After GFC, governments of the European Union have tried to incentivize the economy through the reinforcement of private investment. For instance, the Juncker Plan intends to allocate EUR 500 billion until 2020 to promote industrial projects and to reinforce innovation in Small and Medium Enterprises (SMEs). Another example is the PACTE law in France, which looks to facilitate funding for SMEs. Furthermore, the new institutional infrastructure of the French Public Investment Bank (BPI) highlights the efforts made by governments to support French innovative companies.
Credit to private non-financial sector in Euro Area
Sources: Beyond Ratings, BIS
In this regard, the last financial stability review of the Banque de France steers the debate around the shadow banking system. It argues that given the context, the increase of shadow banking funding gives more opportunities to enterprises by diversifying its risk and by moving resources to investment in innovation which is an important determinant of growth in advanced economies.
The December 2017 reform of the well-known Basel III international regulatory framework for banks, focuses more on the liquidity of the non-banking funding more than on the sustainability of the banking system. The excess of liquidity of the banking system and an increased demand for non-banking resources challenge policy makers and international institutions to rethink the regulatory framework of this “shadow” part of the economy that it is not well regulated.
Features of financial markets are now different. On one hand, companies in the Eurozone prefer to save and to fund using their own resources (cash flow) or by private equity, meaning that they are not using the regular banking system. On the other hand, excess of savings in the banking system is allocated to public debt and financing the increasing public deficit. Thus, the main impact remains on the intensification of the vicious circle between banking risk and sovereign risk. If private banks concentrate their portfolio on sovereign debt securities, the banking risk would increase and then affect public financial stability.
This situation is also critical in terms of the transmission mechanism of the monetary policy, since the link between household’s savings and companies is disrupted, a change in the interest rate has virtually no effect on the cost of companies’ funding.
Finally, it is important to understand that the non-banking system is a counterpart of the banking system that changes the macro financial equilibrium and there is a necessity to better regulate it to prevent potential systematic risk.
Gabriela Aguilera-Lizarazu, Analyst