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Conceptually, risk-sharing is closely linked to the capacity of EMU to withstand shocks. It can be seen as the ability of countries to diversify the impact of idiosyncratic shocks among other Member States through private channels (i.e. savings and capital markets) and public channels (i.e. fiscal transfers).
In Europe, in the absence of a significant public budgetary instrument and of well-developed and integrated capital markets to diversify the impact of idiosyncratic shocks, the credit channel is the only way of cushioning shocks across the euro area countries. Nevertheless, this channel is not strong enough to offset the weakness of other channels. Despite the initial expectation when the euro was launched that many banks would provide retail services across the euro area, firms and households rely mainly on their domestic banking systems. Cross-border wholesale banking flows rose notably from the onset of EMU until the start of the crisis, but reversed abruptly afterwards. Finally, the fact that the ultimate backstop for deposit insurance still depends on national governments -implying a fundamental misalignment between liability and control- does not contribute to achieving greater integration.
The creation of a common safe asset for the euro area may be the cornerstone of a common capital market, with important implications for other policy areas2. A well-functioning capital market requires a broad asset class with ample liquidity and low risk. These assets would serve as a reference for other asset classes and contracts and, at times of uncertainty, they would provide a safe haven for investors without triggering financial fragmentation.
Currently, the supply of risk-free assets in the euro area is very limited, as only the debt of a small group of countries is perceived as riskless. Admittedly, a common safe asset cannot replace sound fiscal policies in the Member States. But it would weaken the doom loop between sovereigns and banks by reducing incentives for cross-border flights to safety, by contributing to diversification of risk in portfolios held by banks and investors, and, more generally, by providing for a more ample, stable and equitable supply of safe assets for the EMU as a whole.
A true Capital Markets Union will also attract global institutional investors, strengthening the international role of the euro and providing Europe with more geopolitical leeway. Crucially, it will help reshape capital markets in Europe after Brexit.