ECB's Cœuré: Cross-border risk sharing needed to address SME credit crunch

Louise Bowman
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In an exclusive interview with Euromoney, Benoît Cœuré, member of the executive board of the European Central Bank, discusses the challenges that the region faces in stimulating financing to small and medium-sized enterprises and says non-bank investors are a useful spare tyre.

In a wide-ranging conversation, Cœuré reflects on the challenge of creating a truly pan-European and cross-border capital market in the region and how securitization can be used to re-establish funding to SME firms.

The recent focus of both regulation and markets has turned towards SMEs and the problems they face. There is recognition of the importance of getting financing to these firms to stimulate economic growth. In the US there is a huge and developed non-bank financing market for these companies. In Europe there is a long-term goal of shifting this financing away from the banks – how can that be achieved?

This is a really important issue right now, because SMEs are key to growth and they have a prominent role to play in kick-starting economic recovery in the region. In Europe, SMEs have traditionally relied on bank financing. This channel is currently impaired, not least because of the significant but necessary deleveraging that is going on in the European banking sector, but also because of the market fragmentation. Therefore it feeds into a more general project, namely recreating an integrated capital market in the euro area. This is something that warrants us all joining forces. The issue of financing SMEs throws into relief the difficulties and challenges that we face when we try to restart financing channels in the region. Right across the euro area, capital markets have been considerably impaired by the crisis and substantially fragmented. However, this has been receding since the summer of 2012 and we have seen many signs of improvemsuent in this respect. As a rough measure of euro area capital market fragmentation, Target2 balances have shrunk by some €300 billion and now stand at more than 25% below their peak level of July 2012.

Benoit Coeure, executive board member of the European Central Bank (ECB)

To what extent is this a product of quantitative easing rather than improved fundamentals?

I would put it more positively: it is a sign of an on-going process of reform and convergence in the euro area economy. The structural adjustment and convergence between euro area economies that we have seen has also been reflected in financial markets in terms of both prices and quantity. To some extent, we have already seen a resumption of cross-border flows within the euro area. It is certainly not enough, but at least it is moving in the right direction.

In addition to the negative impact of the financial crisis, capital markets have been impaired in particular as a result of the link between banks and sovereigns. This adds a very local dimension to the crisis, which wasn’t really foreseen before it erupted. Today, it has morphed into a series of local crises in Europe, and we are still struggling to move out of that situation in the capital market. At the same time, the European banking system is still in the process of deleveraging and is to some extent encumbered with non-profitable loans. I won’t call them non-performing loans, because these loans are not necessarily toxic in any sense – they are just not making any money because the risk and return environment has changed. But as a consequence many euro area banks don’t have much room on their balance sheets to expand lending.

As we emerge from the crisis, I think we have to focus on two main challenges. First, we need to diversify the funding of the euro area economy and euro area corporates to make them less dependent on bank funding. At present bank financing represents two-thirds or maybe 70% to 80% of corporate financing, which is a very different situation to that in the United States. I don’t think that we should adopt the US model lock stock and barrel, because Europe is not the United States; it will always be different. Nevertheless, the crisis laid bare the fragility of a funding model that is exclusively dependent on banks. And when this funding became unavailable, the SME sector was hit hardest – large corporates in the euro area have been able to diversify and tap the corporate bond markets with a great deal of success, although this hasn’t been the case for smaller companies. To remedy this, we need to find ways to diversify, deepen and reintegrate capital markets in Europe.

The second challenge is how to create a truly pan-European and truly cross-border capital market in the euro area? For that to happen, all the actors have to join forces. Certainly, within its mandate, the ECB has a role to play by finding ways to reduce fragmentation and by improving monetary policy transmission. But there is a regulatory dimension too. When the regulators decide on the parameters and modalities of new regulation, this should not contradict the overarching objective to reintegrate European capital markets. Of course, market participants also have a role to play – this is not going to be driven by governments or by public actors alone. But this integrated market has to be profitable: participants are not going to be conjured out of thin air and supported by public money – that simply wouldn’t work.

Within this overarching aim to reintegrate capital markets, the SME sector is almost the hardest sector in which this can be achieved. SME financing is a domestic, local function that is tackled on a local level. It is a market that is almost by definition not integrated. So, is there a way to have pan-European SME financing?