Europe’s Untapped Capital Market - Rethinking financial integration after the crisis

The great financial crisis that hit Europe, along with other advanced economies, threw into relief a long-standing structural weakness of the European economy: the overreliance on its banking system. In the aftermath of the crisis, Europe’s capital markets emerged even more clearly as underdeveloped compared to the sophistication and maturity of the European economy. This weakness manifested itself in two developments that aggravated the crisis. First, insufficient financial integration severely limited the ability of cross-border financial transactions to mutualise the shocks that, in particular in the euro area, eventually caused a persistent split between the ‘core’ and the ‘periphery’. Second, as the banking system became unable to intermediate an adequate amount of funds at reasonable cost, the European economy encountered serious funding problems, with inevitably deleterious macroeconomic consequences. 

The European Commission was thus right in identifying the need to develop a true Capital Market Union (CMU). CMU is an opportunity to relaunch financial integration, on a sounder footing, after the crisis. This project applies to the entire EU, but it assumes a special significance for the euro area. Together with banking union, it is a fundamental step towards building private risk-sharing and towards finishing what the Maastricht Treaty had left incomplete. The difficult experience in building Banking Union (BU), with its three components of single supervision, single resolution and single deposit guarantee, confirms that intellectual and practical difficulties emerge when moving from a general concept to implementation. The task is not made easier in the case of CMU by the fact that it differs from BU in that it takes a ‘bottom-up’ approach, which does not necessarily require a new institutional architecture.

This study offers a comprehensive overview of financial integration in Europe and a thorough assessment of the barriers that still hinder its realisation. It builds on the material collected in meetings of a dedicated group of experts (the European Capital Markets Expert Group, or ECMEG), which I had the pleasure and honour of chairing. The report also draws from an extensive literature review and data analysis assessing the benefits and risks of advancing a Capital Markets Union to boost a still imperfect single market for goods and services. The premise is that, if properly regulated and supervised, market forces will, in the pursuit of profits, lead to market integration, when the barriers standing in their way are removed, and ultimately to a more-efficient asset allocation, with more economic growth and jobs.

The study then suggests a methodology for identifying barriers and prioritising policy actions. The first differentiation is between ‘artificial’ and ‘structural’ barriers. Those of the former type are man-made impediments, such as different laws and regulations, which reduce or altogether eliminate incentives to cross-border financial transactions. Those of the latter type, such as language differences, are more difficult to deal with but are less numerous and do not really pose insuperable obstacles to the achievement of capital markets integration. The second important difference is between those barriers that affect the cost predictability of a financial transaction, and thus have a stronger negative effect, and those that increase the cost of cross-border transactions but in a predictable way. The policy conclusions proposed in the report prioritise actions that remove artificial barriers and generate unpredictable costs. The sheer number of barriers shows the size and difficulty of achieving a genuine Capital Markets Union. But the more the project shows its complexity, the more crucial it is to address it with an organic and considered approach. This report hopes to contribute to this ambitious and necessary effort. .....