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 Topic: European Macroeconomics & Governance

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.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article Download PDF More by this author

External Publication

European Parliament

Sovereign Concentration Charges: A New Regime for Banks’ Sovereign Exposures

Europe’s banking union has been central to the resolution of the euro-area crisis. It has had an encouraging start but remains unfinished business. If it remains in its current halfway-house condition, it may eventually move backwards and fail. EU leaders should seize these opportunities

By: Nicolas Véron Topic: European Macroeconomics & Governance, European Parliament Date: November 17, 2017
Read article More on this topic More by this author

Podcast

Podcast

The future of Capital Markets Union

Bruegel senior scholar Nicolas Véron speaks with Steven Maijoor, the chair of ESMA, about the future of the Capital Markets Union (CMU), and of the EU's financial supervisory architecture.

By: The Sound of Economics Topic: Finance & Financial Regulation Date: November 16, 2017
Read article More on this topic More by this author

Blog Post

A slightly tighter ECB

The ECB’s recent decision on QE was somewhat on the dovish side. Francesco Papadia gives his view on why it is time to start a discussion about reducing the degree of ease of monetary policy.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: November 15, 2017
Read about event More on this topic

Past Event

Past Event

Vision Europe Summit 2017

The 2017 Vision Summit is titled "The Winners and Losers of Globalisation"

Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 14, 2017
Read article Download PDF More by this author

External Publication

The economic effects of refugee return and policy implications

This paper looks at the question of returning asylum seekers and refugees from the economic perspective in the advanced countries that receive refugees: is return in their economic interest?

By: Uri Dadush Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 14, 2017
Read about event

Upcoming Event

Nov
28
12:00

Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Sergei Guriev, Debora Revoltella and Lucio Vinhas de Souza Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Accounting for true worth: the economics of IFRS9

The introduction in 2018 of forward-looking provisioning for credit losses in EU banks delivers on a key objective in the post-crisis regulatory agenda. This was intended to dampen future lending cycles. For now, banks will be sheltered from the impact on regulatory capital requirements, as the implications for financial stability are far from clear. In any case, the new standards should encourage the disposal of banks’ distressed assets, underpinning the ongoing agenda on NPLs.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: November 13, 2017
Read article Download PDF

Policy Contribution

A ‘twin peaks’ vision for Europe

The organisation of the European Supervisory Authorities (ESAs) is based on a sectoral approach with one ESA for each sector, with separate authorities for banking, insurance and securities and markets. But is this sectoral approach still valid? This Policy Contribution outlines a long-term vision for the supervisory architecture in the European Union.

By: Dirk Schoenmaker and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: November 13, 2017
Read about event More on this topic

Upcoming Event

Dec
4
13:00

Flexicurity and labour market reforms in Europe

This event will discuss the potential of the flexicurity model as employment strategy and the way it could be implemented in European countries to be successful.

Speakers: Grégory Claeys, Philip Collins, Werner Eichhorst, Antoine Foucher, Maria Jepsen and Marco Leonardi Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Dec
7
11:00

Health care and macro-economics in Europe

What are the strengths and challenges of health care systems in each EU country? What are the common policy priorities and opportunities for EU value added?What role do healthcare systems play in public finances and macroeconomic developments? What are the economic values of investing in healthcare?

Speakers: Zsolt Darvas, Petra Laux, Xavier Prats Monné and Further speakers to be confirmed Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Dec
6
12:00

Zombie firms and weak productivity: what role for policy?

At this event, we will have the chance to discuss the final findings of OECD's project on Exit Policies and Productivity Growth, which started at the end of 2015.

Speakers: Carlo Altomonte, Christian Kastrop and Reinhilde Veugelers Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More by this author

Blog Post

European worries about isolationist trends

Populist shocks in the UK and US threaten the multilateral order on which the EU depends. What lies behind these earthquakes, and what does it mean for Europe? Withdrawing from the world is no solution to geo-political upheavals, but Europe needs to reassess the future of globalisation.

By: Maria Demertzis Topic: European Macroeconomics & Governance, Global Economics & Governance Date: November 7, 2017
Load more posts