Retail banking in France, Germany, and the United States posted robust productivity growth in the late 1990s as the industry in general benefited from innovation, increased demand, and consolidation. Although the European countries inched closer to US productivity levels for the sector, a large gap remained, particularly in Germany (Exhibit 1).

The diffusion of innovations, strongly linked to IT investment, accounted for half of the productivity growth in the retail-banking sector in France during the late 1990s and for a third of the growth in Germany (Exhibit 2). In both countries, retail banking accounted for more than 10 percent of total national IT spending at this time. Half of the money was spent on back-office automation, which benefited from better and cheaper technologies such as check scanning and image processing and from the optimization of business processes such as payments. New channels—ATMs, call centers, and Internet banking—added to the productivity gains.

Electronic payments too raise productivity, and in Germany they are prevalent. Although paper checks require more labor to process, they are still dominant in the United States and, to a lesser degree, in France. Regulation needlessly prolongs their survival: US retail banks can delay the processing of paper...