It could have come straight out of an episode of Star Trek. "Captain, we are approaching the Capital Markets Union, a new frontier." But the plan to create this 'new frontier' of Europe's single market is a key element of President Juncker's Investment Plan and is designed not to help the Starship Enterprise, but rather Europe's small and medium enterprises (SMEs).
Certainly the CMU has laudable aims. It seeks to develop a more diversified financial system complementing bank financing, which seems an acknowledgement of the failure of the existing banking model to provide sufficient capital for small businesses in Europe. It also aims to unlock capital which is currently frozen and put it to work for the economy, giving savers more investment choices and offering businesses a greater choice of funding at lower costs. The idea is to establish a genuine single capital market across the EU where investors can avoid hindrance across borders and businesses can raise the required funds from a diverse range of sources, irrespective of their location.
Small businesses can fund their investment in two different ways: debt finance or equity finance. Debt finance means taking a loan from a bank, whereas equity finance means selling investors a share in the company and the wealth it generates. Bonds are somewhere in between: they give investors the right to interest in return for investing their money in the enterprise and at the end of a fixed period their money is returned to them. To use an example from my part of the world: let's think about the way Ross Poldark funds the reopening of the Wheal Leisure mine. He distrusts Warleggans Bank, whose unethical owners have recently pulled the plug on another mine that is facing difficulties. So he assembles a group of likely investors who all contribute 50 guineas. Nowadays he might issue them a bond in return for their 50 guineas and offer to pay them at 5% per year to the value of that stake.
So would we, as Greens, favour Warleggans Bank or the equity option? Our starting point must be the regulation of banking with its riskier activities curtailed. This way it will be better placed to meet the needs of small businesses for predictable and affordable loans. Greens believe that a reformed banking sector, where relationships can be developed, suits the needs of Europe's small businesses better than a capital market. One key, socially useful, function we rely on our banks to perform is credit assessment. This requires a close relationship with the customer, something that banks are uniquely placed to do.
When retail banks, seeking rapid growth, have strayed beyond their area of expertise into the open waters of international capital markets it is not surprising that they have run into difficulties. One consequence of these excursions has been an inability to maintain a steady flow of funding to SMEs, who form the bedrock of the European economy. As Greens we see ourselves as the champions of small businesses. We perceive that the CMU could introduce additional risks and reduce accountability by extending the distance between lender and borrower. The risks could be further exacerbated by light-touch regulation.
The diversifying of the range of sources of finance and the growth in unconventional investment models, planned as part of the CPU, could be a welcome development, particularly when these are locally based and tied into local economies. As strong supporters of resilient and vibrant local economies we see how important it is for those with spare money to invest into their local economy. This can provide stronger local ties as well as vital capital for the financing of small businesses. The problem is that the CMU, as currently constituted, seems to fail to achieve such community-building benefits.
Greens believe that rather than scrambling to bring together investors and SMEs who know, and even less care, little about each other, we should seize this opportunity to:
- Focus retail banks on 'relationship banking' and give them every incentive to help nurture the most sustainably productive SMEs
- Support a diversity of community assets models to sustain local economies with investment over much shorter distances which inherently ensure stronger accountability
- Introduce new models of local capital networks and local stock exchanges
- Incentivise banks to provide more and better advice to SMEs that feel mature enough to diversify their funding sources into capital markets.
- Focus the CMU on providing more incentives for long-term investment in projects with positive effects on the quality of life of EU citizens which are, by their nature, often more capital intensive and risky.
Essentially, a system more like the German banking model and less like the US small-scale corporate bond market is what we need. Germany has a mix of savings banks, cooperative banks and private banks [2] and as a business model is based on working for the public or mutual good rather than for shareholders. This model is well suited to the SMEs they serve.