Tackling the challenges of EU financial integration
Just over 25 years ago, the European Union agreed in the treaty of Maastricht to complete the European Single Market (SM). Goods, services, people, and capital were envisioned to move freely across EU countries. The substantial contribution of the SM to growth and prosperity in Europe since then is undisputed. Today, the common economic area is home to more than 500 million people. In terms of size, it can easily compete with the United States or the economies of Eastern Asia.
However, the completion of the SM is not yet finished. While many barriers to the free movement of capital across borders have been removed in the last decades, some important hurdles remain. The euro crisis has shown that particularly the financial sector remains vulnerable and fragmented. This poses serious risks to the stability of both national economies and the euro area.
In addition, despite the size of the SM, not a single one of the top 10 most valuable companies in the world is based in Europe. Instead, tech giants from the United States, like Apple or Google, and China, like Alibaba and Tencent, dominate this ranking. They owe their success to the rapid development of data- and platform-driven business models, which are easily scalable. In Europe, however, companies still face a number of specific impediments to scaling that prevent them from growing at a similar pace.
In a recently published policy paper, we identify the hurdles to financial integration in the EU and propose specific solutions to overcome them. The paper distinguishes between barriers that affect banks, firms, and investors, respectively—and we address some of these barriers below.
National regulators have several tools to restrict intragroup lending for bank subsidiaries with parents in other European countries. This inhibits cross-border activities by banks and particularly affects institutions with a broader European customer base. A solution to this is to delegate more regulatory powers to the European level, specifically to the Single Supervisory Mechanism (SSM).
Moreover, European banks often face steep discounts when they attempt to securitize their loans. This is due to investor distrust in the composition of the offered mortgage pools (a classical “lemon market problem”). It may thus be helpful to have an independent and trusted institution as, for example, the European Investment Bank to certify and rate mortgage pools to facilitate securitization.
EU companies that want to go public face a considerable bureaucratic effort. The European Commission is currently in the process of reforming the IPO prospectus regime, which is very welcome. However, the current reform proposals might actually increase bureaucracy. The prospectus requirements should be designed as useful information to potential investors, not as a listing of all factors affecting business outlooks in all imaginable circumstances.
Another big issue firms in Europe are confronted with is the debt-bias in corporate taxation. Most tax systems of EU members feature deductibility of interest payments from corporate tax payments while no such measure exists for equity funding of firms. This distorts firms’ financing decisions towards debt over equity. Removing the debt-bias in corporate tax systems could significantly contribute to the development of equity markets in Europe.
Many European countries have only low stock market participation rates in comparison to other developed countries. This is a major challenge because stock returns are significantly higher over longer investment horizons than most other asset classes. A reason for this might be regulation and associated bureaucracy for retail investor advisory. It would be reasonable to establish an opt-out rule, according to which informed customers can invest in a large class of financial products without repeated bureaucratic requirements.
Furthermore, differences in accounting standards across EU countries make it hard for investors to gather reliable data from firms. Since balance sheets and income statements are among the most fundamental sources of information, this poses a significant hurdle. Consequently, investors need to engage in costly information acquisition, which leads to information asymmetries. A solution to this could be a centralized regulator that enforces a consistent application of accounting rules across the EU.
These proposals are neither comprehensive nor final. They are meant to invite and stimulate a discussion around these important issues. For further information and a more complete list of hurdles and possible solutions, see the full paper:
Katharina Gnath, Benjamin Grosse Rueschkamp, Christian Kastrop, Dominic Ponattu, Jörg Rocholl, Marcus Wortmann (2019). Financial market integration in the EU: A practical inventory of benefits and hurdles in the Single Market. ESMT White Paper No. WP-19-01.