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Britain's performance in international financial markets.

There have been few attempts to compare and explain inter-country contrasts in the efficiency and performance of service industries. This largely reflects the inapplicability to services of productivity comparison techniques developed for manufacturing industries, relying as they do on physical output measures and focussing essentially on labour inputs. A study for the National Institute,(1) shortly to be published, endeavours to break new ground by comparing the performance of the British commercial and merchant banks with that of the relevant financial institutions in our major competitor countries on the basis of the shares obtained by these institutions in selected international financial markets.

With the advent of the liberalisation of the European Economic Community's internal market it was thought that such a study would have special interest at the present time. It was felt necessary to test the view that, in contrast to more pessimistic expectations voiced about the likely fate of the United Kingdom's manufacturing industry in 1973, Britain's financial service industries might currently be in a position to |clean up' at the expense of continental competitors.

The sample of financial markets chosen for analysis was specified on the basis of their size and representativeness, the selection being strongly biased in favour of financial services that are traded in international rather than domestic arenas. Country shares of such markets are a superior guide to the inherent competitiveness of their respective financial institutions than are domestic financial markets where for a variety of reasons, regulatory or less formalised, national institutions enjoy advantages that owe nothing to their intrinsic efficiency.

The chosen markets are: the market for foreign exchange; the market for merger and acquisition advice; the market for syndicated bank loans; the Eurobond market; the international equity market; the Eurocommercial paper market; and the market for Euro medium-term notes. For each of these markets country performance has been measured by aggregating on the basis of the nationality of the individual major participating financial institutions the market shares obtained. The results thus reflect the relative performance of British banks regardless of the global location of their operations, and not the performance of the City - comprising as it does financial institutions of all nationalities - with that of overseas financial centres.

Changes in country shares during the 1980s have been traced, and the picture at the end of that decade analysed in depth, for each market. The results reveal that whilst the United Kingdom has won substantial shares in all the markets examined in none did these shares approach those commanded by the most successful country, the United States. Britain's performance ranged from second place (in each case after the United States) in the markets for foreign exchange, M&A advice, syndicated loans, commercial paper and medium-term notes, to third place (after the United States and Japan) in the market for international equities down to an also-ran position in international bonds and Eurobonds.

The accompanying table constitutes an attempt to aggregate the results obtained for these individual financial markets using as weights typical fee/margins charged for the services. Although subject to some statistical qualifications it clearly reveals that the United States plays an undisputed dominant role accounting for about two thirds of the world market for these services, followed at some distance by Britain with rather less than a fifth of the total. As for the rest of the pack - Japan, France, Switzerland, Canada, Germany, Australia, the Nordic group, the Netherlands, Italy and Belgium - none won shares in excess of 10 per cent of markets which, clearly, are the preserve of a handful of industrialised countries.

It is illuminating to compare national performances quantified in this way with country size as measured by GDP. The table reveals that when fee-weighted shares are standardised for this factor Britain occupies pole position, the United States coming second and Switzerland third, performances which contrast sharply with those of major economies such as Japan, Germany and France.

A second part of the study is taken up with identifying the factors which account for these contrasts in national performance in international financial markets. Differences in market shares can be explained, quantitatively, in terms of such basic industry characteristics as: the number of national financial institutions playing significant roles in these markets; their output in terms of the numbers of deals, loans and issues for which they are responsible; together with the average values of these units of output. In terms of all three factors the United Kingdom's performance suffers in comparison with the United States: fewer British institutions operate in these markets and on average produce a smaller number of units of relatively low value.

A different picture emerges when the United Kingdom's performance is assessed alongside that of other country rivals taken as a group. Here the analysis reveals a relatively high degree of United Kingdom firm participation, especially in the case of M&A activity where British institutions outnumber the rival group, and, except in the case of the international bond market, comparatively large numbers of units produced per British institution. In terms of average values the United Kingdom's position is more equivocal vis-a-vis these competitors: in two markets - syndicated loans and medium term notes - British average values are relatively high but in others they are lower or about the same as those achieved by competitors. Nevertheless the net outcome is that, the international bond market aside, output values per British firm are superior to those achieved by our non-American competitors.

To explain contrasts in national performance a great deal of weight has also been attached to views expressed by the protagonists in these market. For this purpose thirty six interviews were conducted in London, Paris and Geneva, with financial institutions of British, American, Japanese, German, French, Swiss, Canadian and Nordic nationalities. The type of institution covered embraces the whole gamut of those active in the selected financial markets: commercial, merchant, investment and universal banks together with security houses.

Joint Anglo-Saxon market domination of the global market to the tune of more than four fifths of the total is surely remarkable. It is difficult to dissociate such success from two features which the two countries' systems share in common: basically open, unprotected, domestic financial markets and a consequent exposure of national financial institutions to untrammelled international competition; together with a degree of separation of commercial and investment banking activities, to a greater extent in the United States than in the United Kingdom.

It emerged that performance as measured by market shares is influenced by a series of factors that range beyond the efficiency, narrowly defined, of a country's financial institutions, although by biasing the market selection towards international arenas it was intended that, as much as possible, national contrasts in innate competitiveness substantially influence the results. Some of the forces which, it emerged, have the strongest influence on market shares are those such as the nature of domestic markets, national economic features, regulatory regimes and industrial structures, that reflect the ambience in which a country's financial institutions function rather than factors which have a more narrow and immediate impact on their operational efficiency. Some factors which fall into the latter category - human resources, capital inputs, technology - whilst absolutely very important in the production of these financial services appear to have a relatively muted impact on contrasts in inter-country performance. Since the study suggests that Britain's commendable results in these capital markets have been achieved largely in the absence of the special background features which have favoured the operations of major rivals it is very probable that the outcome reflects a comparatively high degree of efficiency and competitiveness among these British institutions.

The interviews unearthed a whole series of causes responsible for the United States domination of these markets: regulatory factors that triggered an early entry into international capital markets; a consequential expertise which was reflected in an ability to innovate and exploit the life cycles of capital market products; access to human resources and technologies in some measure superior to those available to rivals; and a scale of operations characterised by the participation of large numbers of financial institutions, producing large volumes of high value products and a wide range of market diversification.

Two further background factors have had major impacts on the American performance. First all the evidence suggests that separate structures for commercial and investment banking, legally enforced in the domestic markets of the United States, provide a superior competitive basis than universal banking for operations in international capital markets. Secondly the existence of a large sophisticated but open domestic market for financial services endowed American financial institutions with a test bed for new products and promoted their efficiency as a result of unfettered competition from national and foreign companies.

Japanese institutions too have enjoyed some competitive advantage as a consequence of their access to a large domestic market which has also been the source of inexpensive funds. In their case however the existence of a domestic springboard is in part due to formal and informal barriers to foreign entry, a factor inimicable to operational efficiency. As in the United States Japanese institutions gain from the domestic separation of commercial banking and security operations.

For the most part Britain's major Continental rivals find themselves at a disadvantage insomuch as their operations in these markets are for the most part conducted by less suitable universal banking structures. They also lack the efficiency boost associated with open domestic markets. However formal and less formal market protection, and in the case of Switzerland the local availability of large expatriate funds, provide relatively secure domestic bases from which forays can be made into international markets. In the case of Switzerland and Germany, especially, this has been accompanied by the competitive advantages which have stemmed from beneficial domestic economic conditions: strong currencies and relatively low interest rates.

In contrast British financial institutions have derived little competitive benefit from these latter influences though the earlier international role of sterling helps to explain why the United Kingdom is strong in some of the older markets examined. Neither, compared with the United States, Japan or even Switzerland, can British institutions be regarded as gaining from access to a large domestic market. Nor have capital costs, as dictated by national interest rates, worked to their advantage. On the positive side the analysis revealed - as noted - relatively large numbers of British institutions active in international markets, producing service units in above average quantities. However their record in terms of unit values, especially compared with the United States but also in some instances relative to other competitors, is less good.

This latter operational failing is associated with a structural weakness highlighted by the study: the comparatively small size of independent British merchant banks. The evidence strongly suggests that had recent changes in the structure of British banking taken the form of mergers between merchant banks rather than acquisitions of merchant banks by commercial banks the British industry would be more competitive in international markets.

Given, on the one hand, the degree of success which the United Kingdom has enjoyed in these markets and, on the other, the disabilities from which, relative to competitors, the country's financial institutions have for the most part suffered it is difficult to avoid the impression that their achievements are substantially attributable to a measure of inherent efficiency, even though this concept may be difficult to identify and quantify directly. In turn it is hard not to attribute much of this to the exposure in recent years of British institutions to essentially unrestricted competition in domestic and international markets from the best financial institutions in the world. This honing of the competitive capabilities of the British industry has not been without cost. Rivals - especially American institutions - have won substantial shares in British markets to the point where in some cases the United Kingdom experiences a deficit in supply. Also British market shares have been lost when, in order to enter the relevant markets, foreign banks have bought British institutions.

Operational and financial problems associated with recession, collapses in property markets, and increases in bad debt provisions - all of which have been accentuated since the conclusion of the study - have damaged the banking sectors of the major participants. Nevertheless the extent of these detrimental impacts is not uniform across countries and, in the short to medium term, these differential impacts will influence comparative performance. The evidence suggests that whilst British financial institutions, taken as a group, may not currently be as healthy as those of, say, Switzerland, they are better placed in these respects than their American and Japanese rivals.

Future shifts in relative performance are likely to be strongly influenced by regulatory factors. Whilst it is widely recognised that the introduction of BIS capital adequacy ratios will circumscribe the activities of American and Japanese banks the United Kingdom finds itself amongst those countries where compliance should not pose major problems. Similarly any flirtation on the part of American and Japanese commercial banks with investment bank or security house takeovers consequent on the likely abandonment of their statutory separation in these countries could well be conducive to a loss of performance. Given its recent experience with this form of structural change it seems unlikely that the British financial services sector will go any further down the same path.

Whilst there is no denying the underlying competitive strength of America's institutions, and perhaps in the longer term those of Japan too, the circumstances considered above will not afford them the best basis for entry into continental Community markets following the latters' liberalisation. This should make room for an improvement in the performance of British institutions in the markets of co-member states. It is irrelevant whether the comparatively poor international performance of Continental countries in the chosen markets reflects their dependence on the universal banking system or the degree of protection which their domestic operations enjoy. In the longer term, although subject to delay as a result of the persistence of informal restrictions, the opportunities exist for substantial British gains on the Continent. The study suggests that if one measure were to be singled out for improving Britain's performance in international capital markets it would be a restructuring of the British banking industry from which should emerge fewer, larger, stronger independent investment banks.
Country shares of aggregated financial markets('), 1989
 Fee weighted GDP Fee weighted
 market share % share/GDP
 % relative(b)
United States 66.3 32.7 2.03
United Kingdom 17.0 6.7 2.53
Japan 5.1 22.4 0.23
Switzerland 2.1 1.4 1.50
France 4.2 7.5 0.56
Canada 3.2 4.3 0.74
Germany 0.8 9.6 0.08
Australia 0.3 2.2 0.14
The Nordic group 0.1 3.0 0.03
The Netherlands 0.3 1.8 0.17
Italy 0.2 7.0 0.03
Belgium 0.1 1.3 0.08
Other 0.3
Total 100.0 100.0
(a) Market shares presented in this table should be regarded as approximate.
(b) The markets covered are: global M&A, syndicated loans, international
bonds, international equities, Euro certificates of deposit and commercial paper
and Euro medium term notes.


(1) Anthony D. Smith, International Financial Markets: the Performance of Britain and its Rivals, National Institute Occasional Paper XLV, Cambridge University Press 1992. The research was funded by grants from the Bank of England, HM Treasury, the Department of Trade and Industry, Barclays Bank, Lloyds Bank, the Midland Bank, the National Westminster Bank, Ernst and Young and Daiwa Europe. To these sponsors and to the many officials of the large number of financial institutions who provided, during the course of interviews and otherwise, information on which the study has drawn, both the National Institute and the author express their sincere gratitude.

For a much more detailed assessment of this subject by the same author, a book entitled International Financial Markets: the Performance of Britain and its Rivals by A.D. Smith will be published on 17th September. see page 122 for further details.
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Author:Smith, A.D.
Publication:National Institute Economic Review
Date:Aug 1, 1992
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