Introductory statement by Oliver Gilvarry to the Oireachtas Committee on Finance, Public Expenditure and Reform

Cathaoirleach, Deputies, Senators, I would like to thank the Joint Committee on Finance, Public Expenditure and Reform for inviting the Central Bank of Ireland ("Central Bank") here today to discuss the recent European Commission's Green Paper on Building a Capital Markets Union. 

Capital Markets Union ("CMU") is a key priority of the current European Commission, with Commission President Juncker stating that in order to "improve the financing of our economy, we should further develop and integrate capital markets. This would cut the cost of raising capital, notably for SMEs, and help reduce our very high dependence on banking funding."¹

Commissioner Hill has reiterated this goal and has highlighted the aim is to build a single market for capital from the bottom up by identifying barriers constraining the movement of capital and eliminating them one by one. His view is that liquidity is abundant in Europe, but is currently frozen.²

The reliance on bank funding in Europe is well documented and in the Green Paper and the supporting European Commission Staff Working Document³, this is outlined in detail. The superiority of capital based financing systems versus bank based is uncertain. Academic literature is divided on this point, with no clear supporting evidence in support of either side. 

There is evidence that the impact of economic shocks on consumption is less pronounced in economies which have more integrated capital markets. Examples are Canada and the US, where the capital market channel allows for a greater diversity of risk sharing than in the EU, where the credit market or banking system is the main channel to absorb shocks.⁴

This would imply that having a more diversified funding model is a good thing, and this makes intuitive sense as having more finance alternatives would provide more options for entities looking for financing. Also the provision of equity based financing is found to be more inherently stable compared to debt financing. 

During the debt crisis in Europe, debt financing had been more prone to capital flight than equity financing. Part of this is the fundamental structure of such financing, as equity financing is longer term in nature than debt with little to no refinancing risks. Further, greater cross border holdings of equities across the EU would allow for more effective risk sharing between Member States.

While the provision of more market based financing will potentially have benefits as outlined above, we need to be clear, reliance by SMEs on bank based funding will continue. The European Commission’s Green Paper also states that Banking Union will provide a "platform of stability to underpin the development of CMU across all Member States." Therefore, CMU will not replace bank finance but rather supplement it. 

The Central Bank believes the provision of more diversified funding models in Europe is positive, but there are caveats. 

In the Green Paper, the European Commission outline their five key priorities such as lowering barriers to accessing capital markets and building sustainable securitisation. Particular examples are streamlining the current prospectus regime and a proposed framework for simple, transparent and standardised securitisations, which are both subject to separate consultations. 

Any changes in these areas or others outlined in the paper must take into account the impact on consumers and the level of protections they are afforded. A balance must be struck between promoting greater diversification of funding channels in Europe while ensuring investors, particularly retail investors, are adequately protected. 

Protections that are currently in place must not be unduly diluted. Supervisory convergence should be considered in some cases as the solution rather than lowering existing protections. Avoiding dilution of rules related to macro-prudential protections is also important. 

Macro-prudential policies must also be considered with the implementation of CMU. CRD IV/CRR has imposed new requirements on financial institutions across the EU, and some of these deal with macro-prudential risks. Market based financing should not be seen as a way of avoiding macro-prudential rules. 

Consideration should be also given to regimes which aim to mitigate macro-prudential risks arising from market based financing. For example, last year the Central Bank introduced a regime that covers loan origination by investment funds.⁵ 

This regime was introduced post discussions with industry and importantly after discussions with our European counterparts and after receiving advice from the European Systemic Risk Board ("ESRB"), in particular, in the area of mitigating potential macro-prudential risks.⁶ While not replicating bank capital rules in full, the regime does aim to ensure such activity does not result in entities avoiding the macro-prudential requirements found in banking regulation. 

To conclude, the Central Bank welcomes the Green Paper from the European Commission and the proposed approach which has a mixture of short, medium and long term measures, along with legislative and non-legislative tools. 

The proposals of the European Commission to promote market based financing are not, in our view, to replace bank financing, but rather to complement it. With the potential result of providing more options for non-financial corporations to access funding in Europe and as an alternative source of funding for economic growth. CMU may also have the impact of making Europe more like other jurisdictions and limit the negative impacts from economic shocks in the future. 

We also call for careful consideration of any reduction of protections for investors, as loss of investor confidence in financial instruments will impact the ability of entities to raise financing from these instruments and impact the liquidity of them in secondary markets. Both of which are key in ensuring market based financing becomes entrenched and grows as a form of funding for non-financial corporations in Europe. 

We are actively involved in this debate at a European level and we are engaging with the European Securities Markets Authority in its discussions on this topic and working with other competent authorities to achieve supervisory convergence across Member States. We will continue to be an active participant in this debate in Europe and we will provide advice to the Department of Finance as required on the topic as it develops over the coming years. 

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¹ "A new start for Europe: My agenda for jobs, growth, fairness and democratic change", President Jean-Claude Juncker, 15 July 2014. 

² Jonathan Hill, Commissioner for Financial Stability, Financial Services and Capital Markets Union, 18 November 2014.

³ http://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX:52015SC0013 

⁴ IMF (2013) "Toward a fiscal union for the euro area, technical background notes". Based on Hepp and Von Hagen (2012); Asdrubali, Sorensen and Yosha (1998); Balli, Basher and Rosmy (2011) and Afonso and Furceri (2008).

5 Feedback Statement on CP 85 – Consultation on loan originating Qualifying Investor AIF.

⁶ 31 March 2014 – ESRB General Board meeting in Frankfurt.