Speech by John Townend, Director for Europe
at a British Bankers' Association Conference on 5 November
2001
The Completion of the Changeover to the Euro Across the First Wave and its Implications for the UK
I am very grateful for the invitation to contribute to another BBA conference on the euro. It is obviously very timely, not because it is November 5, since it is not the occasion for fireworks, but because the end of the transition is now just 38 working days away. I have been spending a great deal of time visiting euro-area countries, to discuss with the central banks and literally dozens of commercial banks how the changeover is going, and the kind of issues that are arising. In the last five weeks alone, I have been to seven countries - so we can be as well informed as possible in the UK, and both learn about, and from, the first wave before their collective memory fades.
Completing the euro changeover is an unprecedented undertaking, directly affecting over 300 million people in 12 countries. It involves both the completion of the non-cash changeover, particularly the conversion of legacy bank accounts and payments, by the end of this year, and the introduction of euro cash in exchange for legacy cash at the beginning of next year. Besides its direct impact on the euro area, the changeover is also of great interest in the UK, because there are implications for UK banks, for importing and exporting companies and for travellers here, and because we all want to learn any lessons from the changeover in the first wave in case the UK subsequently joins.
It is too early to draw any detailed lessons, until the cash changeover is complete. But what we can do is to compare and contrast the approaches to the changeover that different countries in the euro area have taken, within the overall framework agreed at European level. And out of the mass of information available, I shall try to pick out the issues that matter and those which have so far proved most problematic. I shall start by considering briefly the way in which the changeover has been organised in the first wave, and then discuss the following aspects: the completion of the non-cash changeover; the cash changeover; the information campaign to familiarise the public; some of the risks and costs; and the economic impact, particularly on prices. I shall end with some remarks about the implications for the UK. Obviously, I shall be looking at the completion of the changeover from a central bank perspective.
Organisation
All the euro-area countries have a common interest in ensuring that the changeover is completed in a smooth and orderly way. But in different countries, the changeover has been organised in different ways. In Belgium, France, Italy, Portugal and Spain, the national changeover committee or equivalent has closely co-ordinated the changeover according to a common plan, while in the other euro-area countries the approach has been less prescriptive and more informal, leaving more to the initiative of individual banks. The central bank role has varied from country to country. But in all countries, the central bank has, at the minimum, played a role in monitoring or assisting preparations for completing the non-cash changeover in the financial sector, and in organising the cash changeover, within an overall framework set by ECOFIN and the ECB.
Completing the non-cash changeover
The main objective in the case of the non-cash changeover is to ensure that it is completed on time by the year-end. That is not of course a problem in the wholesale financial markets, where the changeover largely took place when the euro was launched at the beginning of 1999. There are only a few residual end-of-transition issues, affecting legacy bonds, company accounts, historic information and external reporting, including by screen providers. With our encouragement, the Commission has clarified how these questions should be addressed, and we have set them out in the June Practical Issues and provided an update to the City Euro Group in October.
Completing the changeover in the retail payment infrastructure across the euro area is also not expected to be problematic, because of the preparatory work already done, much of it in the run-up to the launch of the euro in 1999. The main exception is that POS and ATM terminals need to be adapted by the end of the year to enable payment in euro. From the beginning of 2002, all non-cash payments should be denominated only in euro. The main residual question is how to handle cheques and other payment orders denominated in legacy currency and due to be settled after the year-end. The legacy currency clearings will stay open to settle these outstanding payments, for a period which varies from case to case. All legacy cheques dated 31 December or before need to be cleared, as in most cases it is not possible for banks to determine whether a cheque has been written after 31 December, but dated before. There is also a risk that some customers will confuse legacy amounts with euro amounts. This is a problem particularly in Ireland, because the conversion rate there is relatively close to unity.
The most important issue for banks in preparing for the completion of the non-cash changeover has been planning the conversion of their customers' accounts and related products from legacy currency to euro. Given the sheer scale of the project and its complexity, the necessary work has had to be meticulously planned.
The preparatory work has been at two levels. First, the authorities in each country have had to decide whether to leave planning on an early or late conversion entirely up to the banks, through a decentralised approach, or to co-ordinate the work and encourage the banks all to convert according to a common plan. Second, individual banks have either had to take the initiative to convert their customers' accounts gradually over a period of time before the end of this year, or to prepare for a 'big bang' conversion at the year-end. Customers have, of course, been entitled to ask for conversion earlier themselves, but few have chosen to do so.
Although approaches have converged over the past year, both across countries and between individual banks, clear differences have remained. In some countries (Belgium, France, Portugal, Spain and, to some extent, Italy) the authorities have taken various initiatives to co-ordinate banks' preparations, encouraging them to convert accounts early and promote the use of euro payments ahead of the year-end. In other countries (Austria, Finland, Germany, Greece, Ireland, Luxembourg and the Netherlands), the authorities have taken a more decentralised approach, leaving the timing of the non-cash changeover up to individual banks to decide.
In practice, individual bank plans do not always fit in to these national patterns. In Belgium, France, Italy, Portugal and Spain, many banks plan in practice to leave the conversion of at least some of their customer accounts until the year-end. And in the other seven countries, many individual banks, such as the large commercial banks in Germany and the two largest banks in the Netherlands, have converted at least some of their customer accounts before the year-end. Only in Austria, Finland, Greece and Ireland are all, or nearly all, banks planning a 'big bang' at the year-end. But even in these cases, banks have spread the preparatory workload, at least to some extent, so they will be ready in time.
There are a number of reasons for these divergences in approach. Different countries traditionally have different project management styles. In this particular case, they have also had differing views about what an orderly changeover to the euro should involve. In some countries, the authorities have preferred the non-cash changeover to take place early, so that it does not coincide with the beginning of the cash changeover, which is itself a massive task. They have also wanted the public to become accustomed to using the euro gradually. By contrast, the authorities in other countries consider that a 'big bang' will help to limit any confusion from the changeover, as euro awareness among the public will be higher at the end of the transition period. And they are confident that there is a sufficiently long (four-day) window at the year-end to complete the changeover in time.
To some extent, these differences in approach depend on the size of individual banks. In the larger countries, and also in small countries with a few large banks, there are so many accounts to be converted at the big banks that a 'big bang' conversion at the end of this year is regarded as too risky, or simply impracticable, in the time available. That is particularly the case where banks have old or complex internal systems. Large insurance companies have also found it impracticable to convert all their operations in a 'big bang' at the year-end.
In most euro-area countries, banks planning to convert accounts before the year-end have informed their customers in advance, but assumed that they agree unless they explicitly object. Very few personal customers, incidentally, have done so. Explicit consent from customers was originally judged necessary only in Italy, and there a Government decree in September has enabled banks to convert accounts after publishing a notice in the Official Gazette, giving customers 15 days to object to conversion in writing. But in Spain, banks have only converted the accounts of their business customers early where they have given their explicit consent in writing, which few have done. And in Ireland, one of the reasons for a 'big bang' conversion at the year-end is that it avoids the need to obtain customers' permission, which might otherwise be legally required there.
Banks planning an early account conversion have tended to convert the accounts of personal customers ahead of business customers, because there are a much larger number of them and they are more straightforward to convert. They are also considered less likely to object, as conversion has little practical effect on them. By contrast, banks need a more customised approach for business customers. Many large companies have chosen to convert early. But where companies, including SMEs, plan to continue operating internally in legacy currency until the end of this year, an early conversion of their bank accounts to euro may lead to reconciliation problems, though there are a number of ways of overcoming these.
The main problems with completing the non-cash changeover on time relate, not so much to the changeover by the banks, but to the changeover in parts of the corporate and public sectors. Most large companies are expected to be ready to convert their own operations in time, where they have not already done so. But many small businesses may not. Some of them have not been sufficiently clear what they need to do by when, and have underestimated the scale of the task. There is also a problem with some local authorities, though conversion for them may be more straightforward than at national level. It appears that, at national level, most public administrations are well prepared, even though in almost every case they are concentrating their changeover at the year-end. This is less the case with local authorities, particularly townhalls in remote locations. Completing the non-cash changeover on time is important, because the cash changeover is in itself an extraordinary logistical challenge.
The cash changeover
The cash exchange period was originally intended to last six months, and later shortened to a maximum of two. The Netherlands, France and Ireland are planning an even shorter period. A short cash exchange period is intended to reduce costs to banks and retailers, and also the risk of inconvenience to, and confusion amongst, the public. In most countries, the emphasis now is on completing the cash exchange as quickly as possible, though in Ireland there is confidence that this can be done without changing the normal pattern of cash use.
To ensure that euro cash can be put into circulation on 1 January, notes and coin have been frontloaded to banks and sub-frontloaded to retailers, starting at the beginning of September. The demand for frontloading from banks has varied from country to country. Some countries like Spain, Greece, Austria and Germany, for example, use much more cash per head of population than others, like Finland and Luxembourg, where card use is very extensive, or France, where cheques are still widely used. And the national authorities are following different approaches to the distribution of frontloading, depending on the number of their own central bank branches and cash centres, the capacity of the transport network, the facilities for storing notes and coin, and the period of time they have allowed for the changeover.
Frontloading has been a huge logistical exercise, involving the transport to, and secure storage of euro notes and especially coin at, banks. But with a few exceptions, it has not so far proved to be a logistical problem. And the financial burden on the banks has been eased by the ECB delaying payment for the euro cash, under the so-called 'debiting model' until three dates in January. However, sub-frontloading to retailers has proved more problematic, as the costs and risks of transport and storage and the costs of insurance have left them with few incentives to take cash until the last minute. Some countries have provided financial incentives to help offset some of the costs. Negotiating extra insurance for storage has been difficult in some countries - but in most cases, a solution has now been reached.
All countries plan to convert to euro the majority of their cash transactions by mid-January. In most countries, the aim is to exchange legacy for euro cash as quickly as possible. By contrast in Ireland, where the emphasis is on leaving unchanged the normal pattern by which the public obtains and spends cash, and in Finland, where use of cards is high and cash use is relatively low, the approach to the cash changeover is more relaxed. Nevertheless, both these countries remain confident of meeting the mid-January objective. And throughout the euro area, a number of steps are being taken to facilitate the cash changeover.
First, speedy adaptation of ATMs is important, as they provide the route through which 70% of banknotes enter general circulation. Countries with four drawer machines have a distinct advantage, as two drawers can be filled with euro prior to 1 January, while the other two drawers continue to dispense legacy currency; and the active drawers can then be switched over remotely at midnight.
Wherever possible, small denomination notes are being distributed - before the end of the year in legacy currency and in euro thereafter - so as to reduce the amount of euro that retailers need in stock to provide as change.
National authorities have tried to reduce the workload on the banks during the cash exchange period by encouraging the public to return hoarded coin early. A number of countries have introduced charity schemes to encourage the early return of hoarded legacy cash. Even so, the bulk of legacy coin and virtually all legacy notes will be collected during the cash exchange period. Collecting the legacy cash is a problem, because the authorities will not know in advance precisely when, or in what quantities, it will become available at which collection points.
Retailers are being encouraged to provide, and customers to accept, change only in euro, to help keep queues in shops to a minimum.
Banks are actively promoting the use of electronic forms of payment, including debit cards, instead of cash (or cheques). It is clearly important that electronic payment systems are able to cope with a sudden increase in demand. Most banking associations are confident that they can do so.
Although 31 December is a non-value day for payments in the euro area, bank opening hours are being extended early in the New Year, to service retailers and the public with their notes and coin requirements. In almost all countries, banks will be prepared to exchange cash free of charge, at least until the end of the cash exchange period. And central banks will also exchange the legacy cash of other euro-area countries as well, until the end of March.
The information campaign
Explaining the changeover, especially to retailers and the public, is obviously vital to minimise the risk of public confusion. The ECB and national central banks are taking a prominent part. Their main messages, which are uniform across the euro area, are designed to make the general public in the euro area familiar with the following: the visual appearance of the euro banknotes and coin, including their colour and dimensions; how to recognise their security features (using the catchphrase 'feel, look, tilt'); their denominations; and the timing of the changeover. And public awareness of the euro is being increased in a number of other ways, such as the use of dual price displays, which are compulsory for a period in some countries, while there is voluntary agreement to use them in others.
Risks and costs
It is not possible to eliminate all the risks of the changeover. But they can be minimised by careful preparation. In the case of the non-cash changeover, the risk is that too much has been left until the last minute. This is particularly a risk with small businesses and some local authorities.
The risks arising from the cash changeover are of different kinds. One is that, however well prepared the authorities in each country may be, the changeover is not directly under their control, as the public decides how quickly to exchange their cash, and this determines the timing of the return of the legacy cash which the authorities need to arrange to collect.
Second, there are risks to the cash distribution process. The main risk is ensuring that there is not a shortage of euro cash at the beginning of January. This has been addressed through frontloading and by increasing the production of low denomination notes. There are risks to the cash distribution process from storing and transporting large amounts of cash; there is also a risk of industrial action, and of course bad weather. Many of these risks are greatest during the period of frontloading, though national authorities have contingency plans in place until the cash exchange period is complete, and there will be an information network to enable them - and us - to keep in touch.
Third, there is a greater than normal risk of criminal activity in the form of counterfeiting and money laundering. The counterfeiting risk is obvious because the general public will initially be unfamiliar with the new euro banknotes and coin and the scale of the market for euro banknotes is enormous. But the authorities are countering the risk in a number of ways. The euro banknotes incorporate in their design a very large number of security features, more than many of the national notes they are replacing. Helping the general public to identify the new notes and coin correctly has been a major focus of the information campaign. The ECB is co-ordinating anti-counterfeiting measures. And a new EU Regulation has been adopted.
The other risk is money laundering. No euro-area country will relax its anti-money laundering laws, which have the effect of limiting the amount of cash that individuals can exchange at banks at any one time, during the completion of the euro changeover. Even so, given the much increased workload during the cash changeover period, there is a risk that money laundering may be detected less than normal. The main response at national level is increased vigilance.
Turning to costs, there are no reliable estimates of the precise costs of the euro changeover. However, some broad-brush estimates have been published. The President of the ECB has estimated these costs at between 0.3% and 0.8% of euro-area GDP, spread over a period of time, and covering both the cash and non-cash changeover, but this is inevitably broad-brush.
In the autumn of last year, ECOFIN agreed the general principle that the costs of the changeover should be borne where they arise, and that governments should not provide compensation. This principle has been put into practice, with the modest exception of allowing delayed payment by banks for frontloading, under the ECB's debiting model, and - in some countries - assistance to banks and retailers to help defray some of the costs of frontloading and sub-frontloading. These steps are intended to act as a frontloading incentive rather than to provide compensation as such, and represent a very small proportion of total changeover costs.
The banks have in general not attempted to offset their costs of the changeover by charging specifically for conversion. In accordance with the euro Regulations, there is agreement that banks should not charge their customers for the conversion of their bank accounts from legacy currency to euro; nor charge them for the exchange of their legacy notes and coin during the cash exchange period: there are limits on the amount that can be exchanged and on non-customers in only a few countries. However, this leaves the more general question of whether the changeover will lead directly to a rise in prices.
Economic impact
The main public concern about the changeover is that it will do just that: the fear is that costs will be passed on; prices rounded higher; and menus adjusted upwards to new psychological price points. The ECB and national central banks are doing everything they can to allay public concern and, with the appropriate statistical agencies and organs of Government, they are monitoring the situation closely. By enhancing competition, the introduction of the euro should of course help in the medium term to keep prices down. A number of central bank studies certainly suggest that, while there may be temporary upward pressure on prices, in the longer term, there should be downward pressure, owing to price transparency and increased competition.
Separately, price transparency will also expose some of the remaining cross-border barriers to the Single Market. These include the gap between cross-border and domestic retail payment charges. As you know, the Commission has proposed a regulation, which in its current form is being widely resisted by banks across the EU, among others, though the EBF has recently come forward with new proposals to reduce charges for cross-border credit transfers and ATM usage to domestic levels by 2006.
Implications for the UK
The main implications of the changeover for the UK are making sure that banks and others complete their own non-cash preparations in time, and obtain sufficient euro cash. The end-of-transition questions arising from the non-cash changeover have all been addressed, except for some issues relating to UK companies with legacy currency share capital, which the DTI is currently looking at carefully.
The cash changeover will of course affect travellers between the UK and the Continent. The ECB's decision to allow euro-area central banks to frontload direct to credit institutions in the UK will help to provide the euro cash that UK banks and bureaux de change require. The anti-counterfeiting regime in the euro area has been extended to the UK. With ECB agreement, we have established a test site at our Printing Works for those with a legitimate need to test euro notes. And we have helped to train already more than 60 representatives from the UK financial, retail and travel industries in identifying the public security features of euro notes and coin.
Criteria for success
Although it is too early to draw any detailed lessons for a later possible transition in the UK, what we can do is to set criteria by which the success of the changeover in the first wave can be measured. I think the criteria are of three main kinds.
The first criterion is whether the non-cash changeover is completed on time before the New Year. The most important questions, I think, are these. Will the banks complete the changeover of their customer accounts without major problems by the New Year? Will the vast majority of companies and public sector bodies be ready for business in euro from the New Year? Will POS payment terminals in shops be ready for euro use by the New Year? And will cheques be written only in euro from the New Year?
The second criterion is meeting the mid-January ambition for converting the majority of cash transactions to euro. Some of the conditions for this need to be met before the New Year. Has the storage of euro notes and coin in, and the transport of euro cash around, the euro area taken place safely? Will a large proportion of the launch stock of euro notes and coin be sub-frontloaded to retailers? Will the large majority of coin starter kits produced be sold to the public?
Then during cash exchange period itself, the key questions are these. Will the vast bulk of ATMs supply euro notes without a hitch from New Year's Day? Will change in shops be provided only in euro? Will long queues in shops and at stations be avoided? And will euro counterfeits be very scarce and readily detected?
The third criterion is whether the changeover takes place without any discernible impact on prices. Obviously, the best measure of that will be published price data. Most national authorities and consumer associations in the euro area will be, indeed as I say already are, making more price checks than normal.
Of course, these measures can only be proxies. Ultimately, the best measure of the success of the changeover is how the euro is perceived by the general public across the euro area, once the exercise is complete.
Conclusion
As I said at the outset, the euro changeover is an unprecedented undertaking. I have tried to pick out the issues that matter and those which have proved most problematic, comparing and contrasting the different approaches in euro-area countries. We will be reporting on this in much more detail in the next Practical Issues, which is due to be published in early December.
