Klaas Knot: How Capital Markets Union can bolster Monetary Union
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 47th International
Capital Markets Association meeting and conference, Amsterdam, 4 June 2015.
* * *
Mr. Chairman,
Your Excellency Minister of Finance, Jeroen Dijsselbloem, Commissionner Lord Hill,
Esteemed ICMA-members and conference participants,
1. Thank you for this opportunity to share my views on the European Capital Markets Union.
First, let me express my full support for the views expressed by his Excellency, the Minister
of Finance. I, too, very much welcome the initiatives by the Commission geared at the further
development and integration of European capital markets. I am confident that through the
harmonization of regulation and the introduction of common standards we'll be able to unlock
important new ways of finance; productive ways that will increase the resilience of the
European economy, going beyond the traditional financing channels of banking.
2. It is true that in the euro area, small and medium-sized enterprises are still very much
dependent on financing by banks. This implies that business investment in the euro area also
depends on the availability of bank credit. And this creates vulnerabilities to the European
economy. For example, when banks need to deleverage in order to strengthen their balance
sheets.
3. The European bank-based financial system is often contrasted to the situation in the US,
which is presumed to be more market-based. I should note that this difference is a bit more
nuanced than is commonly acknowledged. For in the US as well, SMEs are similarly
dependent on bank financing, in particular the smallest of firms. To the extent that smaller
firms do access capital markets, this is mostly confined to specific sectors. A well-known
example is the Silicon Valley industry, start-up tech-companies that are able to attract large
sums of financing from venture-capitalists.
4. This refinement notwithstanding, in general it has been shown that well-developed access
to market financing can complement bank financing. And economic research confirms that
this can improve economic performance. The Minister has eloquently explained how this
would apply specifically to the European economy and set out how the Capital Markets
Union relates to the recently established European Banking Union. In my address, I want to
focus on yet another perspective. I will give you my views on why the completion of a true
European Capital Markets Union is beneficial from a monetary policy perspective, for there
are several reasons why better developed and integrated capital markets can make the lives
of European central bankers much simpler.
5. As you know, the Governing Council of the European Central Bank aims to maintain price
stability in the euro area as a whole. To achieve this, the ECB conducts monetary policy.
Based on the outlook for inflation, we set our policy rates to steer overall financing conditions
for households and firms in the euro area. A homogeneous transmission of our monetary
policy decisions throughout the financial system enhances the appropriateness of our policy
decisions. For the euro area as a whole, and for the participating Member States. That is why
monetary policy benefits from a level-playing field in financial markets across countries.
6. Note that I do not intend to suggest that all economic agents should be able to lend
against the exact same conditions. Actual financing conditions for individual households and
firms are to be determined by the market and not by the ECB. And these should
appropriately reflect differences in earnings capacity and risk.
7. This is exactly what went wrong in the run-up to the crisis. Lending rates converged
throughout the euro area, and no longer reflected actual underlying risks. Several potential
explanations have been put forward for this. One reason often mentioned is the
search-foryield as a consequence of the low interest-rate environment. Or the fact that the no-bail out
clause in the EU Treaty was perceived as not credible. Yet another explanation is that gaps
in banking regulation were the primary cause of the mispricing of risks in the run-up to the
crisis. In my view, all three explanations have been relevant. In fact, these factors are likely
to have reinforced each other.
8. In a similar way, I believe that a lack of harmonization in regulation and common
standards in euro area capital markets can also be viewed as an aggravating factor. For
heterogeneity and inconsistencies in regulation can obscure how losses will be distributed
once financial risks materialize. And this can exacerbate the mispricing of risk in financial
markets.
9. I think this is a key issue that the Commission agenda on Capital Markets Union should
address. In my view, one of the obstacles to be tackled is the lack of harmonization in
insolvency laws across countries. Unfortunately, in the Commission's early proposals
initiatives to that effect do not feature very prominently. Yet, I nevertheless believe it could be
an effective way for Capital Markets Union to contribute to consistent pricing of risk across
countries. For it will help ensure a homogeneous, but risk-consistent transmission of
monetary policy decisions.
10. But Capital Markets Union can deliver on more than just that. It can also greatly increase
the efficacy of monetary policy. Common to all monetary policy decisions is that their
transmission to the real economy is sluggish and can sometimes be incomplete. For
example, the extent to which banks are able to lower lending rates following a rate cut
depends on many factors beyond the control of monetary policymakers. One can think of the
level of competition in the banking sector, or the health of bank balance sheets. A successful
Capital Markets Union will open up entirely new channels for the transmission of monetary
policy to the real economy, making central bankers much less dependent on a single sector
for the transmission of its policy decisions. In that sense, central banks can diversify the
channels through which they can influence the economy, adding to its effectiveness.
11. Note that economic agents can benefit from Capital Markets Union in a very similar way.
Households and firms can diversify their dependency on financing, if alternative sources of
finance are in abundance, making themselves less vulnerable to risks stemming from a
single sector. A well-diversified financial structure increases the resilience of the balance
sheets of households and corporations to shocks. And the resilience of the economy as a
whole. And when an economy is better able to cope with external shocks, monetary policy
will not get distracted from pursuing its primary remit: delivering price stability.
12. The latter is even more relevant for monetary policy in a monetary union. Structural
differences between national economies imply that the euro area economy is prone to
asymmetric shocks. Private sector risk-sharing across countries can greatly enhance a
smooth transmission of such shocks. This is what Capital Markets Union can accomplish, for
an increase in the cross-border holdings of financial instruments will enhance risk-sharing
across the euro area, thus improving the functioning of the monetary union.
13. However, Capital Markets Union is no silver bullet. Clearly, its introduction does not
absolve us from pursuing prudent policies in other policy areas, too. Moreover, it will take
time before we can reap the full benefits of Capital Markets Union. But there can be no doubt
that it will prove an important complement to Banking Union in enhancing the functioning of
our monetary union.
14. At the same time, Capital Markets Union will also bring new challenges and risks. For
example, as a result of the shift in the relative importance of the transmission channels of
monetary policy. Interest-rate decisions may transmit to the real economy differently through
markets than they do through the banking sector. This calls for careful analysis. And possibly
a reassessment of the effectiveness of our monetary policy instruments. These instruments
are
currently primarily geared at the banking sector. However, to be able to influence financing
conditions beyond the banking sector we may need to introduce new instruments.
15. Another possible consequence is that risks may shift to the shadow banking sector. A
sector that is currently less transparent and less regulated than the traditional banking sector.
It is yet unclear what could be the financial stability implications if such a development were
to occur. In any case, it would warrant enhanced monitoring of developments in the sector.
One could even argue that a more formalized supervisory framework should be put in place.
Finally, it could be conceivable that macro-prudential policy measures would have to be
applied beyond the banking sector.
16. As for the potential risks associated with developing capital markets, let me highlight one
more issue. Some might worry that by developing financial markets we will again see the
introduction of complex financial instruments. The type of obscure instruments that according
to many were the root cause of the global financial crisis. Here, I would like to reiterate firmly
that this is clearly not what I envisage. Rather, the goal of Capital Markets Union is to create
a level-playing field by introducing simple standards that improve transparency. Only then,
can Capital Markets Union foster financing flows that support economic growth in a
sustainable way.
Dear participants, let me wrap up my address.
17. I presented to you a central banker's view on Capital Markets Union, and why I think this
a very important initiative. Today, the discussion on Capital Markets Union is still at an early
stage. The agenda is being set as-we-speak. Having an exchange of views on such an
important topic with esteemed members of the capital markets community could not have
come at a better time. Therefore, I very much look forward to the discussions later today. I'm
confident that this conference will yield many interesting insights. New ideas that will bring us
closer to completing this important pillar of our Economic and Monetary Union.
Thank you for your attention.