Courtesy Reuters Fireworks illuminate the sky around a huge euro sculpture in front of the headquarters of the European Central Bank in Frankfurt.

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Europe's Quiet Financial Revolution

The European Central Bank’s recently released stress test results aim to clean up the eurozone’s banks before the launch of Europe’s vaunted banking union. But Jean-Claude Juncker, the newly inaugurated European Commission president, has set a different financial priority for his first five-year term, one that has received decidedly less attention: the creation of a European capital markets union. 

It is not yet clear what this project means or how it would benefit the EU. To a large extent, Juncker’s capital markets union is still a slogan in search of a policy program. But it is easy to imagine a set of initiatives designed to help Europe develop healthy nonbank sources of finance and to let capital flow freely across the continent’s national boundaries. If so, it could be hugely beneficial for Europe.

BREAKING THE BANK MONOPOLY 

Europe needs nonbank finance because its banks—which have traditionally been the continent’s main source of finance for business—have become considerably weaker since the onset of the euro crisis. They have been weighed down by bad loans and, in some cases, suffered losses on bonds issued by struggling governments. In the years ahead, European banks will be forced to shrink as the European Commission and European Central Bank (ECB) subject them to tougher regulation and supervision. As such, they will be unable to finance a European recovery on their own. The situation is particularly acute in peripheral eurozone countries such as Italy. 

Of course, there is a vast array of possible alternatives for those in need of financing: public equity; private equity; venture capital; loans made by entities that are not banks, often called “shadow banks”; loans that start on bank balance sheets but are then packaged up and traded in financial markets—so-called securitization; corporate bond issues; private bond placements; hedge funds; and so on. 

Although all of these already exist in the EU, the markets for them are typically much smaller than equivalent activities in

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