Financial Services
Integrated markets

There are few estimates of the direct efficiency gains in financial services or their indirect beneficial effects on trade and investment resulting from the completion of the European Community's `1992' programme. The Cecchini Report's estimated price reductions and consumer welfare gains from integration were based on a limited price survey of EC banks and an estimate of the elasticity of demand for financial services based on a study of the US insurance sector.

In Discussion Paper No. 677, Research Affiliate Cillian Ryan constructs a general equilibrium model of financial services to simulate the effects of `1992' on short-run consumer and industry finance markets and long-run asset markets. He calibrates it to data for 1988 for Belgium, France, Germany, Italy, the Netherlands and the UK and finds both important gains from market integration for the Community as a whole and considerable variations across member countries. The gains are significantly larger than those estimated by Price Waterhouse, because his model encompasses a much broader range of potential effects. First, it measures the benefits to depositors as well as borrowers from efficiency gains in the financial services sector. Second, it considers the effects on financial service providers. Bank returns will initially fall, because the increase in demand for intertemporal financial services is insufficient to offset these efficiency gains. This leaves resources unemployed and redistributes factors away from this sector, but it will eventually lead to welfare gains due to increased output of other goods. Third, the model measures the costs and benefits of an integrated European capital market to borrowers and lenders in each country: Belgian and Dutch lenders and UK borrowers will lose with market integration despite the efficiency gains for the market as a whole. Fourth, it suggests that Belgium and Germany are the most likely providers of financial services in the integrated market, but this depends upon on the ability of other countries to respond to the new competitive pressures. It also provides estimates of the likely intra-EC trade effects on the current and capital accounts of the balance of payments.

Ryan concludes by calling for the development of a model of banks' transactions services incorporating economies of scope, whose growth may accommodate the redundant factors from the intertemporal financial services considered here. The model also advocates the separation and modelling of final consumer and government demands and the intermediate demands of producers, and the incorporation of existing international capital flows.

The Integration of Financial Services and Economic Welfare after 1992
Cillian Ryan

Discussion Paper No. 677, June 1992 (IT)