capital markets union: is the eurosystem ready for...

Journal of Emerging Issues in Economics, Finance and Banking (JEIEFB)

An Online International Research Journal (ISSN: 2306-367X)

2016 Vol: 5 Issue: 1

1699 www.globalbizresearch.org

Capital Markets Union: Is the Eurosystem ready for it?

Sanjay Pawar,

Department of European Studies,

Manipal University,

Karnataka, India.

E-mail: [email protected]

_____________________________________________________________________

Abstract

Europe has witnessed the worst financial crisis in recent years and now, it is struggling to

restore its economy on track. Most of the member states are burdened with sovereign debt and

the banks aren’t in a position to finance the economy. The whole idea of coming together for

economic growth and peace is being questioned. Meanwhile, the newly elected commission

announces to create the “Capital Markets Union” which would open up the non-bank financing

options for economy. But, is the Eurosystem really ready to take up this project? Even after

years of harmonization, fragmentation in financial market is a reality. The tax systems differ

from member state to member state. There are, unfortunately, barriers in extending financial

services to other member states. Moreover, the introduction of the Financial Transaction Tax

has magnified the differences in member states. Keeping aside all the challenges, it is evident

that Europe’s Capital market has a huge potential. This project could help in revamping the

Europe’s economy, and would give a kick start for further economic growth and development.

The aim of this paper is to find whether the Eurosystem is ready for taking up the ambitious

“Capital Markets Union” project. What are the current challenges to it and what changes are

required for making this announcement a reality have been discussed in this paper.

___________________________________________________________________________

Key Words: Capital markets, Eurosystem, Juncker Commission, Venture Capital,

Securitization

JEL Classification: G1, G2

mailto:[email protected]





1. Introduction

The Capital Markets Union (CMU) is an ambitious project and one of the major initiatives

of the newly elected commission headed by Jean-Claude Juncker. The aim is to create “an

integrated, well-regulated and liquid Capital Markets Union” (Hill, 2014) by 2019 with special

focus on increasing the public and private funding, to stimulate the financing options and to get

economies back on track for the longer term. However, the CMU remains an undefined term

so far. This is one of the biggest experiments in EU financial market to be carried out after the

banking union, which is still incomplete. To ensure an effective CMU the European Union must

study the present situation of the market and changes required in it. There is a significant scope

for harmonization in different areas, which needs to addressed, without which the CMU would

be just a great idea with poor implementation. This paper tries to figure out possible areas in

which changes are inevitable for the proper implementation and smooth functioning of the

CMU. The change would not take place overnight and hence called for a rigorous planning

beforehand. The ultimate goal of the CMU is to open up non-bank financing. This paper also

discusses about some possible non-bank financing options, its current situation in the EU and

changes required in it.

1.1 Objectives of the study

1. The primary objective of the study is to find main challenges before the CMU;

2. To figure out changes required in the current system to form the CMU; and

3. The advantages of having a bigger capital market for Europe.

2. Review of Literature

A moderate review of literature was conducted to understand the situation. Many reports

and EU announcements about the CMU as well as different reports published by research

agencies and think-tanks have been reviewed before putting pen to the paper. The first

announcement about the CMU was made in November 2014. All the announcements from the

EU and news pertaining to the CMU from leading news channels during the month of

November and December 2014 were covered.

2.1 Unlocking Europe’s Capital Markets Union (2014) – By Hugo Dixon

This paper by Hugo Dixon helps to understand the capital benefits of the CMU, if

accomplished. This gives a general overview of advantages which Europe could enjoy if the

CMU becomes a reality. The report also investigate in several non-bank finance options trying

to find solutions to challenges involved in it in current financial setting. It suggests development

of many financing options, which are well developed in the United States.





2.2 Driving Growth: Making the Case for Bigger and Better Capital Markets in Europe

(2014) – By William Wright

The New Financial think-tank figures out the status-quo of the European capital market and the

United States in numbers. This report quantifies and compares the EU Capital Market with the

United States. It shows exactly how underdeveloped are European market. It also discusses

why Europe needs to work on a bigger and better capital market. Furthermore, the author

discusses and gives a helpful insight of the advantages of capital market over bank financing.

2.3 Defining Europe’s Capital Markets Union (2014) – By Nicolas Véron

The paper aims at finding main areas which could take place in the CMU agenda. The author

discussed the challenges before the CMU, in general. He also list out six main areas to be

included in the CMU agenda. 1. Regulation of specific market segments, 2.Review of

prudential frameworks, 3. Financial transparency, accounting and auditing, 4. Supervision of

financial infrastructure, 5. Insolvency and debt restructuring frameworks and 6. Taxation. It

covers several important areas which need to be on the CMU agenda, but the list isn’t complete.

There are other areas also which need to be included in agenda such as standardization of

regulations, challenges in private equity market and other non-bank financing options etcetera.

3. Research Methodology

Research approaches can be categorized in three different ways: exploratory, explanatory

and descriptive (Yin, 2003). An exploratory research is useful to clarify the understanding of a

topic or to see it with perspective which is done through the direct observation of a phenomenon

(Glaser & Strauss, 1967). Furthermore, Gummeson (2000) states this type of research is ideal

when there is a little information about the problem and it is difficult to define and determine

the problem and relations. A descriptive research is aimed at presenting a complete picture of

a phenomenon. It mainly involves obtaining information concerning status-quo of the

phenomenon. Lastly, an explanatory research method is used when many variables exist about

the topic under concern. The aim is to establish a cause-effect relationship by finding a

correlations between those variables.

The objective of this paper was to analyze and understand the newly announced CMU that

would help to understand the main challenges and key changes required. A descriptive research

approach has been used primarily, describing what CMU is all about and how current financial

setting in European Union states could pose challenges to this project.

3.1 Research Questions

1. What are the main challenges before the CMU?

2. What are the changes required in the current system to form the CMU?

3. What are the advantages of having a bigger capital market for Europe?





3.2 Research design

Research methods are mainly divided in two categories i.e. qualitative and quantitative

methods (Malhotra, 1996). A quantitative method is a scientific, data-driven and outcome-

oriented research (Yin, 2003; Parasuraman, 1991). It emphasizes on statistical analysis of data

collected through polls, questionnaires, and surveys. On the other hand, a qualitative research

is an attempt to understand a phenomenon under consideration. It is an unstructured,

exploratory research method based on small samples (Malhotra, 1996). Keeping in mind the

objectives of the study, a qualitative study has been chosen to gain deeper understanding of

CMU and challenges before it.

4. Analysis of current EU capital markets

Firstly, the CMU should not be considered as an entirely new project. It is a continuation of

the existing financial market integration. It involves a wide range of initiatives to be taken in

various fields. The ultimate objective of the CMU is to achieve the founding principle of the

European Union i.e. free movement of capital across Europe. The efforts of the European Union

are to implement policies to develop an integrated capital market that can be traced back to the

Single European Act where it ensured the free movement of factors. More recently, initiatives

were taken in mid-2012 for centralizing the banking supervision and several other aspects of

banking and, thus, this created a Banking Union. Until these initiatives were taken, the

fragmentation in the banking supervision and policies were the prime obstacles of the integrated

and unified financial market of Europe. However, now it is important to concentrate on other

barriers of movement of capital, since the fragmentation in the banking policies is being

removed substantially. The establishment of the Single Resolution Board (SRB) and the Single

Resolution Fund (SRF), which is a part of the Banking Union, is underway. Jonathan Hill looks

optimistic about completing this task in the near future.

The major task involved in establishing the CMU is to find and encourage alternative

sources of finance for the businesses and investments, which would ultimately help to overcome

the sluggish growth of Europe’s economy. It should emphasize on the development of the non-

bank finance since the euro crisis left banks with a serious credit crunch and now they are

subject to stiff regulations. Banks are not in the position to finance the economic recovery on

their own. It is evident that the EU is too bank-centric; its non-financial corporate sector is

heavily dependent on financing that banks provide. Around 70 per cent of the debt financing

come from banks whereas only 30 per cent is financed by means of equity, public and private

bonds.1 Non-bank finance includes vast segments like Public and private equity, follow on

offering, venture capital, financing by shadow banks, securitizations, private placements, peer

1 As per “Funding the EU economy (English version)” report from Association for Financial

Markets in Europe published on 22nd July 2014

http://www.afme.eu/WorkArea/DownloadAsset.aspx?id=11361





to peer lending, hedge funds, corporate bond issues and so on which are relatively

underdeveloped in Europe. All of these do exist in the EU but compared to the US, the markets

are much smaller. According to the analysis of the New Financial think-tank, Europe’s capital

market has a huge potential to grow and currently it is roughly half of its potential size.2

This part of the paper envisages finding problems that holds the European capital market back.

We try to analyze each non-bank financial instruments that have the potential to unlock billions

of Euros and finance the real economy and the challenges faced in current situation. As

mentioned earlier, an efficient CMU cannot be created overnight, and it would take time to

address all minor rules and regulations that affect the flow of capital and to build the investors’

confidence in non-bank finance, which is traumatized after the crisis.

4.1 Reviving Securitization market and introducing High Quality Securitisation

“Time has come to revive a sound and safe securitization market in Europe,” said Jacques

de Larosiere, the President of EUROFI, the European Think Tank dedicated to financial

services.

Reviving the securitization market and introducing high quality securitization is a focal point

in Juncker’s plan. Securitization is one of the most important funding tool and a channel for

borrowers to ingress the capital market. A Corporate or banks can wrap up their receivables to

create a financial instrument, which can be sold in capital market. Fig: 1

Source: Association for Financial Markets in Europe (AFME). Report “Funding European Economy”

dated 22 July 2014.

At a time, when Europe is undergoing sluggish economic growth and the markets are having

trouble to raise finance, Securitization would play a vital role. Securitization can help banks to

clear up their balance sheets which would allow them to lend more thus making the much

needed credit available to the real economy.

2 “Driving growth: Making the case for bigger and better capital markets in Europe”, report

published by New Financial think-tank in September 2014. Size of capital market relative to GDP.





The financial crisis has significantly affected the European securitization market, dropping

the annual issuance level to €80-90 billion (2013) from the €450 billion of pre-crisis years

(2005-2006) as per the report by AFME. The demand for securitized assets is slowly recovering

after the great recession of 2009. Despite its large potential; the securitization market remained

impaired in Europe. The securitization does not enjoy the same level of recognition as other

forms of debt instruments do. The lack of popularity and trust, negative experiences from crisis

and the complex and opaque structure of the securitization could be the reason behind

securitization market being underdeveloped. It is seen that, the complex and less transparent

subprime instruments have fanned the flames of the financial crisis especially in the US,

therefore it is of utmost important to design simple, transparent and sound ‘High quality’

securitization. The positive talk of the EU over the ‘High quality’ securitization should translate

into action so as to bring harmonized rules and practices in securitization market. The growth

of the securitization market is dependent upon supportive rules and regulations. In addition, the

rules of capital and liquidity requirements for banks and insurance companies would be a key

point. The solvency II directive for insurance companies, binds them to maintain a certain

amount of capital to lessen the risk of insolvency. The capital requirement for securitized

products is considerably higher than covered bonds, which discourages the investment in the

securitized products, which needs to be addressed by the European Union.

The payment and settlement system in Europe for both debt and equities remains inefficient

and fragmented. This regulatory challenge poses a threat to the development of the

securitization market and for the single market altogether. Particularly the smaller firms, who

have to pay a higher cost in adapting to different circumstances in the Member States. The

“Target2Securities”, an IT platform for settlement of securities on real-time basis, is fully

developed. It is expected to go online by June 2015.

Therefore, standardization of securitization, addressing the fragmented rules of insolvency

procedure (the later part of this paper shed light on problems in insolvency procedure) and

commissioning of “Target2Securities” are the three prerequisites for an efficient securitization

market.

4.2 Developing Peer to peer lending and Crowd-funding for Small and Medium

Enterprises

Peer to peer lending is an internet based platform where investors (Individuals and

businesses) can lend to companies, especially SMEs in need of capital. Most of the alternate

financing instruments in Europe are still in their babyhood, peer to peer lending is one of them.

In Crowd-funding, the investors receive their returns, in most cases, in terms of finished

products and not in monetary terms. The market is relatively small but has shown growth in

recent years. The UK and U.S peer to peer and crowd-funding market has shown a significant

growth. In the UK this sector is regulated by the Financial Conduct Authority after the request





from providers themselves, this would result in increased credibility, transparency and stability

in market. As per the European Federation of Finance House Associations (eurofinas) there is

no necessity for any action at the EU level for this market.3 However, the EU should look into

this type of financing options for SMEs to stimulate the growth across Europe.

The public’s confidence in internet based lending plays a vital role. In USA the investors

are accustomed with peer to peer services because it has been several years that such a market

exists there, however, in Europe people are relatively uncomfortable in making contracts and

lending money online. The US and UK have raised billions for SMEs and individual borrowers

through this innovative way of financing. Now, looking at peer to peer lending potential to

finance small and medium enterprises and individuals, some of the large banks in Europe are

considering entering into peer to peer business. It can further reduce the financing cost, and cost

to raise capital for SMEs.

4.3 Private Placement’s potential

In private placements, a company issues fixed interest bearing instrument directly to a set

of sophisticated investors rather than issuing it to the public. It is typically a long term financing

instrument, suitable for mid-sized companies who are in need of long term capital.

However, in Europe the market is small, except France and Germany which raised €15

billion in 2013. The US private placement market has 90% market share in global market. As

a result, many companies in Europe issue bonds in the US private placement market; they issued

around $15 billion in 2013. The UK private placement market is also underdeveloped and

companies in the UK look to the US market for private placement. The popularity of private

placement has gained momentum since the inception of the financial crisis. The encouraging

thing about this type of financing option is the low issuance cost since they are not subject to

registration with Securities and Exchange Commission. As stated by the International Capital

Market Association (ICMA), approximately bonds worth $50 billion are issued every year.

However, the European private placement market remained relatively little and

underdeveloped. There are numerous reasons for this, firstly the EU does not have institutions

specialised in private placement. The investors wouldn’t be able to make use of this type of

financing until institutions issue such debt and the companies are unenthusiastic to do so

because of absence of ready investors, and secondly, because of the regulatory differences

between the countries. The development in this sector is underway. ICMA is now actively

involved in the work of the pan-European private placement working group (PEPP WG) along

with AFME, ABI, EU PPA, EURO PP, LMA etc., which also includes representatives of major

institutional investors. The Banque de France and the Economic and Finance Ministry of UK

3 (Eurofinas, 2013), the summery of position of eurofinas on crowd funding.





(HM Treasury) are the observers for this work. The main goal of this initiative by the ICMA is

to introduce common market practices for the Pan-European private placement market.

According to the ICMA’s report, approximately, 200,000 mid-sized companies in Europe

are looking for alternate sources of finance, as a result of bank deleveraging. Hence, the demand

would increase for private placement. Standard and Poor research indicates that mid-sized

companies would need €2.7 trillion of debt refinancing between 2014 and 2018. The real

European private placement market would not meet this level of demand, but it would play a

crucial role in raising substantial amount of long term finance.

4.4 Venture Capital: key for long term growth

The European venture capital showed some positive signs in the second quarter this year

raising $2.8 billion, which is the largest amount raised since 2001. Since the dot com boom

venture capital firms are finding it difficult to raise finance in the EU. In the same quarter, the

US venture capital market raised around $13.8 billion.4 These stats from Dow Jones Venture

Source show that the European Venture Capital market is relatively underdeveloped and small.

The US venture capital market is very active in financing start-up businesses, expansion

activities etc. In the EU, SMEs and start-up businesses find it challenging to raise capital, since

the investors are unenthusiastic about investing in a firm which has no assured returns.

According to New Financial think tank, “approximately 36,000 extra companies could have

been backed by venture capital firms in Europe between 2008 and 2013 if the Venture Capital

market were as deep as in the US” (Wright, 2014). One should understand that Europe is not a

bad place for entrepreneurship; it is the bad experience that the market had from dot com bubble

in 2001, which unfortunately posed challenges for the venture capital market to raise funds.

The European Venture capital market cannot match the US’s dynamic venture capital

market in the short run. But it can take several steps to revive this sector in order to close the

gap. At present, the regulation governing venture capital differs across member states and the

markets are fragmented by borders. Firstly, the Tax treatment of equity and debt should be

addressed which has contributed to the over-dependence on bank loans by SMEs and start-up

business. Most of the countries in Europe put double tax burden on equity capital. This, for

sure, discourages the investment in long run. Secondly, “Undertakings for Collective

Investment in Transferable Securities” (UCITS) are the EU’s main investment document which

demands to keep 90 per cent of the companies’ assets in securities which are listed. This means

that, this amount cannot be used for this illiquid form of investment but is vital from the point

of view of long term economic growth. The EU should push for a creation initiative of the

European Long-term Investment Funds (ELTIFs) which would allow investing in illiquid assets

like shares of unlisted companies, venture capital etc. This initiative is very important for one

4 Data from Dow Jones Venture Source





simple reason, boosting long term investment in the economy which, at this time, is crucial for

Europe.

5. What are the possible changes required in current setting?

5.1 Addressing the obstacles of the Public and Private Equity

Unlike private equity, in the public equity market the companies become publically listed

and the shares can be bought and traded by public. The public equity market is usually highly

regulated. It is one of the most used and efficient nonbank financial instruments. Budget 2013

eliminated the stamp duty for the companies which are listed on AIM or any other growth

market. “Alternative Investment Market” (AIM) is a public equity market operated by the

London Stock Exchange, for growing businesses in the UK and Europe. The decision to abolish

the stamp duty would result in larger availability of finance. This shows that appropriate fiscal

measures to broaden the investor base for SMEs could be an effective way to increase access

to finance. The EU should take measures which would further simplify rules for the public

equity market and for Small and medium Enterprises. One such measure could be creating an

SME asset class to be included in the Markets in Financial Instruments Directive (MiFID).

The private equity remained, like other nonbank financial instruments in the EU, less

developed than the US. Private equity can play a crucial role in financing the SMEs, in the time

when these enterprises are facing difficulties to borrow from bank. Equity is considered to be a

healthier form of financing than debt. The enterprises would prefer equity over debt for couple

of reasons. Firstly, a company can have long term vision and planning of its opportunities if it

has equity finance. Secondly, in case the company suffers losses or downturn, the dividend

payment can be postponed unlike interest payments which are obligatory to pay on regular

basis. Furthermore, the equity finance, whether private or public, is not just good for Small and

Medium enterprises or any other individual companies for that matter, it is good for overall

economy since it facilitates risk sharing and adjust to shocks effectively. The types of Private

equity finances typically include, Angel investing, internet based instrument crowd funding,

investment in venture capital and leveraged buyout (LBO). All these types of private equity

mentioned above are relatively small and underdeveloped in the EU. Several reasons can be

pointed out in this context.

First of all, there is tax discrimination against equity. As mentioned earlier, in most of the

countries, not just only in the EU, the interest payments are deductible from profits before it is

taxed. Such benefits are not available for equity shareholders i.e. on dividends. The EU should

take necessary measures and introduce concrete policies which would remove this tax

discrimination against equity. This policy change would result in a great impact. But, the

European Union does not have the power to influence Member States to adjust or change their

tax system, especially the corporation tax. Nevertheless, it can encourage the member states to

http://en.wikipedia.org/wiki/Markets_in_Financial_Instruments_Directive





eliminate the current bias in tax on equity and debt. The commission has taken a step forward

in this context promising to give country specific recommendations as a part of the European

semester process, “in particular for member states with high debt bias in corporation taxation”5

5.2 Addressing the fragmented regulations

The CMU is, supposedly, intending to improve the flow of capital, but some upcoming

regulations would gum up the flow of capital. The member states remain divided with the

introduction of the Financial Transaction Tax (FTT) which is set to be implemented in 2016.

Through the enhanced cooperation between eleven member states led by Germany and France,

they have agreed to a tax of 0.1 per cent on share and bond transactions, and 0.01 per cent on

derivative transactions (Other member states include Austria, Belgium, Estonia, Greece, Italy,

Portugal, Slovakia and Spain).

This initiative of FTT by member states risked leading to further fragmentation in the EU

single market. The United Kingdom is opposing the introduction of Financial Transaction Tax

on the basis that it would impact the jobs, investment and pension funds and it should be

reconsidered before the implementation. Some exponents argue that the financial sector,

especially banks, had created a mess in liquidity and credit crunch and should pay more. But

the snag is that this tax would hit investors and companies more than the banks. This kind of

taxes could make Europe’s Capital Market a less attractive place to invest. The idea of the

Financial Transaction Tax is surely clashing with Juncker’s plan to deregulate the financial

sector. Other example of fragmented regulations in Member states is that the Non-bank

institutes can only offer credit in the state in which they are established. For lending in other

member states they must acquire a banking licence.6 Also, the bank levies are different across

member states, the EU must address this fragmented rates and take necessary measures to

harmonise it.

5.3 The key factor: Transparency

A free and good flow of information is the lifeblood for any capital market. The market

transparency is strongly associated with the easy access to market information, which is a must

for an efficient and effective capital market. The improved transparency and access to

information would significantly reduce the cost of raising the capital and the search cost. A

higher cost to access the information not only restrains the investment and competition but also

raises the cost of capital. The banks can evaluate the creditworthiness of their borrowers but the

non-bank investors find it difficult to do so and hence rely on public financial data. Hence, the

availability of pre-trade and post-trade information becomes essential for efficient and genuine

5 Long-term financing of the European Economy: “Communication from the commission to

the European Parliament and the Council”, March 27 2014. 6 Refer “Capital Idea”, news article by Hugo Dixon published on 21 July 2014.

http://www.breakingviews.com/hugo-dixon-what-is-eu-capital-markets-union?/21156455.article





market for equities. So, what is required? Steps towards addressing this issue is already taken

with the introduction of Transparency “Directive 2004/109/EC” “Harmonisation of

transparency requirements in relation to information about issuers whose securities are admitted

to trading on a regulated market and amending the Directive 2001/34/EC”. Another significant

step taken in this area is the European Union’s decision to implement International Financial

Reporting Standards (IFRS) in 2002. But this does not apply to all the market participants since

only listed companies abide to follow this decision. The unlisted group which includes many

banks and other financial institutions use different accounting standards which results in

incomparable results and insufficient quality of data. Furthermore, auditing of IFRS reports

are done on national level. Almost every member states follow different set of rules of auditing

provided by national authorities. This further deteriorates the quality of reporting.

For the EU’s CMU, it is necessary to improve the flow of information in two key areas the

infrastructure finance and the small and medium-sized enterprises (SMEs). According to the

report by Finance ministers of the European Union last year, these two areas lack in

transparency. The EU should take necessary actions to enhance the transparency in the market

and particularly in aforementioned sectors. In order to attract more capital in the public

infrastructure projects, the EU should publish the past performance reports which would help

the investors to take decision about investing in future public projects. The “Report of the High

Level Expert Group on SME and Infrastructure Financing – Finance for growth” recommended

that the EU needs to have a credit risk performance database which would bring the SMEs

closer to the capital markets.

5.4 Standardisation

No investor would like to deal with 28 separate standards. The European Union is working

hard on streamlining the financial regulations but the work is still in progress. The biggest

concern in this context is the fragmented insolvency procedures across Europe. The annual

“Doing Business” report, released by the World Bank, ranked 189 countries by their

attractiveness to do business. The data shed light on the time taken to resolve the insolvency

issues, commercial disputes and winding up of a company. It is evident that investors prefer

countries where above-mentioned things are easy and quick to do.

According to the World Bank’s Annual Report “Doing Business” 29th October 2014, in

Southern Europe these procedures are much slower than in countries like France and Germany,

which partially explains why these countries failed to draw in new investment. The other

reasons could be historical and cultural legacies, deep rooted special interests, protection to the

government linked creditors, and inefficiency of insolvency courts. The European Insolvency

Regulation which is in effect from May 2002 intends to promote the co-operation between

different insolvency regimes of the Member States within the EU.





It is high time that the EU must come up with some concrete measures to harmonise the

national insolvency rules and cross border insolvency settlement procedure. But full

harmonisation is not a realistic target due to severe differences in insolvency legislation and

constitutional arrangements. The European Commission is likely to come up with new rules on

harmonising the insolvency procedure across all the member states next year. But, the

imperviousness to change of some judicial systems will be the major concern for the EC. If the

European Union somehow manages to address this issue, a harmonised insolvency procedure

would be a big step towards the CMU and would give a finishing touch to the Banking Union.

A truly integrated and regulated CMU can possibly invigorate the EU’s economy and help them

to discard the sluggish growth.

6. Benefits of CMU for the EU

6.1 Alternative financing option for the Economy

The CMU would work as an alternative financing option for EU’s economy. As per the

European Commission’s agenda for Europe 2020, 1 trillion Euros are required for investment

in telecom, infrastructure, and energy and transport (The European Commission, 2014). Banks

alone cannot finance this ambitious project, more of non-bank finance is essential to take up

this responsibility. As discussed above, lots of possible alternatives to finance the economy are

available.

6.2 Competitive financing options for SMEs

The Small and Medium Enterprises confront troubles in raising funds as a result of limited

choice of funding options. A handful of lenders have the majority of market share in some of

the Member States. This is EU’s one of the major problems, its financial system is not as

competitive as it ought to be. On top of this, the credit is usually provided to companies or

borrowers having incestuous relationships with banks. The introduction of the CMU would

surely help the Small and Medium-sized enterprises by making the financial system more

competitive.

6.3 Sharing negative shocks

The balance sheet of the government, particularly in Ireland and Spain, was weighed down

by the failing banks, which added huge liabilities to it. In contrast, the failure of the sovereign

threatened the major national banks in Greece. The interaction of stressful sovereign and

troubled banks somehow needs to be addressed, since the banks are failing to absorb the

negative shocks. The bank-centricity of Europe exacerbated the crisis. The banks are more

vulnerable to runs because they mostly depend on short-term deposits. At the point when the

banks confront challenges, the government needs to safeguard them to secure the depositors.

However, in some cases, particularly in Ireland, it proved to be a disaster for the government

too. On the other hand, the Capital markets particularly deals in long term funding and hence





is well prepared to take the hit. If an equity-financed company runs into trouble, it can revise

its business plans and it would not affect the banking system largely. Hence, the economy is

less vulnerable to runs if the risk is really being handed over to the institutions, that are not

being profoundly leveraged themselves, and to those institutions that deal in long term funding

and do not depend upon transient money.

A well-developed capital market would help the European Central Bank to manage the

inflation in future. How? At a point when the ECB opts for Quantitative Easing, it has very low

range of capital market instruments. The CMU would bring a wider range of financial

instruments wherein the ECB can sell or buy in order to manage the money supply in the

market.

One should remember that creating a CMU is only one part of Jonathan Hill’s portfolio. If

the banking or financial crisis erupts in the near future, this ambitious project is expected to be

kept on hold. Also, the Eurosceptic UK government wing is not keen on the idea of the CMU

as it sees this project as an attempt of the European Union to seize power from them. David

Cameron, provided he wins the general election of 2015, plans to have a referendum on exiting

the EU in 2017. The US-owned financial institutions such as Bank of America, Citigroup and

Morgan Stanley are considering exiting from the UK if “Brexit”7 takes place. The CMU is a

good reason for the UK to stay back in the European Union. The city of London wouldn’t like

to miss on the opportunity to join the capital market. The potential of capital market will

diminish, to a great extent, if the city of London is out of it.

7. Conclusion

Is the Eurosystem ready for all the challenges? In the current setting of financial system it

is hard to say “Yes”. However, one should not presume the success or the failure of the CMU

based on a few of announcements from the EU. The project has all the potential to stimulate

the European economy. A lot is dependent on the action plans to be presented in the summer

of 2015 by Jonathan Hill and the willingness of the member states to welcome the reforms.

Europe will hit the jackpot with the creation of a genuine CMU. But, harmonising the tax

system, insolvency procedures and bankruptcy laws is not a piece of cake. The Juncker

commission shall at least place concrete founding stones by 2019 if not a fully integrated capital

market. Europe should utilize this opportunity to achieve the goal for which they came together,

economic prosperity of Europe as whole. It is not worth letting such a historic crisis go to waste.

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