Capitel market access: Capital Markets Union is No One Size

The European Commission aims at enhancing the depth of capital markets as well as fostering capital market integration by building a so-called Capital Markets Union (CMU). A collaborative study of the Cologne Institute for Economic Research (IW Köln) and the College of Europe (CoE) finds that the CMU can enhance SME financing but also produces winners and losers.

The European Commission aims at fostering the financing options for companies, especially for small and medium-sized companies (SMEs) which make up the bulk of all European companies. A crisis experience was that even sound companies whose banks got into distress had to face restrictive access to finance. Fostering capital market access for SMEs should provide them with additional financing options and lessen the dependency of SMEs to bank financing. And indeed, the capital markets depth of the EU differs from the US. While approximately 80 percent of corporate debt financing depends on capital markets in the US, 90 percent of debt financing depends on banks in the EU.

But fostering capital market access for SMEs will not per se enhance the funding positions of all companies, since companies are different in respect to their age, their size as well as their products – and so are their financing needs. While large multi-product companies rely on capital markets for issuing standardized financial instruments, like stocks and bonds, smaller companies have special financing needs which can be better tailored by a bank credit. And younger firms need a combination of financing and consulting, which can be better supplied by a private equity investor.

Engaging in long-term relationships can be beneficial for both smaller companies as well as for their banks. Through the long-term relationship a bank gets a track record of its customers’ creditworthiness and better estimates of companies’ default risk. This will decrease the credit costs for well-capitalized companies. Signalling creditworthiness to short-term oriented capital market investors is more difficult, especially for smaller companies. This problem arising from asymmetric information between creditor and lender can be better solved by long-term relationships. By fostering capital market alternatives for SMEs, it is important to avoid disadvantages for this customer-oriented financing model.

The EU needs deeper capital markets in addition to stable banks nonetheless. While Germany and the United Kingdom have deep stock markets, stock issuance is very seldom, for example, in Latvia. Fostering capital market integration also means to foster stock and bond issuance in those countries with less developed capital markets. Neglecting these structural differences would lead to a stronger concentration of capital market activity in some financial centres.

The study concludes that much of the CMU’s success depends on enhancing the access to those financial instruments that fits the best the companies’ financing needs. But like any ambitious policy project, the CMU initiative will likely produce winners and losers. In contrast to recent policy projects - which were mere crisis responses - the CMU project can be regarded a long-term framework for the financing of the economy. Thus, the Commission should take the time needed to learn more about the different country-specifics and country best practices and avoid one-size-fits-all solutions.