salvatore rossi : finance for growth – a capital markets union keynote address by mr salvatore rossi, senior deputy governor of the bank of italy, at the rome investment forum 2015 “ financing long - term europe ”, rome, 11 december 2015. * * * i would like to comment on the proposal for a capital markets union ( cmu ) by raising three questions, and giving some tentative answers to all of them. the first question is : do we actually need a cmu in europe? should it really be a priority in the european policy agenda? my answer is a resounding “ yes! ”. the question may seem rhetorical, given the tide of apologetic documents, papers, and seminars ( including perhaps this one ) that have been dedicated to the project since its official launch last year. however, i think it ” s important to keep in mind the reasons for that “ yes ”, because hesitations and even open dislike are quite widespread in some countries and sectors. the fact is that the european economies, with the partial exception of the uk, are strongly dependent on banks for their financing needs. too dependent. let me explain why. a wide literature ( i have in mind for example a very recent piece of empirical research by langfield and pagano, 2015 ), shows that economic growth tends to be lower in economies with a bank - based financial structure, particularly at times of falling asset prices, and systemic risk to be higher. a “ bank bias ”, as l & p dub it, is bad, in any circumstance. but even if we believed, just for the sake of the argument, in the optimality of banking dominance in our financial systems, here comes another hard fact : also as a consequence of the new regulatory and supervisory framework, banks are less and less willing to lend money to risky borrowers such as smes, because of the heavy burden of non - performing loans which is the legacy of the crisis ; because more capital is required against risky assets, and capital is costly. requests for more capital buffers come from all international regulating bodies, both at the global level ( financial stability board, basel committee ) and at the european level ( single supervisory mechanism – ssm ), as a shield against a new, devastating financial crisis. up to now, in europe the effect has been procyclical : notwithstanding the cheap, abundant liquidity supplied by the ecb, banks are reluctant to increase lending to the real economy. the corporate sector, especially in southern

banks ’ health. it also requires banking and market supervisors to resist the temptation to ring - fence liquidity and capital within national boundaries. this is a classic problem of collective action : uncoordinated national reactions to heightened uncertainty could be collectively lethal to the single market for capital. two sets of actions seem to be key in tackling these concerns at their root : one set to strengthen bank balance sheets and another set of actions to break the self - reinforcing loop between bank and sovereign debt risks and move to truly unified european supervision. to strengthen bank balance sheets, first, adequate capital ratios must be reached in the banking system. the eba capital exercise, with eu banks being expected to reach a core tier 1 capital ratio of 9 % by the end of this month, will be an important milestone. regulators should then make sure that the subsequent transition to the basel iii framework does not result in a weakening of the capital buffers. the heterogeneity of capital ratios must also be reduced. the median core tier 1 capital ratio of large euro area banks is not significantly lower than that of their global counterparts. however, the variation in this ratio across institutions is substantially wider in the euro area, introducing asymmetries in banks ’ access to funding and funding costs. second, leverage in the euro area banking system must be reduced. the aggregate leverage ( asset - to - equity ) ratio of large euro area banks remains comparatively high by international and historical standards. 17 the adverse feedback loop between banks and sovereigns, in which doubts about the solvency of the sovereigns feed doubts about the solvency of the banks, and vice versa, will be broken more readily by the establishment of a true banking union. see, for example, v. acharya and s. viswanathan, “ leverage, moral hazard and liquidity ”, journal of finance, vol. 66, no 1, 2011 ; f. allen and d. gale, “ financial contagion ”, journal of political economy, vol. 108, no. 1, 2000 ; and m. brunnermeier and l. h. pedersen, “ market liquidity and funding liquidity ”, review of financial studies, vol. 22, no 6, 2009. for more information on the deleveraging process in the euro area banking system, see special feature a, financial stability review, ecb, june 2012. bis central bankers ’ speeches this should include the creation of a pan - euro