Blog Post

Europe needs to drop its resistance to non-bank credit

The financial systems in the United States and Europe have long differed on an important aspect. In Europe, most of the credit flows through the banks. In the US the bank channel is less dominant, and borrowers gain access to capital directly by issuing bonds or through “non-bank” intermediaries that do not take deposits and […]

By: Date: April 15, 2012 European Macroeconomics & GovernanceFinance & Financial Regulation Tags & Topics

The financial systems in the United States and Europe have long differed on an important aspect. In Europe, most of the credit flows through the banks. In the US the bank channel is less dominant, and borrowers gain access to capital directly by issuing bonds or through “non-bank” intermediaries that do not take deposits and are not regulated as banks. An oft-quoted measure is that in Europe banks represent more than two-thirds of total credit, whereas in the US the proportion is less than one-third.  In the past few years of crisis, this difference has mattered decisively.  

To begin with, the securitization of residential mortgages in the US went wild in the mid-2000s and was the initial trigger of market turmoil in the summer of 2007. Many continental Europeans have concluded that their bank-based system was less risky or more virtuous. But the subprime securitization debacle, severe as it was, has been one part of a more complex story. Many European banks have made risk-management mistakes just as massive as the reviled originators of US securitization deals. Spanish or Irish banks anticipating a never-ending property boom, or failures such as Dexia in France and Belgium, Hypo Real Estate or WestLB in Germany, or RBS in the UK, are sad reminders that Europeans have no grounds to feel complacent about their own system.

Another less visible point is at least as important. Systemic banking crises are almost inevitably followed by a scaling-back of many credit activities by most banks, a process known as bank deleveraging. In the US, this process has not been traumatic largely thanks to the flexibility and versatility of the system: while banks reduced their exposure, other channels of credit stayed active or expanded, and the credit squeeze was mitigated. By contrast, in many European countries, when banks started applying more restrictive lending standards, there were few substitutes to help even to creditworthy borrowers. Thus, in much of Europe credit provision is impaired, and the situation is likely to worsen further in the near future.

To some extent, governments can intervene to provide incentives via targeted guarantee schemes or to extend credit with direct lending. The UK is creating a Business Finance Partnership to lend to medium-sized enterprises, and both leading French presidential candidates want to create new public banks. But this kind of intervention also entails big drawbacks. Not only are many sovereign balance sheets strained; past experiences of government-directed lending have generally been sobering, as the process tends to be prone to capture by politically-connected special interests, resulting in large misallocations of capital. Therefore, encouraging non-bank credit provided through the private sector should be a major public policy objective.

Unfortunately, in much of Europe and at the EU level, policymakers seem unaware of this need. Instead, the European Commission has frequently appeared to take a punitive approach to non-bank credit channels, particularly in its regulation of investment funds and its latest project to regulate credit rating agencies, which play an enabling role in corporate bond issuance. The Commission also wants to tighten the regulatory screws on “shadow banking,” which the Financial Stability Board has defined as “the system of credit intermediation that involves entities and activities outside the regular banking system.” Some aspects of shadow banking, including securitization but also other types of entities or transactions, can contribute to systemic risk. But that risk does not justify repressing shadow banking in general. Some segments need to be regulated through rules of business conduct rather than of capital or liquidity. Other segments simply need better transparency and monitoring.  In some cases, existing regulations should be dismantled: it makes no  sense, for example, for several EU countries to prohibit leasing services offered by non-banks.

Making the transition from a bank-dominated system to a more diverse one in which non-bank credit plays a bigger role is difficult. Issuing bonds or other fixed-income securities requires high standards of financial disclosure, which is resisted by the culture of many medium-sized companies or banks in a number of European countries. Legal and regulatory differences across borders inside the EU also do not help because they contribute to fragmentation of some financial market segments.

But such legacies must be overcome if the goal is to minimize the risk of credit crunches in large parts of Europe, particularly the struggling southern Eurozone periphery. Incumbent banks are skillful at opposing diversification of credit channels as unfair or dangerous, but their lobbying should be seen as merely self-serving. After all, the financial crisis has been primarily a banking problem, and private equity or hedge funds have been proven to pose less systemic risk than was feared before 2007. The majority of European policymakers who still see finance and financial regulation through the prism of traditional banks need to expand their horizon, so that non-bank credit channels stop being unduly repressed. This is not about financial doctrine, but about long-term growth and jobs.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read about event

Upcoming Event

Sep
6-7
09:30

Bruegel Annual Meetings 2016

The Annual Meetings are a high point in Bruegel's calendar.

Speakers: Michel Barnier, Joachim Bitterlich, Arnoud Boot, Albert Bravo-Biosca, Elmar Brok, Nadia Calviño, Tom Carver, Daniel Daianu, Zsolt Darvas, Paulina Dejmek-Hack, Jeroen Dijsselbloem, Alicia García-Herrero, Sylvie Goulard, Charles Grant, Dominique Guellec, Connie Hedegaard, Michel Houdebine, Vazil Hudák, Brigitte Knopf, Pascal Lamy, Lawrence J. Lau, Matthew Lobner, Robert Madelin, Sylvie Matherat, Simone Mori, Erik F. Nielsen, Barbara Novick, Jean Pisani-Ferry, Romano Prodi, Olli Rehn, Carmen M. Reinhart, André Sapir, Dirk Schoenmaker, Ludger Schuknecht, Egon Schulz, Maroš Šefčovič, Jeremy Shapiro, Scott Stern, Jean-Claude Trichet, Laszlo Varro, Nicolas Véron, Reinhilde Veugelers, Helen Wallace, Guntram B. Wolff and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Autoworld, Brussels, Belgium
Read article More on this topic More by this author

Blog Post

IMG_1985

How to make the single market more inclusive after Brexit

The creation of the single market generated winners and losers. Yet redistribution remains first and foremost a competence of national governments. It is thus fair to state that a failure in national, more than European, policies and welfare systems can be partly blamed for current discontent with the EU and the single market.

By: Alessio Terzi Topic: European Macroeconomics & Governance Date: August 18, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The state of macro redux

What’s at stake: In 2008, Olivier Blanchard argued in a paper called “the state of macro” that a largely shared vision of fluctuations and of methodology had emerged. With the financial crisis and our inability to prevent the greatest recession since the 1930s, the discipline entered into a period of soul searching. The discussions on the state of macro received new echoes this week after Blanchard published a short essay on the future of DSGE models.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: August 16, 2016
Read about event More on this topic

Upcoming Event

Sep
29
08:30

Inclusive growth in the European Union

Why is inclusive growth important and how do the EU’s social problems differ from social problems in other parts of the world?

Speakers: Zsolt Darvas, Monica Brezzi, Jana Hainsworth, Reinhilde Veugelers and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Oct
4
12:30

Barriers to long-term investment

Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

Policy Contribution

coverEuropean Parliament

Total assets versus risk weighted assets: does it matter for MREL?

As a consequence of the global financial crisis, various initiatives have been taken in different jurisdictions to ensure the future resolvability of banks without massive use of public funds. In Europe, the BRRD introduced the concept of MREL, which is in the process of being defined.

By: Bennet Berger, Pia Hüttl and Silvia Merler Topic: European Parliament, Finance & Financial Regulation Date: August 9, 2016
Read article More on this topic More by this author

Opinion

Dalia Marin

What’s the matter with Austria?

Austrian firms invested heavily in Central and Eastern Europe. They offshored the parts of the value chain that required specialized skills and produced valuable research. This resulted in lowered growth in Austria.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: August 9, 2016
Read about event More on this topic

Upcoming Event

Oct
17
00:30

Delivering a Green Capital Markets Union

Climate change presents a growing theat to financial stability. This seminar looks at how the European Union could respond by delivering a Green Capital Markets Union.

Speakers: Per Bolund, Ingrid Holmes, Dirk Schoenmaker and Philippe Zaouati Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Oct
21
00:30

Cross-border insurance in Europe

The cross-border insurance sector is becoming increasingly strong in Europe. This event looks at the current cooporation between national insurance supervisors and tries to define the role of the European Insurance and Occupational Pensions Authority.

Speakers: Gabriel Bernardino and Dirk Schoenmaker Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Nov
3
09:00

Financial Stability Conference 2016

How can we fix the deficiencies in the EU financial system? Bank-state-nexus, business models and the missing level playing field

Topic: Finance & Financial Regulation Location: ESMT, Schlossplatz 1, 10178 Berlin
Read article More on this topic More by this author

Blog Post

André Sapir

Should the UK pull out of the EU customs union?

The UK Government appears divided on whether the United Kingdom should seek to remain within the European Union’s customs union after Brexit. The United Kingdom is likely to want to leave the customs union, even it remains in the EU’s single market. But the UK should try and keep to the EU’s commitments at the WTO, at least at the start, in order to minimise the trade disruption that Brexit entails.

By: André Sapir Topic: European Macroeconomics & Governance Date: August 1, 2016
Read article More on this topic

Opinion

Grégory Claeys
Schoenmaker pic

Now is the time to open Strasbourg’s ‘Bronislaw Geremek’ European University

It is the right time to revive the proposal made 10 years ago by Bronislaw Geremek and Jean-Didier Vincent to create a truly European University in the European Parliament buildings in Strasbourg.

By: Grégory Claeys and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: August 1, 2016
Load more posts