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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chair of Société Générale and a former member of the executive board of the European Central Bank
The buzzword in Europe today — for speeding up the EU integration process and implementing reform recommendations made in reports by Mario Draghi and Enrico Letta — is “simplification”. This, according to policymakers, should not mean “deregulation”.
Several working groups have been set up to make concrete proposals to simplify Europe’s legislative and regulatory framework. Yet, judging from what has been achieved so far, there’s a real risk that all this effort will produce only modest results.
Simplifying rules in the financial sector is no easy task. What’s really needed, instead, is to make them clearer and consistent with the goals policymakers seek to achieve. Indeed, the real problem today lies in a lack of clarity, which leaves too much room for discretion and differing interpretations from one country to another — and even at the European level. This confusing inconsistency undermines the broader objective of building a fully integrated EU market for savings and investment.
Let’s take a practical example. One of Europe’s long-standing economic weaknesses is the absence of a well-functioning capital market capable of adequately financing businesses, particularly small and medium-sized enterprises. Bank balance sheets are simply too limited to meet all financing needs.
One effective way to expand the financing capacity for corporates would be to promote the securitisation of bank loans, enabling banks to sell these assets on the market or to specialised investors such as private credit — a sector that is growing rapidly, including in Europe.
This process allows capital to be freed up, enabling banks to extend new loans. These financial instruments make more efficient use of bank capital and transfer credit risk to non-bank institutions which can manage it more flexibly, reducing the concentration of risk. In the US, securitisation markets have developed significantly — after being reformed following the 2008 crisis. In Europe, instead, this instrument remains underused.
The reason lies in the lack of regulatory clarity. Specifically, European rules fail to define in a precise way how certain key parameters for securitisation should be applied, in particular concerning the proportion of revenues and risk that must be retained by the credit originator (the so-called Risk Retention Requirement).
Such a requirement is meant to ensure an alignment of interests between the entity selling its assets via securitisation and the investors. It mandates that a portion of the risk is retained by the seller in an entity that has significant revenues from other securitisations and investments. However, since regulation does not specify clearly how to measure the revenues attributable to the retained risk, it becomes challenging to assess their relative significance.
In the absence of clarity, the bank supervisor — ie the European Central Bank — has adopted an overly restrictive interpretation of the existing rules which departs from market practices and from the rules prevailing in the US and the UK. Under this interpretation, securitisation is too costly for European banks, in terms of capital requirement.
This creates a paradox: while on the one hand the ECB publicly declares its commitment to developing Europe’s capital markets, on the other it stifles their growth through a narrow reading of the rules. This produces two main consequences. The first is that European banks cannot expand their lending to meet the demand of European corporates, especially the SMEs. The second is that non-European financial institutions, especially US private debt funds that are not regulated in Europe, are given a competitive advantage in the nascent European market.
The overall result produced by unclear rules and their overly bureaucratic application is that companies are left without sufficient financing, while the replacement of European banks by foreign competitors encourages unregulated non-bank entities to directly enter this segment of the credit market. In other words, less credit for the real economy and more unmonitored risk in the system. A true masterpiece of unintended consequences.
What is really needed, in order to develop a unified financial market that truly supports the European economy, is not so much a simplification of the existing regulatory framework but rather its clarification, so that the rules can be applied consistently and with little discretion, making life easier for supervisors, financial intermediaries and companies.
