The capital markets union (CMU) is designed to complement traditional banking finance in the EU. However, should not mean that work is now complete on regulating traditional banking. The CMU should apply pressure on policymakers to complete the banking union, not alleviate it.
There are a few recurring themes in the European Commission's 30-page CMU action plan. It repeatedly acknowledges "Europe's strong tradition of bank financing" and says that it wants to promote a variety of non-bank financing options "as a complement". But as is the case with a bike, a new wheel is little help if the other one remains broken. For a capital markets union that will drive the EU economy, two elements should go hand in hand.
The first one - something often missed by supporters of non-banking finance – is the need to finalise regulation of traditional banking. Few will argue against the crucial role that banks play in the EU economy. Therefore, we must continue to work towards banks that serve the real economy.
Evidently, this was not the case in the years leading up to the financial crisis. An obsession with return and excessively complex products brought about a shift from serving customers and SMEs to serving a rampant financial sector.
Entanglement with other banks and exceedingly close links with governments caused a contagious wildfire in the financial sector following the collapse of Lehman Brothers in 2008.
This has taught us that although regulation can sometimes be costly, no regulation is far more expensive. Legislators have been playing catch up. Within a few years, we have increased capital requirements, capped bonuses and laid the foundations for a banking union. Now it's time to finish our regulatory efforts, so that banks can begin to work properly once again.
Concretely, this means - among other things - that we should cut the contagious links between governments and banks. A European deposit guarantee scheme can pool risks and contain possible new wildfires.
The second element is the promotion of capital markets. In short, this means looking at how non-banking finance can more effectively allocate finance for SMEs. For example, British lending company Funding Circle has raised €1bn without a banking license. It is now expanding into the Netherlands, Spain and Germany. While its current impact is relatively low, it demonstrates the potential of alternative financing models. Other innovative approaches include private placement and peer-to-peer lending.
The regulators task should be to strike the appropriate balance between these two elements. On one hand, they should acknowledge that an institution that looks like a bank and acts like a bank should be regulated like a bank. Revitalising capital markets cannot be about revitalising the harmful shadow banking practices of the past. On the other hand, truly disruptive financing models such as Funding Circle should be allowed breathing space and should not be regulated out of the market.
Promoting capital markets could be an opportunity for Europe. But it should not be about hopping from one leg to the other. If finance in the EU wants to thrive, it needs to walk on two legs once again, and it should fix banks with the same zeal as it tries to promote capital markets.