Banking union dominated much of the second five-year mandate of José Manuel Barroso, the president of the European Commission in 2004-14.
In the wake of the financial crisis of 2007-10, banking union sought to bring Europe’s banks under a single regulatory framework, backed by a mutualised bail-out fund, to forestall the kind of financial excesses and regulatory lapses that had triggered several banking crises since 2008.
During his campaign to succeed Barroso as Commission president, Jean-Claude Juncker promised Europe his own big financial integration project: a capital markets union (CMU). Although catchy, the name is misleading: banking union built a pan-European framework for regulating banks, whereas CMU is not so much about linking up particular markets, or uniting their supervision, as about knocking down barriers and freeing-up capital for investment.
One lesson of the crisis has been that the European economy is too dependent on its banks, which provide some 70% of all financing. When the banks suffered a crisis, funding for small and medium-sized companies dried up. This is widely held to have contributed to a fall in investment across the European Union.
The European Commission estimates that “annual gross fixed capital formation” in the EU economy in 2014 is about €800 billion below where it would be on its pre-crisis trend.
The think-tank Bruegel estimates that investment is around €260bn below where it should be. This shortfall is in stark contrast to the United States, where banks provide no more than 30% of business financing, and where private placements, equity and other instruments provide the rest. “Those countries that had mature capital markets recovered most quickly,” says Alan Yarrow, the Lord Mayor of the City of London, the EU’s biggest financial centre.
A genuine CMU would allow companies to raise capital, issue bonds and invest seamlessly across the EU, Juncker told MEPs in July. That aspiration is nothing new. The free movement of capital across Europe was enshrined in the Treaty of Rome in 1957. But it has remained largely theoretical, with national rules and regulations restricting financial institutions’ ability to operate across border.
Knocking down those barriers would open up new opportunities for pension funds, insurance funds and other sources of capital. It would also level the playing-field for firms looking for finance. At present SMEs in countries such as Italy and Spain have fewer options for raising money than their rivals in northern Europe. They pay more to raise capital because their national banking sectors are struggling.
There is some continuity between the banking reforms of recent years and CMU, says Josina Kamerling, head of regulatory outreach in Europe for the CFA Institute, a body that represents finance professionals. She argues that a CMU is the natural complement to banking union and describes a banking union without a CMU as “like a supermarket without products”.
“Capital markets union…is about making an attractive marketplace with products that can be sold across the EU.”
But CMU’s focus on lending and investment raises questions about whether previous financial reforms are proving too onerous for Europe’s banks.
Gunnar Hökmark, a Swedish centre-right MEP, is responsible for drafting the European Parliament’s position on new legislation that could lead to Europe’s largest banks being broken up. He warns against rushing to imitate the financial model of the United States, pointing out that the European system has developed over hundreds of years with bank lending at its heart.
Policymakers must recognise that Europe’s banking sector is “de facto one of the few institutions that operate cross-border” and so one of the few institutions that can channel capital across borders. He worries that breaking up Europe’s largest banks will make them less, not more, likely to lend and invest. Yarrow sounds a similar warning about capital requirements.
“You cannot have a situation where a central bank is asking banks to increase capital buffers and at the same time expecting them to increase lending,” he says. The new European Commission has already given signs that it is prepared to reverse the previous Commission’s policy on certain banking issues, in particular asset-backed securities, which had been deemed the “bad boys” of the financial crisis. EU regulations subsequently rained down upon them. But the likes of Kemerling argue that they must still play a role within any capital markets union.
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