Europe’s Capital Conundrum: Unlocking Funding for Growth
Unlock the Editor’s Digest for free
Funding the Future
Europe faces a significant challenge in financing its energy transition, digital infrastructure, and defence. Despite having a vast pool of savings, the region’s capital markets are underdeveloped, and its banking sector is too small to meet the growing demands for capital expenditure.
The Problem
Europe’s policymakers are grappling with enormous investment requirements. The European Commission estimates that an additional €620 billion will be needed each year to 2030 for the green transition, while another €125 billion will be required for digital transformation. The invasion of Ukraine by Vladimir Putin and the prospect of a second Donald Trump presidency in the US are further escalating demands for greater military expenditure.
The Conundrum
Growth in lending to companies in Europe since 2014 has been less than half that of the US. This has resulted in a widening economic performance gap between the two regions. "We need to mobilize private savings on an unprecedented scale, and far beyond what the banking system can provide," said former Italian Prime Minister and ECB President Mario Draghi.
The Gap
European companies have fewer funding options to help them invest and grow. Despite some progress, there remains a significant gap in venture capital relative to GDP between Europe and the US. This limited funding options hinder the growth of European businesses.
The Call to Action
There is a growing chorus of calls to revive the plans for a capital markets union, led by ECB President Christine Lagarde. Recent heavyweight reports by former Italian Prime Minister Enrico Letta and former French Central Bank Governor Christian Noyer also argue the case. However, the idea of a single market for capital across Europe has been stalled for a decade.
Time to Change Tactics
To clear the system-wide blockages, policy architects should team up with financial experts, especially from the private sector. Revitalizing securitization is the place to start, enabling insurers and pension funds to support Europe’s growth.
The Solution
Securitization allows banks to transfer assets to investors, freeing up their own lending capacity. This is particularly important as banks provide the majority of credit to European small and mid-sized businesses, which account for almost two-thirds of jobs.
Rules and Regulations
Rules written in response to the financial crisis harshly penalized securitisations, and the European market for them has never really recovered. An unintended consequence is that banks have resorted to complex synthetic transfers of risk, which only the largest can undertake, thus holding back regional banks.
Calibrating the Rules
It’s time to recalibrate securitization rules to better reflect the true risk profile of assets, keep pace with evolving capital markets, and encourage investment for European growth. Reforms to Solvency II rules are also essential, along with system-wide tweaks to the banking framework and financial market standards.
A More Flexible Financial Market
Europe needs a more flexible and diversified financial market. If capital markets union plans fail to deliver, it may result in lower growth. It’s time to call in the plumbers.
Conclusion
Europe’s capital markets are underdeveloped, and its banking sector is too small to meet the growing demands for capital expenditure. To address this conundrum, policy architects must work with financial experts to revitalize securitization, recalibrate rules and regulations, and create a more flexible financial market. Failure to do so may result in lower growth and a widening economic performance gap with the US.
FAQs
Q: What is the significance of securitization in financing European growth?
A: Securitization allows banks to transfer assets to investors, freeing up their own lending capacity. This is particularly important as banks provide the majority of credit to European small and mid-sized businesses, which account for almost two-thirds of jobs.
Q: Why has the European market for securitization never really recovered since the financial crisis?
A: Rules written in response to the financial crisis harshly penalized securitisations, resulting in an unintended consequence of banks resorting to complex synthetic transfers of risk, which only the largest can undertake, thus holding back regional banks.
Q: What are the key reforms required to address the capital markets conundrum in Europe?
A: The key reforms required include recalibrating securitization rules to better reflect the true risk profile of assets, reforming Solvency II rules, and system-wide tweaks to the banking framework and financial market standards.
Q: What is the ultimate goal of creating a more flexible financial market in Europe?
A: The ultimate goal is to create a more flexible and diversified financial market that enables European businesses to access the funding they need to invest and grow, ultimately resulting in higher economic growth and reduced economic performance gap with the US.
Author: www.ft.com
Orginal Source link