The author is vice-chair at Oliver Wyman
How will Europe fund the huge sums needed to invest in energy transition, digital infrastructure and defence? Despite a vast €33tn pool of savings, Europe has a plumbing problem. Its capital markets are under-developed, while its banking sector is insufficiently sized to handle the growing demands for capital expenditure. To address the investment conundrums, deeper capital markets are needed.
The requirement is enormous: the European Commission has estimated that the green transition requires an additional €620bn each year to 2030, with another €125bn needed for digital transformation. Moreover, Vladimir Putin’s invasion of Ukraine, and the prospect of a second Donald Trump presidency in the US, are escalating demands for greater military expenditure.
Yet despite multiple bazookas from the European Central Bank, growth in lending to companies in the region since 2014 has been less than half that of the US. The gap in economic performance between the two has long nagged at Europe’s policymakers. A widening divide makes this angst acute.
“We need to mobilise private savings on an unprecedented scale, and far beyond what the banking system can provide,” former Italian prime minister and ECB president Mario Draghi argued ahead of publication of his upcoming report on enhancing Europe’s competitiveness.
Despite some progress, there remains a vast gap in venture capital relative to GDP between Europe and the US. European companies have fewer funding options to help them invest and grow.
There is a growing chorus of calls to dust off the unfinished 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.
But the idea of a single market for capital across Europe has been stalled for a decade. Bold ideas often get bogged down.
The recent European elections are likely to make things even more difficult, so perhaps it’s time to change tactics. To clear the system-wide blockages, policy architects should team up with financial plumbers, especially from the private sector.
Revitalising securitisation is the place to start, enabling insurers and pension funds to support Europe’s growth. Securitisation allows banks to transfer assets to investors, in turn 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 written in response to the financial crisis harshly penalised 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.
Solvency II, the rule book for insurers, makes it economically unappealing to fund a long-term infrastructure project or buy a package of small business loans too, reducing potential returns and limiting available financing.
It’s time to recalibrate securitisation 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.
The venture capital ecosystem must be nurtured, private credit harnessed and the cumbersome sustainability rules for funds recalibrated.
Above all, 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.
