRU using a filter technique that seeks to disentangle movements in the unemployment rates into a structural and a cyclical component, on the basis of a Phillips-curve relationship. The estimates by the IMF are not based on any “official” method – meaning that they do not publish a model or a given methodology, since their internal estimates are subject to judgement.

^[6]European Commission, “Labour Market Developments in Europe 2013”, European Economy 6/2013.

^[7]In the short pre-crisis period between 1995 and 2007, for which we have homogeneous euro area data, average unemployment rates were around 9% in France and Italy, but above 14% in Spain. In Germany, the unemployment rate was also 9%, but only as a result of a large, previous increase following reunification.

^[8]Blanchard, Olivier, and Justin Wolfers (1999), “The Role of Shocks and Institutions in the Rise of European Unemployment: the Aggregate Evidence”, NBER Working Paper 7282.

^[9]See Burda, Michael C., and Jennifer Hunt (2011), “What Explains the German Labour Market Miracle in the Great Recession”, NBER Working Paper No. 17187; and Brenke, Karl, Ulf Rinne and Klaus F. Zimmermann (2013), “Short-time work: The German answer to the Great Recession”, International Labour Review Vol. 152, Issue 2.

^[10]Average of European Commission, OECD and IMF estimates.

^[11]While both Ireland and Spain experienced a strong influx of foreign-born labour in advance of the crisis, an important difference between the two counties is that in Spain a large proportion of these workers were naturalised. This in part accounts for the different emigration dynamics since the crisis.

^[12]European Central Bank (2010), Wage Dynamics in Europe: Final Report of the Wage Dynamics Network (WDN), European Central Bank.

^[13]See OECD Employment Outlook (2012), “How Does Spain Compare?”.

^[14]OECD, “The 2012 Labour Market Reform in Spain: a Preliminary Assessment”, December 2013.

^[15]The recommendations for the euro area adopted in the context of the 2014 European Semester explicitly call on the Eurogroup to explore ways to reduce the high tax wedge on labour.

^[16]   Alesina, Alberto, Carlo Favero and Francesco Giavazzi (2014), “The output effect of fiscal consolidation plans”, mimeo, May 2014.

^[17]The incoming European Commission President, Jean-Claude Juncker, has proposed a €300 billion public-private investment programme to help incentivise private investment in the EU economy.

^[18]Blanchard, Olivier, (2006), “European unemployment”, Economic Policy, pp. 5-59.

^[19]Cross-country transfers between euro area countries exist as part of the EU cohesion policy. These funds are however in principle temporary, as they designed to support the “catching-up” process in lower income countries.

^[20]Beyer, Robert C. M., and Frank Smets (2013), “Has mobility decreased? Reassessing regional labour market adjustments in Europe and the US”, mimeo, European Central Bank.



ASEAN ECONOMIC COOPERATION

 ASEAN Economic Cooperation
 
Created in 1967 mainly for political and security reasons, ASEAN has matured
over time as an institution moving from cooperation by consensus to integration
by choice. It is today a successful model for regionalism, widely recognized
globally. The first ASEAN Leaders’ Summit in 1976 was a watershed. It
introduced a significant economic agenda that helped drive progressive trade
and investment liberalization. By the early 1990s, the economies of ASEAN’s
five original members (Indonesia, Malaysia, the Philippines, Singapore, and
Thailand) were an integral part of the “East Asian Miracle.” Remarkably, the
group introduced several cooperative initiatives at a time when its membership
considerably expanded with the admission of Cambodia, the Lao People’s
Democratic Republic (Lao PDR), Myanmar, and Viet Nam (together known as
the CLMV countries).
The 1997/98 Asian financial crisis hit ASEAN economies hard. In the crisis
aftermath, the group’s dynamics changed dramatically, both internally and
externally, creating a drive for expanded cooperation and integration with the
PRC, Japan, and the Republic of Korea — through a newly established ASEAN+3
process. Amid huge socio-economic uncertainties, ASEAN pushed its integration
agenda forward with the adoption of Vision 2020 — a major commitment to
regional cohesion.
Further progress toward regional integration was made in 2003 with the
decision to form the ASEAN Community3 and, in 2007, with the adoption
of the ASEAN Charter and the creation of the Committee of Permanent
Representatives. More recently, ASEAN leaders promoted policies aimed
at narrowing development gaps and strengthening the group’s centrality in
the regional architecture for cooperation. Today ASEAN represents a major
economic bloc, home to about 620 million people with a gross domestic product
(GDP) of more than $2.3 trillion — 3.3% of the world total. Importantly, ASEAN
economies are also among the world’s most open, with merchandise exports
over $1.2 trillion — nearly 7% of the global total.
The trend of proliferating free trade agreements (FTAs) with partners around
the world started in the early 2000s. By the end of 2013, ASEAN countries
had signed 40 FTAs, including five ASEAN+1 agreements with key East Asian
partners (Australia/New Zealand, the PRC, India, Japan, and the Republic of
Korea). The Trans-Pacific Partnership (TPP) and Regional Comprehensive
Economic Partnership (RCEP), two of the 29 FTAs currently under negotiation,
have massive economic implications and potentially hold significant benefits for
signatories. This is particularly true for the RCEP, which would also greatly boost
ASEAN’s centrality in expanding Asian regionalism.
As for the AEC, although it is highly unlikely its blueprint will be completed
by 2015, it nonetheless represents one of the most important milestones for
ASEAN economic integration. It is structured on four pillars: (i) a single market
and production base; (ii) a competitive economic region; (iii) equitable economic
development; and (iv) integration into the global economy. Moving beyond the
2015 agenda toward 2030, ASEAN needs to further deepen regional integration
by creating a truly borderless economic community. Otherwise, it will risk losing
its centrality and competitive position vis-à-vis the PRC and India.

Highlights of the  international banking statistics

 Between end-December 2013 and end-March 2014, the cross-border claims of BIS reporting
banks rose by $580 billion. This marked the first substantial quarterly increase since late 2011.
The overall increase was broadly spread across countries and sectors.
 The largest increase in the first quarter of 2014 was reported in claims vis-à-vis borrowers in
China. This increase took the outstanding stock of cross-border claims on China above
$1 trillion at end-March 2014, including inter-office transactions by Chinese and other banks.
 Claims on the rest of Asia, Latin America and Africa and the Middle East also increased, albeit at
a more modest pace. By contrast, claims on emerging Europe fell for a fourth consecutive
quarter.

1. Recent developments in the international banking market
The contraction in overall international banking activity which began in late 2011 came to an end in the
first quarter of 2014. The cross-border claims of BIS reporting banks rose by $580 billion between end-
December 2013 and end-March 2014. While not enough to offset the preceding quarterly declines, the
rise in Q1 2014 caused the annual rate of contraction in cross-border claims to slow from –3.7% as of
end-2013 to –2.0% as of end-March 2014.1
The upturn in overall activity in the first quarter of 2014 was boosted by the first quarterly
increase in cross-border claims on banks since late 2011 (Table A1). Interbank claims, which in the
locational banking statistics2 capture positions with related offices as well as unrelated banks, rose by
$306 billion. As a result, the annual rate of contraction of cross-border interbank activity slowed from
–5.3% at end-December 2013 to –2.9% at end-March 2014. As usual, the expansion in interbank claims
consisted almost entirely of loans (Graph 1, left-hand panel). Claims on other banks and related offices in
the euro area, including intra-euro area activity, increased by $111 billion in Q1 2014.
Matching the rise in cross-border interbank lending to the euro area, overall euro-denominated
claims also grew during the first quarter of 2014. The $158 billion quarterly increase was the first since
early 2012 . It reduced the annual rate of contraction in euro-denominated cross-border claims
from –11% at end-2013 to –8.4% at end-March 2014.
1 Annual percentage changes are calculated as the sum of exchange rate- and break-adjusted changes over the preceding four quarters divided by the amount outstanding one year earlier.
2 The locational banking statistics are structured according to the location of banking offices and capture the activity of all internationally active banking offices in the reporting country regardless of the nationality of the parent bank. Banks record their positions on an unconsolidated basis, including those vis-à-vis their own offices in other countries.

Cross-border claims of BIS reporting banks
By type of instrument and sector of counterparty Graph 1
Annual growth rate1 Share of outstanding claims Per cent Per cent
1 Calculated as the sum of exchange rate- and break-adjusted changes over the preceding four quarters divided by the amount outstanding one year earlier. 2 Other claims include equities, derivatives and other financial claims not classified as loans, deposits or debt securities.

Overall cross-border claims on non-banks – mainly non-bank financial institutions, governments and non-financial corporations – also grew between end-December 2013 and end-March
2014. The $274 billion rise was the largest since late 2010. While loans accounted for the bulk of the
increase in Q1 2014 ($196 billion), BIS reporting banks continued to increase their holdings of nonbanks’
securities as well ($78 billion). However, the pace of their securities purchases slowed from the
growth rates seen in 2012 and 2013 (Graph 1, left-hand panel, purple line). Cross-border lending to non-banks in the United States was especially strong, expanding by $73 billion in Q1 2014. The BIS consolidated banking statistics3 on an immediate borrower basis suggest that the majority of this rise was due to increased lending to the US non-bank private sector, whose share of all international claims on the United States rose by a full percentage point (from 52.0% to 53.0%) between end-December 2013 and end-March 2014. By contrast, the share of claims on the US public sector declined by 0.7 percentage points (from 23.5% to 22.8%) during the same period. Notwithstanding the latest quarterly upturn in cross-border interbank loans, their share of overall cross-border claims has gradually declined from roughly two thirds at end-1995 to 46% at end- March 2014 (Graph 1, right-hand panel, red line). By contrast, the share of cross-border loans to nonbanks, which remained stable at around 20% between end-1995 and end-2005, has grown over the past few years, and reached 24% at the end of Q1 2014 (blue line). In the meantime, the share of banks’ cross-border holdings of securities issued by non-banks more than doubled between end-1995 and end-2005 (from 8% to 19%) before retreating to 17% as of end-March 2014 (purple line). Finally, the share of banks’ cross-border holdings of securities issued by other banks increased from 3% at the end of 1995 to 13% at the end of March 2014 (yellow line).
3 The consolidated banking statistics are structured according to the nationality of reporting banks and are reported on a worldwide consolidated basis, ie excluding positions between affiliates of the same banking group. Banks consolidate their inter-office positions and report only their claims on unrelated borrowers.

Credit to emerging market economies
Cross-border lending to emerging market economies continued to grow in the first quarter of 2014. The
$165 billion increase in Q1 2014 brought the annual growth of claims on emerging markets to 10% at
end-March 2014.
Just as in the preceding several quarters, the overall expansion in cross-border claims on
emerging markets during Q1 2014 was driven primarily by lending to China, which rose by $133 billion.
This took the annual growth rate of claims on China to 49%. At end-March 2014, the outstanding stock
of cross-border claims on China stood at just over $1 trillion, with interbank claims accounting for almost
three quarters ($726 billion) of that amount. The consolidated banking statistics indicate that a
significant share of the reported cross-border claims on China – over $400 billion – is booked by banks
headquartered outside the BIS reporting area through their offices in BIS reporting countries: for
example, through Chinese banks located in Hong Kong SAR.4, 5 By comparison, the consolidated foreign
claims of banks headquartered inside the BIS reporting area on Chinese residents totalled $796 billion
on an ultimate risk basis at end-March 2014.Claims on the rest of emerging Asia also grew (by $21 billion) during Q1 2014, but at a much more moderate pace than those vis-à-vis China (7.8% on an annual basis).
Just as in the preceding quarter, claims on Latin America and the Caribbean grew at a very modest pace during Q1 2014. Claims on the region rose, but only by $8.0 billion. Internationally active
banks increased their claims on Brazil by $7.2 billion. By contrast, cross-border lending to the residents
of Mexico contracted by $3.8 billion.
Cross-border lending to emerging Europe fell for a fourth consecutive quarter. The $14 billion
contraction, which was larger than any of the three that preceded it, caused claims on the region to fall
by 1.9% on an annual basis. Among individual countries, claims on Turkey and Poland shrank the most
(by $5.3 billion and $4.8 billion, respectively). By contrast, claims on Hungary rose by $1.3 billion in
Q1 2014.
As the geopolitical uncertainty surrounding Russia and Ukraine increased in the first quarter of
2014, internationally active banks reported declines in (the US dollar value of) their consolidated foreign
claims on both countries. The consolidated banking statistics on an ultimate risk basis reveal that the
outstanding stock of foreign claims on Russia declined from $225 billion at end-December 2013 to
$209 billion at end-March 2014, while those on Ukraine dropped from $25 billion to $22 billion.
However, the reported reductions in foreign claims were amplified by the sharp depreciation in the value
of these countries’ currencies against the US dollar during the first quarter of 2014, which reduced the
US dollar value of claims booked in local currencies through local affiliates. The locational banking
statistics indicate that, on an exchange rate-adjusted basis, cross-border claims on residents of Russia
remained virtually unchanged in Q1 2014 (–$0.3 billion), while those on Ukraine declined by $1.5 billion
(–15% on an annual basis).

Single Euro Payments Area

 

What is SEPA?

Safe and efficient payments, throughout Europe

The Single Euro Payments Area (SEPA) is a project to harmonise the way we make and process retail payments in euro. The goal is to make payments in euro and across Europe as fast, safe and efficient as national payments are today. SEPA enables customers to make cashless euro payments to anyone located anywhere in Europe, for example by credit transfer, direct debit or debit card.

SEPA countries

The Single Euro Payments Area (SEPA) initiative aims to overcome technical, legal and market barriers between countries in order to create a single market for retail payments in euro. The SEPA territory consists of 34 European countries and also includes countries which are not part of the euro area and the European Union.

Stakeholders and legal framework

The SEPA project was launched by the European banking and payments industry and is supported by EU governments, the European Commission, the Eurosystem, and other public authorities .Agreed standards, technical requirements, and a common legal basis are the foundation for payments within the SEPA area, irrespective of the countries involved in the transaction.

Migrating to SEPA

Two new SEPA instruments were introduced in 2008 (SEPA credit transfer) and 2009 (SEPA direct debit). EU Regulation No 260/2012 establishes the technical and business requirements for credit transfers and direct debits in euro. The regulation is also referred to as the “SEPA end-date regulation” and defines the deadlines for the migration to the new SEPA instruments. The deadline for the euro area is 1 February 2014 and for non-euro area Member States 31 October 2016. As of these dates, the existing national euro credit transfer and direct debit schemes will be replaced. A proposal amending the SEPA end-date regulation introduces a further transition period of six months that can be applied in euro area countries..