Brexit may be the start of a breakup of the European capitals market, which to a large extent is London. In an article written by Howard Davies the author also explains the difference – we would almost say, in capitalism – which exists between the US and Europe. This is the origin of the problem which may be caused by Brexit if there is no provision for precautionary measures which at least would ensure the market would not dwindle for the continent.
That likely division (Brexit) is very unfortunate, to the extent that it makes the real problem identified by the European Commission worse. Compared with the US, Europe depends to a great extent on bank financing. In the US, the corporate bond market is the source of almost three quarters of corporate funding. Bank loans make up the remaining quarter. In the remaining 27 EU countries, the proportions are almost exactly reversed. In the UK, it’s approximately half and half: as is usually the case. The UK is somewhere in the middle of the Atlantic Ocean. There are structural and historical reasons behind the different role the EU banks play. And we can’t expect that the European capital markets follow the pattern of their US counterparts to the letter.
In the so-called Rhineland model, the banks are often very close to their corporate clients, and sometimes have interests in them. But the consequences of the financial crisis showed how important it is for firms to have diversified sources of funding. Total financing for EU companies fell from 112% of GDP in 2006 to 106% in 2016, due to a sharp decline in bank loans, which decreased by one-fifth in real terms. Bank loans also fell slightly in the US, given that the banks tried to restructure their balance sheets and their capital base. Stricter banking regulation made this inevitable, and much of the improvement in capital coefficients after the crisis was down to a reduction in loans. But in the US, the capital markets could take over and the total financing available for companies increased, fuelling a more robust economic recovery. In Europe, the capital markets have not played this key role of absorbing the impact of the credit rationing on the part of the banks. The European Central Bank has done all it can to help, with special schemes which provide funding for the banks to grant loans to SMEs. These have been successful, to some extent. The last plan raised € 740 billion ($ 888 billion) – money which will be paid back in the next three years. But these programmes are a burden on the ECB and limit its capacity for withdrawing non-conventional funds and normalising monetary policy. It would be much better if the European capital markets were more flexible and open to a wider range of companies.
So what’s being done to alleviate the problem? According to Howard Davies, not a lot:
Progress is slow and Brexit is an additional obstacle. The biggest European liquidity and capital funds are still located on the banks of the River Thames. And no-one yet knows how the UK’s exit from the EU will affect them. Investors and bankers warn that dividing these groups by imposing controls on cross-border activity between the UK and the EU will delay the capital markets union. It will also make financing more expensive for EU companies. But for the time being the Brexit policy, on both sides of the English Channel, is blocking a favourable solution for the market. The UK, understandably, is trying to keep the broadest access to the market as possible for companies headquartered in London.
Michel Barnier, Europe’s negotatior on Brexit, insists that as the UK makes its transition to the state of a “third country,“ only a limited regulatory equivalence is possible. And this, according to Barnier, will restrict the financial transactions between the two groups.
When the signs of an incipient slowdown in the European economy begin to multiply – the matching indicators suggest that industrial production slowed in 2018 – the case for reaching an agreement on Brexit and refocusing attention on unifying the capital markets becomes increasingly more powerful and urgent. At end-April, the commissioner who is now responsible, Valdis Dombrovskis, said in London that the “construction blocks” will be in force at the beginning of next year, to “help our companies better face the exit from the single market of the biggest financial market in Europe.” This is a worthy goal, but it could well be too little or too late.