There is more than one reason why Europe’s recovery from the financial crisis has lagged so far behind the US — but at the heart of the European malaise is a shortage of equity capital for small and medium-sized enterprises (SMEs).
This was acknowledged in last week’s Capital Markets Union Green Paper from the European Commission and is the central conclusion of an in-depth study, Bridging the Growth Gap, co-written by the Association for Financial Markets in Europe (AFME) and The Boston Consulting Group (BCG), comparing Europe’s capital markets with the similar-sized US economy.
Small businesses play a vital part in Europe’s economy. They employ 88m people across the 28 European Union states, more than 65pc of the workforce. Yet compared with the US, there are relatively few small companies that make it to become big businesses. Without greater access to risk capital this is unlikely to change, as only equity funding is suited to the risks of backing fast-growing, young businesses and supporting them to the next level.
In aggregate, Europe’s SMEs do not suffer from a shortage of capital. In fact, our analysis shows that Europe’s SMEs receive considerably more financing from banks, non-banks and governments than their US counterparts. The outstanding stock of SME finance stands at €2 trillion compared with €1.2 trillion in the US. The problem is that bank financing accounts for such a large proportion of this. This over-reliance on debt is a feature of the European economy and is reflected in the structure of the financial system.
For example, Europe has only three-quarters as much equity capital — €10 trillion versus €19 trillion in the US. The structure and sources of finance are also different. In Europe, regulated insurers and banks are the main suppliers of funding, whereas in the US funding sources are more diverse. Private pension funds and fund managers play a bigger role in the US and their risk appetite is greater. US pension funds and fund managers typically invest more than half their assets — 53pc — in equity, versus 37pc in Europe.