Europe’s economic future depends on better integrated financial markets | AFME

Share this page
Europe’s economic future depends on better integrated financial markets
21 Jun 2019
Jacqueline Mills Managing Director

After the 2008 financial crisis, policy makers and regulators worldwide took steps to strengthen banks against future shocks. As a result, banks today are much less likely to fail and, should a failure occur, it is very unlikely they will be bailed out with taxpayers’ money.

While these are extremely positive developments, European banks’ profitability remains low, with the average return on equity (RoE) for ECB supervised banks only just above 6% at the end of 2018. This is partly due to overcapacity in the banking system, but is also caused by the effects of ultra-low interest rates, poor cost efficiency, as well as ongoing and cumulative regulatory demands. The performance of the banking sector matters as profits are the first source of additional bank capital, which is necessary to support lending to the wider economy. As outlined by the ECB, banks need to earn returns above their cost of equity – and a 6% average RoE is not enough to outweigh this cost.

We also have yet to see cross-border banking activity in the EU resume to the extent is has in other jurisdictions post-crisis, be it in terms of the provision of finance directly across borders or via cross-border merger and acquisitions activity.  

Even in the Eurozone, where there is a single supervisor and resolution authority, national authorities continue to limit cross-border capital and liquidity flows within banking groups by putting up national “fences”. They do so as a means of dealing with the “European in life, national in death” experience of the financial crisis. While understandable, particularly when national authorities are accountable to their own parliaments, this approach disregards the significant improvements in banks’ resiliency and ignores the system-wide capacity that has been built up to absorb losses if they do occur. And while there may be a protective advantage for a single state to act in this way, when all states do the same, the entire system becomes brittle and inefficient, and everyone loses.

At a recent AFME conference, delegates heard that at least an estimated EUR 180 billion of liquidity is “trapped” locally in Member States. This results in increased costs to end users of financial services who also pay different prices for the same service, depending on which country they are in. This is not an optimal allocation of resources and negatively impacts banks’ end customers and profitability alike.

Restoring, and pursuing, EU financial integration since the crisis has clearly been a challenge. While the recent European Parliamentary elections were far more positive than some had expected, with the anti-European vote being fairly limited, many national governments still struggle to see, and deliver, the benefits of European financial integration. As evidenced by the recent report of a high-level group of national experts, Member States have reached an impasse in taking the steps we need to move forward. European Commission officials have noted the lack of ambition of Member States. And international and market observers, including those who are fully aware of the complexities of European decision-making, wonder why progress is not being made. 

Yet it is clear that it is precisely by moving forward with the well-known steps identified by the European Commission to complete the Banking Union and build up our capital markets that economic progress will be made which will benefit all.

For instance, by promoting deeper capital markets, EU economies will not only reduce their reliance on bank financing, thereby opening up a wider range of financing options, especially for new or smaller growth companies which need equity financing, but it will also allow risk to be diversified and shared more widely. This is something which is currently lacking in the EU compared to other more integrated markets, such as the US and will further reduce the need for any public risk sharing.

Moving forward with the European Deposit Insurance Scheme, which guarantees the protection of EU depositors’ money in the event of bank failure, is also necessary to create the trust required to overcome fragmentation and achieve an integrated banking market in Europe.  This will be key to enabling the efficient allocation of capital and liquidity across banks, avoiding ring fencing and enhancing the safety and growth potential of the entire European economy.

Unlocking Europe’s growth potential through the creation of a powerful financing union consisting of integrated banking and capital markets is long overdue. We urgently need better integrated markets that are serviced by strong, profitable financial institutions, capable of meeting the borrowing and investment needs of all Europe’s population. The goals are clear. But we cannot afford to wait for another 10 or even 5 years for this to become a reality.