New Financial

Report on ‘The benefits of capital markets to high potential EU economies’

November 2016 • Topic: Unlocking capital markets • by William Wright

Capital markets have made remarkable progress from a standing start in Central and Eastern Europe over the past 25 years. This report, published in collaboration with AFME, shows that there is a huge opportunity for further growth: deeper capital markets in the region could unlock more than €200bn in long-term capital, deliver more than €40bn a year in extra funding for companies, and help restore rapid economic growth.

Download the full report here

New Financial believes that Europe needs bigger and better capital markets to help drive its recovery and growth. Nowhere is this more important than in Central and Eastern Europe, where despite significant progress over the past 25 years, capital markets are much less developed than in the rest of the EU. The 11 EU member states in this report account for 20% of the EU’s population, 8% of its GDP – but just 2.5% of capital markets activity.

The report analyses the depth of capital markets relative to GDP across 23 different metrics – from pensions and insurance assets, to stock and bond markets and venture capital – in the following 11 EU member states:

The Visegrad 4:               Czech Republic, Hungary, Poland, and Slovakia

The Balkans:                   Bulgaria, Croatia, Romania and Slovenia

The Baltics:                     Estonia, Latvia, Lithuania

We refer to these countries throughout the report as the EU11 or HPEs. While each country is different, in many cases their similarities in the depth of capital markets, economic challenges and historical context are far more striking than the differences between them.

The report addresses some of the following questions:

How developed are EU11 capital markets? And how reliant are the EU11 on bank lending?

What was the impact of the financial crisis on the EU11 economies?

What is the growth potential of capital markets in the EU11?

What are the main obstacles to developing capital markets in the EU11 and what initiatives are already underway

How can the EU, national governments, and market participants promote further development?

The high potential economies in the EU11 could benefit significantly from more developed capital markets. Here is a summary of the main findings of the report:

* Economic growth in the EU11 has virtually halved since the financial crisis, productivity growth has slowed, and the rate of convergence with the rest of the EU has stalled. EU11 countries with deeper capital markets and larger pools of long-term capital have seen less shrinkage in GDP and productivity growth rates since the crisis.

The slowdown in GDP and productivity growth in the EU11 since the crisis coincided with a falling investment rate. EU11 corporates largely rely on internal profit generation to fund their expansion. Greater access to external funding, particularly from the capital markets, could spur more investment and raise the sustainable growth rate.

* The EU11 economies have made sustained progress over the past 25 years. Today, their capital markets are around one third as developed as in the EU as a whole when measured across 23 different sectors of activity relative to GDP. Capital markets in the Balkans and Baltic states are about one fifth as deep as the EU average.

* Companies in the EU11 are more heavily reliant on bank lending than in the rest of the EU. Bank lending represents 85% of corporate debt compared with 75% in the EU; however the flow of new bank lending has fallen by nearly 30% since the financial crisis as foreign banks reduced their exposure to EU11 markets.

* The pools of capital in the EU11, particularly pensions and insurance assets, are only one third as large relative to GDP as the rest of the EU, with households making more use of cash deposits for their savings. Lower personal disposable income in the EU11 helps to explain lower savings rates and smaller investment pools.

* Overall, capital markets in the EU11 have shrunk relative to GDP by a fifth since 2006. EU11 bond markets have more than doubled relative to GDP over the past decade but equity markets have shrunk significantly in relative and absolute terms.

* The potential growth opportunity in EU11 capital markets is huge: if each country had markets as deep as the ‘best in class’ (the most developed country in the EU11 in each of the 23 sectors we analysed) it would mean an extra €225bn in pensions and insurance assets to put to work in the EU11 (about 20% of GDP), and annual flows of financing for companies in the EU11 of around €45bn (4% of GDP).

* There are range of obstacles to developing capital markets in the EU11, including the relative ease of accessing bank funding, limited market breadth and liquidity, the relatively smaller size of firms, fragmented market infrastructure, and public policy.

* National governments, market participants and international bodies are active on a number of initiatives to boost capital markets, including regional cooperation, investor education, and legislative reform. Several EU11 governments now have defined programmes in place to develop their domestic capital market.

* The CMU project has pushed capital markets up the political agenda in the EU11 and could help remove barriers to cross-border investment. The EU should focus on how best to tailor CMU to benefit those countries with less developed capital markets.

For more information on AFME, visit