Guest Commentary: Andreas Dombret
(This commentary appeared in SAFE Newsletter Q3 2015)
Capital Markets Union: The Next Big Step of Financial Integration in Europe
Andreas Dombret is a Member of the Executive Board of the Deutsche Bundesbank.
The European Commission has announced the objective to create a European capital markets union by 2019. Following monetary union and banking union, this will be the third major step of financial integration in Europe.
The capital markets union has two objectives. The first objective is to increase the share of capital markets in the funding mix of the real economy. The second objective is to integrate capital markets more closely across borders.
The first objective is based on the idea of diversification. A system in which the real economy relies on a single source of funding will most certainly run into trouble when that source dries up. The capital markets union is therefore supposed to supplement bank-based funding with capital markets-based funding. And in Europe above all places there is ample room to do so.
Increasing the share of capital markets will improve access to funding for the real economy. At the same time, it will improve the matching of investors to financial risk, thereby increasing the efficiency of the financial system. As a result, the financial system will be able to better support sustainable economic growth.
The second objective of the European capital markets union is to improve the integration of capital markets in the entire European Union. One of the main arguments is that integrated capital markets can improve private risk sharing.
Empirical studies for the United States show that integrated capital markets cushion around 40% of the cyclical fluctuations among the US federal states. A share of around 25% is smoothed via the credit markets, while fiscal policy cushions 10-20% of shocks. Altogether, around 80% of a given economic shock is absorbed before it can affect consumption.
In Europe, it is mainly credit markets that cushion economic shocks – and they are not very effective in doing so. Altogether, only around 40% of a given shock is absorbed before it can affect consumption. Integrating capital markets across borders would help improve private risk sharing within Europe.
To sum up: a European capital union would pay a double-dividend. It would contribute to economic growth and it would improve risk-sharing. But how do we get there?
With regard to the objective of increasing the share of capital markets, we should focus on equity markets. Tax treatment, for instance, still favors debt financing over equity financing. Removing this bias in taxation would encourage companies to strengthen their equity base and thus turn more towards equity markets as a source of funding.
With regard to the objective of integrating capital markets across Europe, there are some areas where standardization could give us some early gains. The market for high-quality securitization is one of these areas. So far, a number of policy initiatives have been launched to restart European securitization markets. Other areas for early action include private placements, crowd-funding or the harmonization of prospectuses. With a view to the long run, it might also be beneficial to harmonize insolvency laws across Europe.
In any case, we should not exclusively focus on the institutional and legal framework. There might also be soft factors at play, such as cultural preferences for certain forms of funding or the level of financial education. We also should address these issues in order to achieve our objective.
Ultimately, the path towards a European capital markets union will be long and arduous. Nevertheless, I consider it a path well worth taking.