Capital Markets Union: A Central Banking Perspective on the
Way Forward
Keynote lecture prepared for the 2nd Annual Conference of the Joint Research Centre
(JRC) Community of Practice in Financial Research Capital Markets Union: Unlocking
Europe's Economic Potential
04.12.2019 | Brüssel | Claudia Buch

1 Motivation

2 Financial markets in Europe: Where do we stand?

2.1 Financial structures and capital flows

2.2 Insolvency regimes as an example of institutional differences

3 What can be done?

3.1 Transparency about data and regulation

3.2 Communication and financial literacy

3.3 Identification of frictions and policy evaluation

4 Summing Up

Figures

References
1 Motivation
The free movement of capital constitutes a cornerstone of the European integration process. More
than 60 years ago, the Common Market was initiated with the Treaty of Rome in 1957. Since
then, a number of initiatives have been undertaken to further this integration by abolishing capital
controls, harmonising financial sector and banking regulation, and by establishing the Single
Supervisory Mechanisms and the Single Resolution Mechanism.
Despite these significant efforts of institution-building and legal harmonisation, there is a sense
that the cross-border integration of financial markets in Europe remains incomplete compared to,

for instance, the United States. [1]
Incomplete cross-border integration of financial markets may impede investment opportunities for
households and firms and an efficient allocation of assets across countries. At the same time,
European societies need to deal with challenges such as demographic change, climate change,
and changing patterns of globalisation. This creates a need to re-assess the state of integration of
financial markets and to evaluate policy measures that can help to eliminate existing bottlenecks
and reduce frictions.
This, in a nutshell, is the background against which the Capital Markets Union (CMU) project was
launched in 2015 in order to "get money - investments and savings - flowing across the EU so

that it can benefit consumers, investors and companies". [2] In this sense, the Capital Markets
Union complements the Banking Union, which focuses on banks and the centralisation of
supervisory powers.
The CMU project has many facets and implications, and not all of the objectives or policy
measures are of core relevance or even within the mandates of central banks. Still, the Eurosystem

as such and individual central banks in Europe [3] have taken a key interest in the Capital Markets
Union project because it is closely linked to central banks' objectives and tasks:
As regards price stability, well-functioning and integrated financial markets facilitate the smooth
transmission of monetary policy. The traditional channels of monetary policy transmission - the
bank lending channel or the portfolio channel - essentially operate through the way banks'
balance sheets respond to monetary policy instruments. Even more fundamentally, banks are key
counterparts for the operational implementation of monetary policy measures and play an
important role in payment systems.
As regards financial stability, resilient financial markets do not amplify but rather smooth shocks to
the real economy and reduce systemic risks. Since the financial crisis, several macroprudential
measures have thus been implemented that mitigate systemic risk in the banking system. Beyond
banking, a healthy balance between debt and equity finance can mitigate systemic risks, as it
provides ex ante insurance against economic risks. In contrast to creditors, equity owners
participate directly in economic gains - but also in losses. In addition, equity finance is essential for
start-ups and can contribute to the financing of innovations and thus growth. In this sense, equity

finance can yield a "double dividend". [4]
Taking into account these potential benefits of well-functioning, integrated capital markets, new
proposals are being developed on how to further advance the project. In October 2019, the "Next
CMU High-Level Expert Group" presented recommendations "to shape and strengthen capital
market-based investment and financing for the real economy in the EU 27, in the medium and

long term". [5] Recommendations range from enhanced opportunities for long-term savings and
investment, developing equity markets, increasing liquidity across markets, and measures to
improve the international role of the euro. In November 2019, the EU Commission announced the

composition of a High-Level Forum to take forward the Capital Markets Union. [6] These
initiatives add to and build on a number of earlier initiatives and proposals on how to advance the

integration of financial markets in Europe. [7]
So why has progress been rather slow? Why do we, more than 60 years after the initial inception
of the Common Markets, after the abolition of capital controls in Europe, and after the
harmonisation of key elements of the legislation, still see the need for further integration of
markets?
I see four main reasons:
First, the global environment has changed. Capital markets have become more integrated - and
will become increasingly so, due to the digitalisation of financial services. This calls for the
identification and potential removal of barriers to integration that remain in Europe. In addition,
the introduction of the euro and the conduct of a common monetary policy impose more
demanding requirements on integrated capital markets than the conduct of monetary policies at
the national level.
Second, frictions are hard to identify. The academic literature in the 1990s focused primarily on
the importance of capital controls for the cross-border integration of financial markets. Capital
controls have been reduced significantly in most advanced economies, leading to expectations
that the integration of financial markets would proceed rapidly. Yet barriers to full integration
remain in place. In Europe, price-based measures of financial integration declined strongly after
the financial crisis and remain below pre-crisis levels (Figure 1). Quantity-based measures have not

increased over the past 15 years or so. [8] Key advancements in the measurement of frictions
based on gravity models and micro-level data have indeed shown that there are many regulatory,

cultural, and institutional frictions beyond capital controls that matter. [9]
Third, communicating the benefits of the CMU project is difficult. Public discussions often portray
the CMU as a project that may diminish the role of banks or that may be promoting Anglo-Saxon
capital markets. Consequently, and given the ongoing discussion on Brexit, the project may be
perceived as having lost its political urgency. Yet neither of these narratives captures the core of
the CMU project: the potential welfare benefits that it can bring for consumers and households.
Fourth, removing remaining barriers of integration is becoming increasingly harder. Initially, the
removal of capital controls and restrictions to the cross-border movement of capital was a
relatively easy administrative task. As those "low-hanging fruits" have been picked, more difficult
measures remain to be tackled.
Take, for example, frictions resulting from different legal systems to deal with insolvencies. Such
differences constrain the collection of collateral and the securitisation of bank loans across
countries in case of a default of the borrower. It has been argued that harmonisation of insolvency

legislation would bring benefits. [10] Yet insolvency legislation is so deeply engrained in legal
traditions and national norms that it is hard to see how a strong degree of harmonisation could be
achieved in the foreseeable future. Hence, a more realistic approach would be start with, identify,
and remove issues that impede the transparency, speed, and costs of national insolvency laws and
thus increase their effectiveness.
More fundamentally, any steps towards further integration depend on the political economy of
reforms: Do reforms provide net benefits to incumbents? How powerful politically are those

incumbents? [11] As key steps towards integration have been taken, additional reforms will
almost inevitably move into areas where core interests of incumbent market participants and
institutions are affected. These are likely to resist further harmonisation and the removal of
barriers to integration - barriers which may impede the efficient functioning of pan-European
markets, but which also protect existing market structures. At the same time, public scepticism
concerning the overall benefits of the European project make opponents to reform politically more
powerful.
So how can we address these issues? How can we reap the potential benefits of CMU while
remaining realistic about what is achievable? In this talk, I would like to stress three aspects that I
consider important for the CMU project and where central banks can make concrete
contributions:
1. Transparency in terms of data and relevant regulations: Over the past decade, the data
infrastructure in Europe has improved significantly. Central banks, statistical agencies, and
reporting entities have invested massively to improve our understanding of financial markets.
Yet regulatory and technical constraints hamper using these data smoothly across public
institutions and making relevant data available for private market participants and researchers.
Similarly, obtaining information on relevant national regulations at low cost is not always
straightforward. Improving transparency and access to existing information can thus make
relevant contributions to the CMU project.
2. Improved communication and financial literacy: A CMU project that is to bring benefits to
individual consumers and households must be communicated and explained accordingly. Many
terms that are used to describe the benefits of the project, such as "enhanced private sector risk
sharing" or even the name "Capital Markets Union", are reasonably clear for trained economists,
but their concrete meaning is much harder for laymen and -women to grasp. A sufficient degree
of financial literacy and consumer protection is needed for consumers and firms to actually
grasp the benefits of integrated financial markets or of pan-European pension products. Hence,
developing or strengthening national strategies to improve financial education can complement
further steps towards the CMU.
3. Evaluate policies and identify relevant frictions: Since the launch of the CMU project, the
Commission has initiated and implemented a number of concrete measures. It is certainly too
early to tell whether these measures have been effective in reaching the objectives of the
project. Hence, much remains to be done with regard to research and analytical work to follow
up on the progress made so far, identify remaining frictions, and assess potential benefits of
future policy changes. A good data infrastructure is a core element of such an evaluation
agenda.
Before going into more detail on these proposals, let me give a quick recap of where we stand in
terms of financial market integration and development in Europe.
2 Financial markets in Europe: Where do we stand?
The financial crisis of 2007-09 and the sovereign debt crisis in Europe exposed critical fault lines in
the European financial infrastructure: a heavy reliance on debt finance, including cross-border debt
flows, a lack of harmonisation of supervisory practices and exchange of information, a lack of
institutional infrastructure to resolve failing financial institutions, and missing mandates to address
financial stability risks. The institutional infrastructure has been overhauled in the meantime and
new regulatory frameworks have been implemented in line with globally agreed standards. These
institutional changes, together with a changing market perception of risks, have altered the
structures of financial markets and cross-border capital flows. Still, financial markets across
European countries display a significant degree of heterogeneity in terms of financial institutions,
capital flows, and legal frameworks.
2.1 Financial structures and capital flows
Despite differences in financial systems across European countries, bank finance continues to
provide a higher share to the financing of firms than, for example, in the United States. In the Euro
Area, bank assets have a level equivalent to 300% of GDP, compared to 85% in the US. Equity
shares listed on stock markets stand at 68% of GDP, below the United States' 170% of GDP.
Finally, private sector debt securities outstanding are almost 85% of GDP in the Euro area and

roughly 100% in the US. [12] The financial system in Europe thus remains bank-based, but other
financial institutions have caught up (Figure 2).
Overall, financial market development is also quite heterogeneous across Europe. It is lower than

in the US because of differences in financial market depth (Figure 3). [13] By contrast, the
development of financial institutions, capturing banks, insurance companies, and mutual funds, is
more similar across European countries. Comparing these indices over time shows that financial
structures change very slowly, and it is not easy to link changes to regulatory quality or the
intensity of banking supervision. If anything, capital controls seem to be an important covariate of

financial market development and depth. [14]
Cross-border portfolio equity investments within the euro area have grown steadily over the past
15 years (Figure 4). These capital flows were also the most resilient during the financial crisis
(Figure 5). The composition of intra-euro area asset holdings has shifted towards a growing

foreign share of equity investment and a stable or declining share of foreign debt instruments.
[15] In the global financial system, there has been a similar trend, showing a shift towards
portfolio investments and direct investments. Within the category of portfolio investments, the
composition has shifted from debt flows towards equity flows (Figure 6).
At the same time, markets for venture capital remain highly fragmented and underdeveloped
compared to, for instance, the United States. Between 2012 and 2014, investments of private
equity and venture capital funds in the United States were more than eight times higher than in
the EU. GDP, in contrast, is about the same. This gap increased further in the years 2015 to 2017.

[16] In addition, almost 90% of private equity and venture capital in Europe is concentrated in

eight member states that represent 73% of EU GDP. [17] There is little cross-border investment in

this market segment. [18]
National banking markets are also quite fragmented in Europe. At least in the core countries of the

Euro Area, the share of bank assets held by foreign branches and subsidiaries is still very low. [19]
Additionally, cross-border mergers and acquisitions among banks have been on a declining trend
in the Euro Area since the last financial crises, both in terms of the number and the valuation of

the transactions. Mergers are still mainly performed within countries. [20]
As a result of the incomplete cross-border integration of financial markets - and in particular
equity markets -, cross-border risk sharing through private markets remains limited in Europe.
Almost 80% of the idiosyncratic shocks to a country's GDP growth remained unsmoothed as of

2017 (ECB 2018). [21] Consumption is about four times more sensitive to asymmetric shocks in

Europe than this is the case across the individual states in the US. [22] For every 1% point drop in
national GDP growth below the average growth rate of the EU, private consumption in the
affected country falls by some 80 basis points, on average, if the country is in the EU. This
consumption variation - and thus the unsmoothed element of local shocks - is only about 20
basis points for the 50 US states.
2.2 Insolvency regimes as an example of institutional differences
Insolvency rules play a critical role for savings and investment decisions. Deciding where and how
to invest requires forming expectations about expected return and legal rights in case risk
scenarios materialise: Will my rights as creditor be protected? How will I, as a debtor, be able to
service my debt obligations? Insolvency legislation answers such questions by providing decision
rules on how to reallocate resources to more productive uses when a firm or household
encounters serious financial difficulties.
Ineffective insolvency regimes, in contrast, may delay adjustment to adverse shocks. This was
particularly evident in the post-crisis deleveraging process and the reallocation of capital in the
European economy: balance sheets were often burdened with legacy assets from the past, thus
preventing the shifting of resources to new and productive uses. Effective insolvency regimes that
allow swift recovery or liquidation in a predictable and transparent manner can thus facilitate debt
restructurings and the reallocation of funds to their most productive use. It would also increase
the likelihood that viable businesses do not end up in inefficient liquidations.
How different legal systems contribute to the efficiency of insolvency proceedings can be judged
against the costs, speed, and transparency of these regimes:

Costs: Insolvency proceedings in Europe tend to be lengthy and costly, in particular for SMEs.
[23] In the euro area, for example, the cost of insolvency amount on average to 10% of the

insolvency assets' value. [24] The range of this value across countries is quite high though, with a
mininum of 3.5% and a maximum of about 22%. Hence, when restructuring a loan and
liquidating assets, almost one fourth of the total value may get lost due to the cost of insolvency.
These are resources that cannot be put into more productive use after the restructuring has
happened.
Speed: Insolvency regimes influence the time required to enforce debt contracts and, therefore,

the cost of credit. [25] It can take up to 4 years in some countries or 0.4 years in others to

recover assets and collect contractual claims. [26] Such delays again imply that time is lost until
new productive activities may resume.
Transparency: Transparency is important because investors need sufficient information to exercise

their rights under the law. [27] For instance, creditors must receive adequate notice of meetings
at which creditor decisions are to be taken, as well as receive sufficient information on the debtor.
Additionally, insolvency law should provide guidance on how courts might exercise their

discretion, and the judicial proceedings should be open and transparent. [28]
Intransparency and fragmentation of insolvency laws pose special challenges for cross-border
investments if there are differences in corporate insolvency regimes, and if there is uncertainty
with respect to the duration of insolvency proceedings. European countries differ in terms of the
treatment of collateral in insolvency proceedings. Some Member States have insolvency regimes
that make it costly to collect collateral, while others have regimes that provide for an easy and
quick collection. The same holds true for silent privileges of tax authorities, social insurance, and
labour claims, which some countries have abolished in favour of equal treatment of senior
creditors.
The efficiency of insolvency regimes, indeed matters. Empirical evidence suggests that countries

with more efficient insolvency regulations receive higher levels of cross-border investment. [29] In
this context, efficiency is a combination of the number of rules, administrative and judiciary
resources, procedures, processes and measures taken. Improvements of restructuring, insolvency
and discharge procedures will help to reduce the length and the costs of procedures and increases
their efficiency. Pre-insolvency regimes, i.e. measures that take effect before bankruptcy

proceedings are started, are especially important. The effects differ across sectors:
[30] Households and institutional investors are particularly sensitive to the efficiency of the
insolvency framework, and debtholders respond more to the availability of restructuring tools than
shareholders.
3 What can be done?
The list of potential policy measures that can address the incomplete integration of financial
markets across Europe and the under-development of specific market segments is quite a long
one. In discussing what can be done, I would thus like to focus on three aspects: transparency and
access to data and information, communication and financial literacy, and policy evaluation.
3.1 Transparency about data and regulation
Data and information are core inputs into the production of financial services. Measures that
promote access to relevant data and information for markets, investors, and households can thus
contribute to an improved functioning of financial markets.
The role of publicly available, standardised credit information is a key difference between

bankbased and market-based financial systems. [31] Creditors assess loan applicants' creditworthiness
based on two criteria: the applicants' financial capacity or ability to repay a loan, and the

applicants' willingness to repay the loan. [32] Gathering and processing private credit information
from long-standing customer relationships is at the core of banks' business models. Therefore,
investors rely more on publicly available, standardised information that allows them to compare
alternative investments.
Much has indeed been done since the financial crisis to improve the data infrastructure in Europe
and to collect data on financial market segments that were difficult to analyse prior to the crisis:
Credit registries that provide information on the supply side and the demand side of credit
•

markets differ across European countries. [33] They differ, for instance, in terms of reporting
thresholds or types of data collected. In order to provide a harmonised data infrastructure, the

Eurosystem started the Analytical Credit and Credit Risk Datasets (AnaCredit) initiative in 2016.
[34] Since September 2018, banks within the European Monetary Union report up to 89 data
attributes per loan and involved counterparties on a monthly basis. AnaCredit only collects data
on non-natural persons as counterparties. Banks have to report loans granted to a single debtor
if the outstanding exposure over all loans to this debtor is at least 25,000 Euro. Additionally,
implementing feedback loops, which require an adequate legal basis, would be a way to share
and use the rich information contained in AnaCredit more widely, including across market
participants.
The unambiguous identification of a firm is of crucial importance for the collection, aggregation,
•

and dissemination of information. [35] During the financial crisis, it became obvious that
authorities and market participants lacked key information on the connectivity and the
interdependence of the global financial system. This prevented an adequate pricing of risks
related to interconnectedness and adequate policy measures addressing resulting risks. Ensuring
that each firm receives a Legal Entity Identifier (LEI) can thus contribute to improved information
and transparency. The LEI is a 20-digit code that enables a unique identification of legal entities
participating in financial transactions. The G20 endorsed the LEI in 2012. The Global LEI System

[36] is now operational and has issued 1.5 million LEIs worldwide. However, in order to fully
reap the benefits of the identifier, further steps to broaden its coverage are needed.
New data initiatives have been launched that provide granular information on markets for
•
derivatives with the European Market Infrastructure Regulation (EMIR) or securities holdings
(Securities Holdings Database, SHSDB). EMIR aims at enhancing the transparency of
over-thecounter derivatives trading. Financial and non-financial counterparties must report their activities
to trade repositories, which provide granular data access to supervisory authorities. The SHSDB

contains positions and transactions of security-by-security holdings. [37]
Essentially, all of these initiatives have been developed in the traditional systems that serve
statistical purposes, on the one hand, and supervisory purposes, on the other hand. In terms of
costs and information provided, these systems would benefit from the development of a
consistent and integrated system for collecting statistical, resolution and prudential data. The next
steps to be taken to reach this objective are currently the subject of a feasibility study on
integrated reporting of the European Banking Authority (EBA). This study will take into account
the work that the European System of Central Banks has already carried out regarding the
integration of data.
More specifically, the European System of Central Banks has been working on two initiatives with
the aim to develop an integrated reporting system. The Banks' Integrated Reporting Dictionary
(BIRD) is a "dictionary" that specifies which data should be extracted from banks' internal IT

systems to generate the reports required by authorities. [38] It has been developed since 2015 in
close cooperation with the banking industry. It is a voluntary initiative aiming to reduce the
reporting burden on banks and to enhance the quality of reported data to authorities. The
objective of the Integrated Reporting Framework (IReF) is to harmonise and integrate existing
ESCB statistical requirements. Following a cost-benefit analysis in 2020, implementation is

currently planned for the years 2024 to 2027. [39]
The EBA feasibility study together with the ESCB initiatives on IReF and BIRD are expected to help
banks with their data reporting, reduce redundancies, minimise the reporting burden, foster data
standardisation and enhance data quality. Users, including external researchers, would benefit
from consistent and standardised reports and the enhanced possibility of data sharing.
Apart from information on the activities of market participants such as banks, a high-quality data
infrastructure requires transparent and accessible information on relevant regulations. Currently,
there is no central database or website where such information is collected. While all EU legal acts

are stored in a central database, [40] information on whether, when and how these legal acts are

transposed into national laws is often hard to gather. [41] That makes finding relevant
information slow, cumbersome and thus costly for both, market participants and academics.
3.2 Communication and financial literacy

[42]
"Improved private sector risk sharing" is often cited as one of the main objectives of the CMU in
economic terms. Translating this abstract objective into an intuitive language is important as a
means of ensuring public support for the project.
What "risk sharing" essentially means is "enabling productive investments through insurance
against adverse events". Assume two owner-run firms that have fully financed their firms through
equity capital. In good times, the owners enjoy the full gains from their activities. These gains
accrue to individual owners but also to the economy as such through a greater variety and better
quality of products and services, growth and innovation. In bad times, however, owners that have
invested their wealth in their individual firms have to bear the full losses. If they do not have any
other means of income, their consumption will thus fluctuate with the firm's profits.
Owners thus have two options. They can save some of their income in good times, invest in bank
deposits, and draw down deposits in bad times. The bank can then extend credits to other firms.
Alternatively, the firms' owners can hold equity in their neighbour's firm. If the profits of the two
firms are not perfectly synchronised (or "correlated"), they will "share risks": if one firm is doing
well, the other one is not, and vice versa. Both owners can stabilise their income and consumption
and thus insure against the perils of fluctuating profits. Without this insurance mechanism, they
may not have started their enterprise in the first place - thus foregoing economic benefits.
Of course, going from this simple example to an intuitive communication of the benefits of cross-
border risk sharing in modern market economies is not trivial. Nevertheless, I think we need these
simple examples to explain why "risk sharing" can be economically beneficial.
Take the example of the development of pan-European savings and pension products, one core
objective of the CMU. Well-functioning pensions systems can indeed provide savings instruments
and insurance services for the individual. In order to reap these benefits, individual market
participants must have a basic understanding of relevant financial concepts, and appropriate
regulations must be in place to prevent the build-up of risks for the individual household or even
the financial system.
Financial literacy is the key to informed decision making at the individual level. It is an individual
skill, related to the capability of individuals to deal with financial concepts, to take sound financial
decisions, and to balance the risks and returns of these decisions. Lusardi and Mitchell (2011a,
2011b) developed three questions measuring fundamentals necessary for financial decision
making related to interest rates, inflation and the benefits of investment diversification. These
questions have been widely used and added to several national surveys, including the Panel on

Household Finances (PHF) in Germany. [43] A related concept is financial capability, which
includes economic behaviour such as managing day-to day spending well, looking ahead and
planning for unanticipated expenditures, as well as selecting and using available products
appropriately.
The OECD International Network on Financial Education (OECD/INFE) defines financial literacy as a
combination of the awareness, knowledge, skill, attitude, and behaviour necessary to make sound

financial decisions. [44] Results from an OECD/INFE Survey of Adult Financial Literacy
Competencies show that there is considerable scope for improvement in terms of overall levels of

financial literacy (Figure 8). [45] On average across G20 countries, fewer than half of adults (48%)
could answer 70% of the financial knowledge questions correctly. Furthermore, the percentage of
men achieving the minimum target score for financial knowledge is about 11 percentage points
higher than that for women. In terms of behaviours or actions required to improve financial well-
being, only 52% of adults reached the minimum target of exhibiting six of the nine behaviours

discussed. [46] Such differences in financial literacy can have implications for investment

behaviour and cross-border financial flows. [47]
3.3 Identification of frictions and policy evaluation
The European Commission launched the Capital Markets Union project in 2014. Following a public
consultation, an Action Plan proposed 33 concrete measures. The European Commission delivered

all the measures it put forward in the CMU Action Plan of September 2015 [48] and in the mid-

term review of June 2017. [49] The majority of these measures have been adopted in the
meantime, while a few are still under negotiation. However, because many proposals were
adopted only recently, it is hard to gauge their effect at this point.
Ultimately, deciding "what works" in terms of mitigating frictions that prevent an improved
functioning of financial markets in Europe requires a structured impact assessment. A sufficient
amount of time needs to elapse before reforms can work their way through the financial system
and, ultimately, affect the real economy.
In 2015, the European Commission initiated a Call for Evidence to solicit feedback on the effects

of the overall EU regulatory framework. [50] Based on the responses, the Commission adopted a

Communication in November 2016. [51] The Commission concluded that whilst the financial
services framework in the EU was generally working well, targeted follow-up measures were
justified in four areas: reducing unnecessary regulatory constraints on financing the economy,
enhancing the proportionality of rules while preserving prudential objectives, reducing undue
regulatory burdens, and making the regulatory framework more consistent and forward-looking.
Generally, evidence-based policymaking in Europe can build on the Commission's "Better
Regulation Guidelines", which set out key principles for evaluation