Beware capital markets union hype

| | Updated on: Jul 09, 2015

One of the key lessons of the financial crisis is the importance of financial markets in supporting the real economy. The new European Commission, under the Juncker plan, has given priority to the creation of a capital markets union in the European Union. The project is complex, and managing expectations will be vital.

The transition needs to be handled carefully. If the reduction in the role of banks financing the real economy is too rapid, without alternative market sources already in place, we will be putting at risk the process of economic recovery in the EU. We need to ensure that banks continue to be in a position to finance solvent demand from EU households and firms.

That calls for a sense of perspective when it comes to CMU. Small enterprises will continue to rely on banks, as they do in the United States, a country where capital markets finance 80 percent of the real economy. Achieving a similar percentage in Europe is unnecessary and unwarranted - especially as the American system relied upon Fannie Mae and Freddie Mac, the two US mortgage guarantors which required a massive bailout. Getting markets to finance half of the real economy is a more realistic and preferable target for the EU.

This more balanced approach should complement the role played by EU banks with a better access to equity-based finance such as venture capital - an area where the EU is clearly lagging behind the United States. European banks should continue to play a key role in the EU, be it as direct financiers or as facilitators towards a market-based funding of the private sector.

Instead of obsessing about CMU, there should be a smart review of recently approved legislation. The regulatory tsunami after the 2008 crisis has changed almost every piece of pre-crisis financial regulation in the EU, and introduced many more in previously uncharted areas, such as bank resolution or Too Big to Fail.

This new regulatory paradigm is here to stay, but it may be able to fine tune the reforms and reduce unwanted side effects. Given the mammoth scale of the transformation, the scope for unintended consequences is high. There has been a withdrawal of international banks from correspondent banking in many developing economies. Regulatory uncertainty has hit lenders' cost of capital and funding, meaning liquidity remains a big problem.

Stricter regulation has also encouraged more shadow banking. A financial institution without solvency requirements and without access to central bank financing is dangerous from a financial stability perspective. Its not a stable structure - remember when structured investment vehicles collapsed in the crisis. Even if bodies such as the Financial Stability Board are developing a framework to deal with these issues, one really wonders if the system is being developed at the speed arbitrage may be taking place.

European banks need a measured approach to capital markets union. The authorities should be spending just as much time ensuring that the overall set of new bank regulation is fit for purpose.

(Josş Marţa Roldŕn is chairman of the Spanish Banking Association and vice president of the European Banking Federation. He was director general of banking regulation at the Bank of Spain and member of its executive board between October 2000 and October 2013. Roldrn is a Reuters Breakingviews guest columnist. The opinions expressed are his own.)

Published on January 24, 2018

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