Journal of Financial Economics

REF 123 The on-going reconstructing of financial systems

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The European economy is facing a real challenge regarding the financing of its growth opportunities. It needs to diversify corporate financing, channel households savings towards long-term and riskier investments and achieve a genuine European capital market. This should be achieved through a real « Investment and Financing Union ». Setting the conditions of an efficient capital allocation of the European financial system is essential to support productive investment. Hence a new significant increase of capital requirements for the banking system must avoided. Increasing equity financing of corporations demands a modification of the saving fiscal rules and the supply of new saving products for households. Financial regulation also has to guarantee a plurality of the different capital financing channels and a better control of the shadow banking institutions is necessary to achieve its stability.

Considered as the new industrial revolution, the digital revolution faces the issue of the NICT companies' financing. Significant funding needs cannot be satisfied by the banking sector, given the difficulty to value such companies and their potential markets. Financing is provided by venture capitalists and business angels in the inception of businesses, but also by other channels such as public support and crowdfunding. Volumes of such investments grow rapidly.

Major tech firms have created unprecedented interest, which is perceivable by the irrational growth of their stock prices. Tech giants such as GAFA (Google, Amazon, Facebook, Apple) have accumulated considerable reserves of cash which allow them to invest in R&D, but also to acquire or control potentially disruptive start-ups (fintechs, biotechs, unicorns). As a result, the industry will face increasing concentration until antitrust legislation is implemented. In the meantime, financing will be the instrument of the major tech firms' domination, through acquisitions or fund financing.

Europe is dramatically lagging behind the USA and China in innovation and this weighs on its economic development. Savings and talent are available though. The transformation of savings into equity and cultural factors are the missing links. More specifically are lacking essential ingredients such as the ability to accept ambition, and institutions and governance adapted to the development of entrepreneurship. This article explores the way to a new economy and the role of venture capital.

This article reminds why saving now seems particularly abundant, but criticized the notion of « excess saving ». It argues that in the medium term, substantial saving can be absorbed into productive investment and as such promotes productivity and growth. The low European economic growth in recent years was not a fatality linked to a saving glut, but the result of inaccurate economic policies that have left productive investment collapse without reacting. On a structural level, however it is true that the abundance of saving penalizes investors who receive a poor, or even negative, real return on their investments. In this context, economic theory speaks of « over-accumulation » when long-term real interest rates are lower than the potential growth rate of the economy. In these situations, public debt weighs on no generation and the balanced budget target loses its legitimacy. Moreover, in this overview of « bad economic policies » related to savings, this article is concerned about the ability of financial institutions to continue lending during the next recession, in a context where they are now threatened by use of arbitrary resolution powers.

Deficiencies in international financial integration have contributed to the recent crises in the dollar zone and in the euro zone: the expansion of cross-border capital flows has relied too much on debt instruments at the expense of equity investment. It has resulted into excessive exposure to external liquidity risk, which has in turn inflated the demand for « public » insurance, either through the accumulation of foreign exchange reserve (dollar zone) or through cross-country fiscal transfers (euro zone). Both the diversification of China's external assets and the Capital Market Union in Europe offer opportunities to enhance market-based risk sharing mechanisms relying more on cross-border ownership of equity capital.

In theory, financial globalization should contribute to a better allocation of saving and investment at the global level, while also enhancing the diversification of risks for global investors. In practice however, net saving transfers across countries remain substantially more limited than what theory suggests (« Feldstein-Horioka puzzle »). This article illustrates the most noteworthy developments of global saving and investment, taking a long run perspective; it highlights in particular the higher correlation between saving and investment across countries since the 2008 Global Financial Crisis. The article then summarizes the expected benefits of financial globalization and reviews the factors that hinder net saving transfers across countries. Finally, it concludes by outlining a few potential avenues to enhance these transfers without compromising financial stability.

Since the 2008 Great financial crisis, the Chinese financial system, largely shaped by its « Soviet » past, has continually evolved. This has allowed China to absorb the huge amount of savings that has kept accumulating. The growth of a shadow banking system is a major feature of this evolution. It has helped enlarge existing financing channels and respond to the needs of an increasingly diverse range of borrowers and to investors seeking high returns. While useful, this largely « spontaneous » development is nevertheless a source of risks for financial stability, the more so since the amount of lending extended to non-financial agents has now reached extremely elevated levels.

An efficient financial system is essential to the good functioning of the economy. The various functions of the financial system can be provided either by banks or by markets. These two sources of funding are complementary, and the exact composition between banks and markets is usually not decisive. Nevertheless, the European financial system is too strongly bank-based and its markets are underdeveloped. It is absolutely necessary to rebalance it to make it favourable to growth and employment again. Developing and integrating European financial markets will allow firms to access a diversified source of funding, adapted to their needs, and increase risk-sharing between European countries to help them absorb shocks. The capital markets union is a long-term project, but a series of ambitious reforms and a new institutional architecture could steer the financial system in the right direction.

This paper deals with the causes and consequences of the disintermediation that has been observed for some time in Europe, in particular since the financial crisis. Firstly, we present the evolution of bank and market-based financing, which can be largely explained by the singular current economic context. Secondly, we analyse the objectives of some national and European institutions which campaign for more disintermediation, against the so-called « overbanking ». Last, we critically review the effects of disintermediation in terms of financing for (small and medium) enterprises, monetary policy efficiency, and financial and real stability.

Eurozone corporates already finance more on the capital markets and less through bank lending. This evolution is due to the new regulations of European banks, but also corresponds to a theoretical view according to which financing on the capital markets in more efficient. We believe that the switch of Eurozone corporates to financing on the capital markets is a mistake for two reason: the weakness of the demand of risky assets by individual investors; the requirement, with this type of financing, of a larger flexibility of the labor market.

In the context of current discussions on the development of a Capital Markets Union at the EU level, the reference is often made to the disintermediation funding model of the US economy that relies less than in Europe on bank financing. This financing structure seems more the result of a long historical process marked by a joint influence of factors related to the market size and financial regulations, than the result of a strategic choice by public authorities. The securitization of credits, a widespread practice particularly for real estate loans, also helps explain the financing structure of the economy.

The emergence of new issuers among medium-sized enterprises are a new development of financial markets. These developments are driven by a mix of external factors (low interest rates for long and prudential reforms in the banking sector and in the insurance sector) and the rise of alternative financing options (non-banking private financing) that have changed the terms of the previous trade-off between public (market) financing and bank-based financing. An examination of the drivers of the trade-off enables us to characterize the population of new and potential new issuers that could benefit from private financing. Going forward, the sustainability of the widening of financing options for medium-sized enterprises rests on the robustness of solutions that contributed to changing the terms of the trade-off, in particular with respect to information, analytical and monitoring abilities of investors, practices underpinning the confidentiality of some of the information, risk management and ability to restructure when needed.

Private Placements offer an alternative way of funding, especially for SME firms. This paper explains the circumstances under which the Euro PP (Private Placements) market has seen an increasing amount of transactions in France in the last few years. Based on the analysis of transactions between July 2012 and July 2015, this article describes the situation of the Euro PP market. It has seen a rising issuance volume of non-listed and small companies as well as longer maturities, attracting investors searching for a higher return. This paper puts forward that Euro PP require less covenants and that investors appear to select investments according to the characteristics of the issuer such as its credit quality, rather than according on the economy context.

Banking disintermediation induces a greater role for shadow banking firms, among which investment funds. These funds attract a large part of savings that were previously channelled by banks. This evolution justifies scrutinizing the behavior of those agents and identifying the risks that they bear. We review theoretical and empirical literature that shows evidence for the risks caused by delegated monitoring, herding, runs and first-mover advantage. We propose a test of run risk for several French mutual funds (2005-2015), and show that funds invested in bonds exhibit a first mover advantage. We do not find such relation for funds invested in stocks.

The (re)insurance industry has shown a great capacity of resilience during the financial crisis and its activity is still developing. It is nonetheless undergoing big changes with the strengthening of prudential requirements, an increasing capital intensity and a growing internationalization. The financial crisis and the subsequent monetary policies have also induced insurers to underweight equities and sovereign bonds in their portfolios and consequently to increase the share of the so-called alternative investments, in order to offset the low interest rates effects. Because of its profitability and resilience, the industry has attracted more investors. As a result, (re)insurance companies can provide better insurance coverage and margins are narrowing on some business lines such as insurance against natural disasters. Therefore the restructuring of the insurance industry is not yet achieved.

Classification JEL: G01, G22, L11.

Small and medium-sized enterprises (SMEs) are considered the backbone of the economy and often also a key engine of technological innovation and the creation of new employment. Despite of the fact that many SME support programs exist, especially to facilitate access to bank finance, and that the scope of these programs has been extended in response to the effects of the global financial crisis, small and innovative firms seem to continue facing a lack of sufficient external financing. This observation suggests that the design of existing support mechanisms such as especially credit guarantee schemes needs to be improved. The present article argues that the moment is opportune for OECD and EC member countries to adopt more structured approaches to the evaluations of costs and benefits of their SME support mechanisms, where they exist. Some guidance is available from an emerging academic literature that places a sharp focus on the design of a robust evaluation of this type of policy interventions. A survey of that literature suggests that the activities of CGS create both economic benefits and costs, and these – we argue – need to be more carefully weighed against each other.

The emergence of virtual currencies, based on cryptographic protocols, raises questions about their status. Here, we analyze the case of Bitcoin. We show that bitcoin does not fulfil the traditional functions of money. Acceptability as a means of payment is limited. Its volatility is too high to serve as store of value. And bitcoin is not used as a unit of account. However, as a collaborative and decentralized technology, the blockchain, used to issue the currency and settle transactions has the potential to change the centralized organization of payment and settlement system.