A Capital Market Union for Europe: Why It’s Needed and How to Get There

IMF Blog, September 10, 2019

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European finance is "still sharply segmented along national lines", with savers and investors depending heavily on national banking systems and pervasive "home bias".
Financing costs vary substantially by country of incorporation:
- Firms in Greece pay "a 2.5 percent higher rate of interest on their debt than similar firms in the same industry in France".
- Italian firms pay "0.8 percent higher interest on debt than comparable firms in Belgium".
Firms with limited collateral (for example, an IT start-up) face hurdles accessing bank loans; such companies "grow significantly faster in more developed capital markets" where venture capital funds with diversified portfolios provide unsecured financing.
Private cross-border risk sharing is limited:
- Local consumption is "four times more sensitive to local shocks in the 28 EU countries than in the 50 US states".
- For every "1 percentage point drop in national GDP growth", consumption drops by "80 basis points, on average, if the country is in the EU", compared to "only 18 basis points for the average US state".

Reductions in funding costs from improving insolvency practices:
- If Italy improved its insolvency practices to best-in-class standards, it could reduce its firms’ average debt funding cost by "some 0.25 percentage points".
- Estonia and Greece could see interest cost reductions of "some 0.50 percentage points".
Effects on portfolio asset holdings and shock absorption:
- Bilateral portfolio asset holdings would "double" if insolvency regimes and regulatory quality in destination countries improved by "1 standard deviation" (example: Portugal improving its insolvency practices to the UK standard and regulatory quality to that seen in Belgium).
- Improvements in regulatory quality and insolvency regimes would improve shock-absorption, "halving the sensitivity of local consumption to local shocks".

Improve transparency and disclosure:
- Introduce centralized, standardized, and compulsory electronic reporting for all issuers of bonds and equities, irrespective of size, on an ongoing basis (a major change to the European reporting framework).
- Use digital technologies to streamline cross-border withholding tax procedures.
Contain systemic risk and improve investor protection (guided by proportionality):
- Bring systemic entities such as central clearinghouses and large investment firms under centralized oversight.
- Strengthen the European Securities and Markets Authority by introducing independent board members.
- Enhance the new pan-European pension product with design changes to improve portability and cost-efficiency.
- Aim for maximum regulatory cooperation with non-EU countries, recognizing the global nature of capital markets.
Upgrade insolvency regimes:
- The European Commission should carefully collect data where existing information is unreliable.
- Develop a code of good standards for corporate insolvency and debt enforcement processes.
- Systematically follow up on EU member states’ progress toward observing such standards.

Lowering identified barriers offers the prospect of powerful macroeconomic benefits: lower funding costs for firms, larger intra-EU portfolio capital flows, and more risk sharing across borders.
The authors argue that the "relatively technical steps" recommended to remove identified barriers "should be feasible without high-level political deliberations" and would help move the EU toward realizing its full economic potential.

Authors: Ashok Vir Bhatia, Srobona Mitra, Anke Weber — September 10, 2019