By Eddy Henning, Michael Torben Menk and Joachim von Schorlemer
The majority of political and business representatives are aware that a European economic and monetary area will only have a competitive future if, around ten years after the European Commission’s action plan – the Green Paper on the creation of a Capital Markets Union – it finally succeeds in transforming the currently fragmented and mostly underdeveloped national capital markets into an integrated single European capital market. This article firstly highlights the need for investment in transformation, which is a fundamental and lasting challenge for Europe. In addition, the authors see the revitalization and deregulation of the European securitization market in particular as a considerable opportunity for banks and other financial intermediaries to use capital markets more consistently and efficiently in order to create scope for additional lending and stimulate real and financial economic activities. Finally, the authors do not fail to mention the predominantly short-term savings behavior of private households, which could prove to be a problem in the future insofar as not enough capital is raised for long-term investments – a reallocation of private capital should therefore be worked towards.
Obvious need for action – no transformation without the capital market
Even if banks play a very important, allocative role in the clash between capital supply and demand, a big question mark must be raised as to whether and to what extent financial intermediaries are able to manage the restructuring of the European economy on their own without a complementary, integrating capital market. The idea that the goals set by the European Union, such as decarbonization, digitalization and diversification – to name just a few examples here – can only be financed via bank balance sheets, which is entirely justified from aEuropeanbanking perspective, quickly turns out to be a fallacy. According to estimates by the Noyer Group, the additional financing required by 2030 may amount to around EUR 1 trillion per year: volumes that neither the European banking sector nor public programs can manage without an accompanying, complementary capital market union. The green transformation codified in the European fit-for-55 package alone is expected to require around EUR 500 billion in investment expenditure per year. In addition, the digital transformation will require funding of around EUR 125 billion per year. For defense and other investments, a further EUR 300–400 billion of capital per year, which can only be roughly calculated at present, may need to be raised, as shown in ► Fig. 01. Against the backdrop of being able to successfully manage the aforementioned far-reaching transformation process – and thus increase Europe’s attractiveness for non-European investors and strengthen Europe’s global competitiveness – an efficient, deep and liquid internal capital market with effective risk sharing seems unavoidable.
Fig. 01: Additional European investment volume by 2030 – per year
European capital market currently considered underdeveloped and fragmented
Unlike in the United States of America, banks in Europe play a prominent role in both lending and borrowing capital. Companies and private households alike predominantly finance their investments with their house bank, with companies accounting for around 70% and private households for around 90%. Accordingly, capital market financing hardly plays a role in Europe. Almost the opposite relationship – and this seems unsurprising – can be seen on the other side of the Atlantic. This should by no means lead to the conclusion that banks do not play an important role in the USA. Quite the opposite – in addition to their core business, banks act as market makers, asset managers and bridge builders between market participants, not least through securitization, as will be shown below.
Serious capital market-related differences between the USA and Europe, which signal a relative underdevelopment and fragmentation of European markets, occur primarily on the equity market. The European equity market accounts for just over a tenth of global market capitalization, whereas the US market accounts for around 45 percent of global market volume. In contrast, Europe’s share of global value creation (GDP) is just under 18 percent, i.e. around seven percentage points more than the relative market capitalization of equity. This, among other things, is a good illustration of the distortion between value creation and the capital market. Not only does a relatively small European capital market as a whole make the long-term financing of high-volume investments more difficult, but fragmented, individual national capital markets within Europe also block the completion of a uniformly competitive and therefore attractive capital market for European and non-European investors. In addition to examining quantitative criteria such as capital market size and capital market depth, the analysis of infrastructural and institutional framework conditions in Europe should not be forgotten. Consideration should be given to encouraging and incentivizing existing and, above all, potential new capital market participants to become (more) active on the capital market, to impose lower administrative and technical costs on them and not to burden them unduly with additional regulatory barriers and formal requirements and possibly slow them down.
Essential: Revitalization of the European securitization market
With the theoretical and practical knowledge that, on the one hand, securitizations can build a bridge between bank financing and capital market financing and, on the other hand, that the regulatory framework with CRR, VVO, numerous RTS and EBA guidelines as well as other detailed regulations – i.e. restrictive and prohibitive (market entry) hurdles – will not allow the European securitization market to gain momentum, in the course of an integrated European single capital market, a wide range of small, medium-sized and large banks should be enabled to create scope for additional lending and new business by selling receivables and placing risks, and also to become active as investors in senior securitization positions with the aim of relieving the burden on third-party banks and providing them with additional liquidity.
Even if politicians and regulators attempt to justify the CRR’s disproportionately high capital requirements for securitizations – keyword: non-neutrality principle – through increased model and agency risks, the empirically unprovable, blanket overcapitalization should be put to the test conceptually. Overcapitalization could be reduced, for example, through risk-sensitive and differentiated senior floors in the formula-based approaches (SSFA). This would result in risk-adequate floor levels based on the IRBA or SA reference portfolio. The current rigid floor levels are decidedly too high, especially for high-credit quality and low-risk reference portfolios. In both the SEC-IRBA and the SEC-SA, overcapitalization could be counteracted by lowering the p-factors, for example, as shown in ► Fig. 02 Coupled with the abolition of a time limit (Art. 465(13) CRR), the halving of the p-factor in particular should be deleted. Instead, it would be advisable not to use fixed numerical p-factors – currently 0.25 for STS securitizations (Art. 262 CRR) and 0.50 for non-STS securitizations (Art. 261 CRR) – but merely to apply a “halving of the values specified in Art. 261 and Art. 262 CRR”. This would not only take account of the general reduction in complexity – it would also mean that a possible subsequent adjustment of the p-values could be carried out with significantly less readjustment effort.
Apart from the modifications to the European securitization regulations, which are intended to counteract overcapitalization and reduce the general level of complexity, particular attention is paid to the recognition of securitization positions as High Quality Liquid Assets (HQLA), which is necessary for LCR purposes. After all, bank investors (treasurers) regularly rate the costs in the form of haircuts of an AAA senior tranche currently only classified as HQLA 2b higher than the benefits of a securitization position eligible for central bank borrowing. As a result, consideration should be given to recognizing senior STS securitizations as highly liquid level 2a assets and senior non-STS securitizations as highly liquid level 2b assets. At the same time, the attractiveness for investors could be increased by adjusting the haircuts to bring them to a comparable level with covered bonds and corporate bonds. Ultimately, the aforementioned corrective measures also take into account the overall objective of ensuring macroeconomic financial market stability, which would be desirable not least as a result of increasing market liquidity and increasing liquidity of the lending banks.
Fig. 02: Regulation of securitizations: Floor capitalization adjustment and LCR eligibility
Reallocate private savings capital for European long-term investments
In addition to reviving the European securitization market, the economy and politicians should strive to encourage private households to adopt an adapted, long-term savings strategy in order to put capital to the best possible use – in the interests of savers and the economy as a whole. Traditionally, European (German) households currently save around 13 percent (20 percent) of their disposable income, significantly more than American households, which only set aside around 8 percent of their income. While American households predominantly invest their savings in long-term equity and debt instruments such as shares, bonds and funds, European households park the majority of their money in short-term, mostly fixed-interest savings, term and demand deposits. It can also be observed that long-term invested capital often flows out of the European economic area, whereas non-European investors provide European companies with long-term equity. Both the European-established short-term investment behavior and the long-term net capital outflow signal the need to reallocate private capital in the face of an ageing population and, at the same time, insufficiently filled state and social security coffers. Alongside the revitalization of European securitization markets, attracting private households to the equity market and the bond market for part of their savings could be one of the keys to financing necessary green and digital investments for the future. This is because, just as at a micro level in the business environment, matching maturities should also be taken into account at a macroeconomic level: long-term investments percent long-term financing.
The guiding principle must be: Steer Europe competitively into the future
Perhaps more than ever, Europe must pull out all the stops to ensure an economically prosperous future for 450 million people. This article underlines the urgency of asserting Europe in global competition and increasing its attractiveness and competitiveness by completing a European Capital Markets Union – beneficial for investors and issuers alike. Empirical studies prove the connection between capital market development, growth and productivity. If Europe does not succeed in further developing the currently fragmented national capital markets into a single European capital market, it will continue to lose ground to the USA, China and other emerging economies – this must be prevented. However, increasing competitiveness must not be formulated as an isolated goal, but rather in close coordination with integrity and stability, as can be seen in ► Fig. 03. Only by observing this triad will Europe as a whole be able to return to a sustainable growth path. For the benefit of all Europeans.
Fig. 03: European capital market in a triad: competitiveness, integrity and stability
Literature
Association of German Banks (2024): Position paper of the Association of German Banks on deepening the capital markets.
Association of German Banks/True Sale International (2024): Strengthening Europe’s Competitiveness: Seizing Opportunities through Securitization; Final Report of the Securitization Taskforce.
Draghi (2024): The future of European competitivenes – Part 1: A competitivenessstrategy for Europe.
Noyer et.al. (2024): Developing European Capital Markets to Finance the Future – Proposals for a Savings and Investments Union.
German Council of Economic Experts (2023): Capital market in Germany and the EU: making better use of potential; in: Annual Report 2023/24.
German Council of Economic Experts (2024): Strengthening the European capital markets, Policy Brief 2/2024.
True Sale International/Foundation Project Capital Markets Union (2023): The challenge of transformation financing for companies and banks in Germany – securitizations as an instrument for linking bank loans and the capital market; Final report of the working group “Securitization Platform”.
German Economic Council (2024): Competitive financial markets for a strong euro, position paper.
