EU securitisation push needs markets, not housing guarantees

Capital markets union tops the wish lists of European Union leaders, outside experts and seasoned financial insiders as a way to find the extra €1 trillion or more needed annually for the green and digital transitions. But after 10 years of trying, the EU has managed only marginal improvements. Cross-cutting issues including pensions, taxes, insolvency and housing have proven too thorny to make much headway in Brussels. 

For the next push, policymakers should pick areas where they can make a difference. Three seem particularly promising: joint supervision, retail investing and securitisation – the  combining of loans or other assets into securities that can be sold and traded.

Europe used to have a decent securitisation market, but since the 2008 financial crisis, its issuance shrivelled while the United States has boomed, issuing €1.3 trillion in 2023 compared to a paltry €213 billion for the 27-country single market. 

The European Central Bank wants more, so that banks can free room on their balance sheets for new loans. In March it suggested that updated risk-management standards and targeted guarantees – so that loans would be easier to bundle – could help. Meanwhile former Italian premier Enrico Letta’s single market report suggested simplifying the EU’s securitisation framework and giving more attention to green securitisations, which could either bundle green assets or make proceeds available for further sustainable investment.

When it comes to prudential standards, the trick will be for regulators and market stakeholders to find ways to unlock the market without spurring undue risk. In the US, subprime mortgage securities were once deemed safe, only to set off a global financial crisis. Europe can take technical steps to loosen up without courting disaster; for example there is active debate about whether the Solvency II insurance rules need further updating so that insurance companies could invest more in this area. That said, policymakers should not relax standards solely to boost certain market segments.  

Experts are now coming forward with more ideas. Unfortunately, some of them are bad. In particular, it would be a misstep to start guaranteeing residential mortgages, as floated in a report commissioned by the French finance ministry. Europe does not need a counterpart to Fannie Mae and Freddie Mac, the two Washington-backed giants that are enmeshed so deep into US markets that they required colossal bailouts and nationalisation. US lenders’ access to government-guaranteed middlemen, which adds moral hazard and mortgage market distortions, is not a good model to copy.

The French report’s broader idea, a central platform for trading bundled loans, is much more promising. It could help smaller banks by lower the costs of finance structuring, while creating a market of standardised, liquid and well-defined products for investors to buy. Scale is key: one of the biggest problems with new bonds is making sure there are enough of them to trade freely. 

There is a role to play for government guarantees, as the French report suggests: after a bank makes a loan, the government in its home jurisdiction could add a guarantee to lower the risk of default and make loans more similar to each other and hence easier to pool. Then these bundles could be issued under common standards and traded centrally. Investors are more willing to buy something if they know they can sell it when they need to. 

What to guarantee is therefore a central question. Answering it requires remembering what the EU needs more of: financing for technology startups, renewable energy innovators and promising small businesses. This is where the EU wants to create jobs and boost its prospects, so this is where government backing should focus. A well-designed government guarantee would make it easier for global investors to do their due diligence. Instead of needing to check the underwriting and default terms of every loan in the package, they could rely on the central platform for a common design and standard procedures for how to handle assets that underperform.

The European Investment Fund (EIF) offers a useful precedent. Since 2013, this unit of the European Investment Bank (EIB) has invested more than €17 billion in securitisation transactions, which it says led banks to make €57 billion in new lending commitments to small and medium-sized enterprises. This is a good model for boosting securitisations and for helping the EIB take on more leverage without adding excess risk. It also echoes the successful guarantee structure that the EIB and the European Commission put together for the 2015 Juncker plan. 

Two big challenges emerge, however: scale and liquidity. An economy-wide accelerator requires a much bigger effort. The EIF itself notes that it has been hard to find buyers for these bundles, which end up mostly retained by their issuers. 

To make markets for loan bundles work better, they need to exist in the first place. The EU has an opportunity to use targeted guarantees to spark change. It just needs to backstop the right things.