The EU is rightly proud of its single market. But in finance, it is still more aspiration than reality, at least for smaller users.
Households in need of banking services, small and medium-sized companies wanting to invest and expand, and new entrepreneurs seeking funding to develop their ideas, have few alternatives to their own domestic banks.
The result is a fragile and fragmented banking system, and small and shallow pools of risk capital. Both problems have long held back Europe’s growth potential, especially on its southern rim.
It is to European policymakers’ credit that they have at least nominally recognised the nature of these challenges since the sovereign debt and banking sector crises a decade ago. This is what the EU’s goals of a “banking union” and a “capital markets union” are all about. It is not to their credit, however, that they have made so little progress.
The resistance runs deep. In Spain and Italy, a drive to strengthen banks has favoured domestic rather than cross-border mergers. The latter have their own problems, but a trend of domestic consolidation will concentrate banking business further within national borders — the opposite direction from a real banking union. A truly single capital market must cut through the thicket of 27 jealously guarded regulatory and insolvency regimes. Despite many attempts at harmonisation, they fall far short of what is required.
Meanwhile, the need to unify banking and capital markets has become more urgent. One reason is Brexit. Continued fragmentation in EU capital markets allows London to continue to play an outsize role in channelling the financing for European growth. With the UK outside the EU’s rulemaking sphere, this becomes a danger — but, as UBS chairman Axel Weber has pointed out, one that is hard to avoid until Europe unifies its own financial markets.
The pandemic is another reason. While the expected wave of bankruptcies has not so far materialised, many companies are in a bad state, and many government-backed emergency loans will probably never be repaid.
This is a unique opportunity to force European business activity to shift from credit to equity financing, by converting debt overhangs into equity stakes and creating a pan-EU market on which to trade those stakes and mobilise investment into new ventures.
Finance ministers signed off last week on treaty reforms for the European Stability Mechanism, the rescue fund created after the eurozone debt crisis. This move will improve the area’s economic governance in two ways. It will be easier to organise creditors to agree a sovereign debt restructuring. And the system to handle failing banks will be buttressed with a new line of defence in the form of a fiscal backstop for the eurozone’s Single Resolution Fund for banks.
These welcome changes are not as important in their own right as they are in removing roadblocks to the bigger agenda. Delay in passing ESM reform halted the little momentum there had been to unify banking and capital markets. An invitation in November 2019 from Olaf Scholz, Germany’s finance minister, to discuss reforms such as common deposit insurance and insolvency harmonisation ran into the sand.
After putting the ESM to bed, governments must start the hard work of giving up their excessive control over their national bank and financial sectors. If harmonisation of national rules is too hard, they should pursue the route of “28th regimes”: EU-level legal frameworks that act as an alternative to national bank licences, insolvency procedures, and incorporation and fundraising rules, and which companies could voluntarily adopt.
A standard criticism of the EU is that inflexibility and indecision make it vulnerable to failure and even disintegration in a crisis. This accusation is mistaken. The EU’s real disability is different: it is bad at making use of crises to create strategic leaps into the future.
Consider the Brexit negotiations, or the agreement in principle in July on a pandemic recovery package to be funded by common bonds. It turns out the EU is quite good at handling crises — even if it tends to string things out to the very last minute. Here the problem is not that the EU fails to do what is necessary, but that it misses opportunities to do more and better. That has been the case for creating a truly single market in finance. In the absence of imminent disaster, policymakers have been too content to let things drag out.
Even this pattern is not without exceptions. The EU has been making impressive progress on putting real policy tools behind the decarbonisation agenda. It must muster the same urgency for financial reform. This is not the time to let another crisis go to waste.
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