17 October 2014

Financial Times: A dose of deregulation for EU capital markets

Europe’s banks are holding the continent back. Struggling under balance sheets four times bigger than the EU economy, the sector cannot exist without help from the European Central Bank and the implicit support of national treasuries. It is both a source of instability and the reason Europe has a gummed-up financial system that fails to channel savings towards worthwhile projects.

Despite the gyrations of this week, the answer lies in greater use of financial markets. The EU is making slow progress towards creating a proper banking union, which should lead to a bank’s creditors being put in charge of monitoring its health. But Europe needs an alternative source of finance. Poor lending decisions and Europe’s long economic malaise have left banks with damaged balance sheets. In a harsher regulatory environment, they have few resources and little inclination to lend to smaller companies.

The answer lies in copying the US where bank assets are at a much more manageable level of 80 per cent of gross domestic product. The US enjoys a diverse financial landscape, with greater use of equity and bond issuance and private placements. In contrast, the creation of a single currency across most of the EU failed to usher in a similarly extensive capital market. While its continuing addiction to banks is one reason, large obstacles can be found in conflicting rules, patchy information and a lack of government support.

This creates a promising agenda for the new European commissioner for finance. By tasking Britain’s Lord Hill with completing a capital markets union, Jean-Claude Juncker, the new commission president, has been shrewd. Lord Hill may hail from a country ever more hostile towards the European project, but in London it has a capital that has long prospered from open financial markets. In their wariness towards all matters European, British politicians tend to make an exception for steps that improve the operation of the single market. Moreover, the proposed capital markets union would extend over the entire EU, so Britain lying outside the eurozone would not present any difficulty.

© Financial Times