Andreas Dombret: What can capital markets deliver?
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, at the ILF (Institute for Law and Finance) Conference on "The European
Capital Markets Union, a viable concept and a real goal?", Frankfurt am Main, 18 March
2015.
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1. Introduction
Ladies and gentlemen
Thank you very much for inviting me to speak at this year's ILF conference. The topics of this
conference are very well chosen, and I am therefore grateful for the opportunity to speak at
today's event and to share my thoughts on the European capital markets union. But let's
begin by taking a step back.
As some of you will know, I spent ten years of my life working for JP Morgan. The legend
goes that one day, old John Pierpont Morgan was approached by a young man who asked
about the secret of the stock market. John Pierpont Morgan looked at the young man and
replied: "it fluctuates".
In my view, that is an important thing to know about the inner nature of capital markets, but it
is certainly not all there is to know. My short intervention today will therefore address a
different question: what can capital markets deliver?
Given the current discussions about a European capital markets union, it seems that we
expect quite a lot from capital markets. Let's take a closer look and discuss whether these
expectations are justified.
2. Diversification - strengthening capital markets
In essence, the European capital markets union has two objectives. The first objective is to
increase the share of capital markets in the funding mix of the real economy. The second
objective is to integrate capital markets more closely across borders.
Some people relate the first objective to the question of whether a capital markets-based
financial system is superior to a bank-based financial system. Well, to sum up the empirical
evidence: it is impossible to tell.
There is certainly some evidence indicating that capital markets-based financing might
increase pro-cyclicality.1 Nevertheless, the recent crisis shed light on these issues from
another angle. A system in which the real economy relies on a single source of funding will
most certainly run into trouble when that source dries up - regardless of whether it is bank
funding or capital market funding.
Therefore, it is not a question of "either/or". The objective of the European capital markets
union is not to abandon bank-based funding but to supplement it with capital markets-based
funding. And in Europe above all places there is ample room to do so. The European stock
market is only 60% the size of the US stock market when measured in relation to GDP.
Likewise, the European market for venture capital is 20% the size of the US market, and for
securitisation the percentage is even lower.2
In the end, it comes down to the uncontested argument of diversification. Increasing the
share of capital markets will improve and broaden access to funding particularly for small and
medium-sized enterprises. At the same time, it will improve the matching of investors to
financial risk, thereby increasing the efficiency of the financial system. As a result, the
financial system will be able to better support sustainable economic growth.
3. Integration - forming a single capital market
The second objective of the European capital markets union is to improve the integration of
capital markets in the entire European Union. What is it that integrated capital markets can
deliver? One of the main arguments is that they can improve private risk sharing. The
technical question is: to what degree does a shock to the economy affect consumption?
Empirical studies for the United States show that integrated capital markets cushion around
40% of the cyclical fluctuations among the US federal states. A share of around 25% is
smoothed via the credit markets, while fiscal policy cushions 10-20% of shocks. Altogether,
around 80% of a given economic shock is absorbed before it can affect consumption3
Studies for Canada yield similar results.4
In Europe, the picture looks different. Here, it is mainly credit markets that cushion economic
shocks - and they are not very effective in doing so. Altogether, only around 40% of a given
shock is absorbed before it can affect consumption.5 Increasing the share of capital markets
and integrating them across borders would therefore help improve risk sharing in Europe and
reduce the volatility of consumption.
4. How to get there
Increasing the share of capital markets in the funding mix of the real economy can contribute
to economic growth. At the same time, integrating capital markets across borders can help
improve private risk sharing within Europe. The Bundesbank therefore believes that the
European capital markets union is a goal worth pursuing.
But how do we get there? The argument for a capital markets union is straightforward, while
its implementation is much less so. The capital markets union is a complex undertaking that
touches upon many different areas. Consequently, the European Commission's green paper
on this subject6 includes a wide variety of suggestions and steps to be taken.
With regard to the objective of increasing the share of capital markets, we should focus on
equity markets. Against this backdrop, let me emphasise the issue of taxes. Currently, tax
treatment still favours debt financing over equity financing. Removing this bias in taxation
would encourage companies to strengthen their equity base and thus turn more towards
equity capital markets in their search for sources of funds.
In terms of the objective of integrating capital markets across Europe, there are some areas
where standardisation could give us some early gains.
The market for high-quality securitisation is one of these areas. So far, a number of policy
initiatives have been launched to restart European securitisation markets, including an
initiative by the European Commission to develop a framework for simple, transparent and
standardised securitisation.
Other areas for early action include private placements, crowd-funding or the harmonisation
of prospectuses. With a view to the long-run, it might also be beneficial to further the
development of funded pensions in order to enlarge and deepen European capital markets.
Another long-term objective could be to harmonise insolvency laws across Europe.
In any case, we should not exclusively focus on the institutional and legal framework in our
efforts to create a European capital markets union. There might also be soft factors at play,
such as cultural preferences for certain forms of funding or the level of financial education.
We also should address these issues in order to achieve our objective.
5. Conclusion
Ultimately, the path towards a European capital markets union will be long and arduous.
There will certainly be resistance, and there will be difficulties. Therefore, we should remain
realistic about what can be achieved.
Nevertheless, we embarked on the path of financial integration by adopting a single currency
in 1999. And we must not stop there but deepen integration in order to make the European
monetary union work. In November 2014, we took a major step by establishing a single
European mechanism for banking supervision; now, we should consider taking another key
step by forming a European capital markets union - one that not only includes the euro area
but extends to the entire European Union.
I would therefore like to conclude with a quote that is attributed to Robert Kennedy, although
he allegedly borrowed it from his brother John F Kennedy, who - according to his advisor
Ted Sorensen - borrowed it from someone else. In any case, the quote goes like this: "Some
see things as they are and say "why?". Others dream of things that never were and say "why
not?". With regard to the European capital markets union, I suggest we should join the latter
group.
Thank you for your attention.