Capital markets, after all, play an important role in sharing economic risks and in smoothing consumption.17 But even more fundamentally, they contribute greatly to innovation 5/9  BIS central bankers' speeches  and growth. Evidence increasingly suggests that while both banks and markets are important for the financing of economic growth, non-bank financial intermediation provides a relatively more powerful contribution to innovation and productivity-enhancing activities in modern sophisticated economies,18 also in the euro area.19 Importantly, complementarities between banks and markets increase, as the economy develops,20 and so deep capital markets will end up complementing banks as sources of financing. While the European Commission’s current CMU initiative is an important step in the right direction, a much more ambitious agenda for bolstering capital markets in Europe is needed in the future. Developing well-functioning capital markets which support economic growth across Europe requires a comprehensive approach. To that end, Europe needs to boost the supply of equity finance. Policies which stimulate individual ownership of traded shares, such as reducing the tax advantage of debt over equity or enhancing financial literacy, can have a material effect on public equity markets in Europe. At the same time, because stock markets often penalise companies which undertake radical, but uncertain, innovative activities, the contribution of private equity – particularly in the form of early-stage venture capital finance – is indispensable, as a critical mass of angel investors who can provide financing for medium-size projects is also needed.

Authorities with a mandate in this area must have well-defined roles and responsibilities, including a distinct set of instruments. Current overlaps between instruments should be eliminated, and more flexibility in the macroprudential policy framework should be maintained, so that authorities can implement those measures in a consistent and timely manner, which would require significant changes to Article 458 of the CRR. A more integrated financial market will support the emergence of new types of risk and also require extending the toolkit with new instruments. For the banking sector, this includes complementing the toolkit with borrower-based instruments (such as limits on loan-to-value, or loan-to-income ratios) as well as sectoral buffers and a time-varying leverage ratio add-on so that all aspects of systemic risks can be addressed in the banking union. Finally, the mandatory reciprocity framework needs to be expanded so as to ensure the effective mitigation of crossborder spillover effects and regulatory arbitrage across jurisdictions in the EU. 3/9  BIS central bankers' speeches  The significant progress we have made with our banking union needs to be recognised also from the international regulatory framework perspective. A case in point is the G-SIB 9 framework, which currently penalises cross-border transactions within the banking union by attaching a higher systemic risk score to banks with more transactions of that kind. This goes against the very rationale of the banking union, as it reduces the incentives for cross-border transactions and risk diversification, thus making banks more vulnerable to local shocks.