The EU is dealing with many challenges: war on its borders, rising inflation and persisting financial fragmentation across the Eurozone are all cause for concern. These issues were at the heart of discussions among leading policymakers and banks at AFME and OMFIF’s 2nd Annual European Financial Integration (EFI) Conference last week in Frankfurt.
Most speakers agreed that Europe needs to strive for more competitive and integrated capital and banking markets and that there is a key role for technological innovation to help overcome fragmentation in European markets.
Panellists also found that there were considerably sharper trade-offs now than during the pandemic, but that these were political rather than economic. Nonetheless, on a European scale there needs to be scope for better policy coordination to fight inflation and build a robust and competitive banking system. Competition, speakers found, needed to be interpreted in a nuanced way. While the single market in the EU is still incomplete, regulatory action needs to embed competition, so that enforcement and regulation can be complementary.
Philipp Hartmann, Deputy Director General Research at the European Central Bank (ECB), presented the ECB’s bi-annual report on financial integration and structure. Previous crisis, Mr Hartmann reflected, were able to teach us a lesson and prompt monetary policy measures and agreement on the EU recovery fund had made a fundamental difference in supporting financial integration, although this has still not returned to pre-GFC levels.
Commenting on the structure of the EU’s financial system, Mr Hartmann, considered how European equity markets can be made fit for green & digital transformation. In its report, the ECB points to Next Generation EU (NGEU), initiative having large public investments in digital and green projects that firms can benefit from. However, this is still far from the EUR 650bn investment per year, which the European Commission estimates is needed. Substantial private investment will be necessary to finance these transitions and equity finance is well suited for innovation-oriented investment. The 2020 CMU action plan could produce tangible progress for developing and integrating European equity and risk capital markets, yet efficiency and harmonisation of regulatory frameworks still need to be enhanced.
Unicredit’s CEO, Andrea Orcel, reflected on how the geographical footprint and scale of European banks is key for competitiveness. Mr Orcel pointed out that the EU has more or less the same GDP as the USA, yet, leading banks in the States spend 10 times more on technological innovation. Over time, this leads to a lack of level playing field, to the detriment of European competitiveness. Scaling up would bring about a more unified pan-European market and for this technology is paramount.
In terms of regulation, Mr Orcel said that the prudential framework and profitability need to be balanced against each other. If there is an excessive focus on prudence, it can make entire sections of banking unprofitable. Furthermore, rules differ from country to country and capital and liquidity can remain trapped locally. In contrast to the US, Europe is not one market. In light of such fragmentation, which limits scale, but also as a result of a likely conscious choice from policy-makers post-GFC, European banks do not feature highly on the league tables of the worlds’ investment banks and global market players.
Edouard Fernandez-Bollo, Member of the Supervisory Board at The European Central Bank (ECB), gave a supervisory perspective on the European banking industry. He noted that one of the ECB’s aims is to help banks realise their M&A projects if these have a valid basis. The ECB is also focused on assisting firms in operationalising and integrating ESG policy into their risk management. When it comes to leveraged finance and industry concerns surrounding supervisory expectations rendering banks uncompetitive compared to international peers, Mr Fernandez-Bollo responded that the ECB is concentrating on outliers to create a safer market.
Profitability of the sector has returned to pre-pandemic levels, but remains structurally low. While the ECB has seen progress in the areas of diversification and harnessing technology to reduce cost base, it is not enough. The ECB has been encouraging banks to look at their cost and revenue structures, while investment in technology is something that needs to be monitored more closely.
The CFOs of Société Générale, Claire Dumas, and Santander, José Antonio García Cantera, spoke about the key driving factors behind lower evaluations of European banks compared to international peers, reiterating the problem of Europe’s fragmentation and issues deriving from this, such as fewer opportunities to streamline their businesses and higher costs. Regulatory issues and differences in requirements between European countries are also a cause for concern.
Both speakers noted that banks themselves can improve their profitability and efficiency, through partnerships, as well as focusing on diversifying their business mix, such as insurance and leasing. Digitalisation and disruption is another area that banks should focus on, as operational efficiency and new business models become increasingly important.
Other panels delved into the regulatory environment for the banking industry, with speakers debating the impacts of Basel 3 implementation on the sector’s ability to continue financing the real economy. The real need to address deficiencies in the securitisation framework was flagged as being key in this respect, while providing a bridge between bank and market-based financing.
Following this, the conference examined the listing, trading and post-trading landscape in the EU, with panellists querying why many EU firms continue to go public outside of the EU. Panellists commented on the fragmented market structure for trading and complexities of post-trade organisation compared notably to the US as being part of the reason behind this. They noted that differences in tax processes and insolvency laws across Member States continue to be high amongst barriers to achieving more efficient capital markets in the EU.
Overall, AFME and OMFIF’s EFI conference brought renewed attention to how fragmentation in European banking and capital markets is impacting the financial sector’s ability to serve the economy and what can be done to combat it. Given the size of our investment needs, deeper, more liquid and competitive markets will be necessary to allow the financing of the green and digital transition to be supported in addition to ensuring that banks continue to have capacity.