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FT editor Roula Khalaf picks her favourite stories in this weekly newsletter.
The author is Vice Chairman of Oliver Wyman.
How will Europe raise the huge amounts of capital needed to invest in the energy transition, digital infrastructure and defense? Despite vast savings of €33 trillion, Europe has plumbing problems. Capital markets are underdeveloped and the banking sector is not large enough to meet growing demands for capital spending. Deeper capital markets are needed to solve the investment challenge.
The sums required are enormous: The European Commission estimates that greening will require an extra €620 billion per year until 2030, with the digital transformation needing a further €125 billion. Moreover, calls for increased military spending are growing in the wake of Vladimir Putin’s invasion of Ukraine and the possible reelection of US President Donald Trump.
But despite multiple bazookas from the European Central Bank, business lending in the region has grown less than half that of the U.S. since 2014. The gap in the two countries’ economic performance has long vexed European policymakers, a concern that is only deepening as the gap widens.
“We need to mobilize private savings on an unprecedented scale, far beyond what the banking system can provide,” Mario Draghi, a former Italian prime minister and president of the European Central Bank, argued ahead of a soon-to-be report on strengthening Europe’s competitiveness.
While some progress has been made, the gap in venture capital relative to GDP between Europe and the US remains large, leaving European companies with fewer financing options to support their investment and growth.
Under the leadership of European Central Bank President Christine Lagarde, there are growing calls to revisit unfinished plans for capital markets integration, an argument backed up by recent influential reports by former Italian Prime Minister Enrico Letta and former French central bank governor Christian Noyer.
But the idea of establishing a single European market for capital has been stalled for a decade. Bold ideas often stall.
With the recent European elections likely to make things even more difficult, it may be time for a change of strategy. To remove bottlenecks across the system, policymakers need to work with financial plumbers, especially in the private sector.
Revitalizing securitization is a first step to enabling insurance companies and pension funds to support Europe’s growth. Securitization allows banks to transfer their assets to investors, thereby freeing up their own lending capacity. This is particularly important because banks provide the majority of their lending to small and medium-sized enterprises, which account for almost two-thirds of European employment.
Rules enacted in response to the financial crisis imposed stiff penalties on securitization, and the European securitization market has never really recovered. An unintended consequence has been that banks have turned to complex aggregate risk transfers that only the largest banks can implement, hampering local banks.
Solvency II, the rulebook for insurers, will make it economically unattractive to fund long-term infrastructure projects or buy packages of loans to small and medium-sized businesses, reducing potential revenue and limiting available funds.
The time has come to recalibrate securitization rules to better reflect the true risk profile of assets, keep pace with evolving capital markets, and promote investment for European growth. System-wide alignment of banking frameworks and financial market standards, as well as reform of Solvency II rules, are also essential.
We need to foster the venture capital ecosystem, leverage private credit, and rejig cumbersome sustainability rules for funds.
Above all, Europe needs more flexible and diversified financial markets. If plans for capital markets integration don’t materialize, it risks slowing growth. It’s time to call in the plumber.
