freedom to smallness ?

Introduction and Executive summary

These last 10 to 20 years have seen throughout most of Europe the emergence of a new generation of financial organisations that have, de facto, served sectors and people that the mainstream banking sector was no more able or willing to serve under the influence of financial liberalisation. These new financial organisations include credit co-operatives that serve the social and mutual economy, micro-finance organisations that serve bank-excluded entrepreneurs, local development funds and investment clubs, environmental banks, à to mention but a few.

This emergence has largely taken place in spite of the prevailing and increasingly restrictive regulatory and limiting tax environment in the EU. With the liberalisation and the integration of the EU market, the political focus went more on harmonising the legal framework, securing deposits, limiting risk exposure and creating a level playing field to ensure fair competition among the larger banks across Europe. It is indeed through increased competition and scale in the financial sector that everyone was eventually to benefit from improved financial services. In thinking so, restricting the access to banking through making the bank license compulsory and through increasing the minimum capital requirement was not seen as a contradiction, on the contrary.

Evidence is there however that competition in the financial sector does not serve everyone equally, especially not those client categories and economic sectors that are considered less profitable. This is evidenced specifically by the American deregulation precedent as well as precisely by the emergence in Europe of this new social finance sector that is serving those that are not served by the mainstrean financial sector anymore. Also the fact that concepts such as general good sectors and universal service had to be introduced in parallel to the liberalisation of certain basic service sectors shows that the EU is well aware of the excluding potential of a competitive market. Not to have submitted the liberalised financial sector to such standards, and even restricting the competition level through limiting entry into the sector has contributed to creating a finance gap at the lower of the social spectrum. Though pursuing the objective of promoting freedom to provide financial services, regulation has rather contributed to creating an environment where it is difficult today for financial organisations to start small, be small and to serve small.

This study is an attempt to understand in more detail what forms of regulatory hurdles social finance organisations in Europe are facing. The study is conducted from the perspective of the practitioners, i.e. from those who have very practically to live (or not) with these legal frameworks. It is based on a survey conducted in three different EU countries. The issues raised were linked to the legal status those financial organisations chose to adopt, and concerned issues such as fundraising, lending to the target public, tax, governance, supervision and access to government funding. The three countries chosen for this survey were Belgium, Germany and Spain complemented by some case studies from other EU countries (Italy, Portugal, Sweden). These represent an interesting combination of characteristics relevant for this survey in terms of country size, longer or shorter traditions in social finance and bank regulation attitudes. It is clear that with the adopted approach û to take the practitioners perspective û there may be inaccuracies, or even mistakes, in this study but which reflect how the legal aspects are seen, understood and interpreted by the people who have to live with them. This is no less a pertinent approach to perceiving and evaluating a legal framework.

Through this perspective the study attempts then to understand the possible shortcomings of the bank status specifically - as this is the royal path henceforth prescribed by banking regulation - the main one being that it is difficult to fulfil its access conditions. But surprisingly it is one of its core advantages, the capital-deposit leverage, that potentially can lead to social finance organisations "loosing their soul" in adopting the bank status. But this has not necessarily to be so, as some examples of social and environmental banks illustrate.

But then a majority of social and micro-finance organisations neither can or want to become a bank. For them it is crucial to understand what their legal needs are, depending on their stage of development. But many of these legal needs are clearly not met by regulation, and it is not always easy to understand why. This is the case for the minimum capital threshold necessary to start as a bank, which make banks actually not necessarily securer than social finance organisations that work with less capital (and without leverage). There are also certain Kafka-like questions raised when going into the details of understanding the protection of deposits, the separation of finance and social objectives or the bank monopoly for credit that is spreading at the level of EU member countries.

This does not exclude however there being good examples of legal forms to adopt for social and micro-finance that are either starting or that want to remain outside the banking status. This is specifically the case of the associative status in countries such as Belgium of France which is interesting to use for starting organisations, or the co-operative status like in Belgium or Italy which is easily accessible while allowing several basic financial functions one can work with outside the bank status.

This study is probably only a start. But it is a necessary one as there is a clear conscience that these are problems here to stay, if not to become even worse throughout Europe.

And, there are serious consequences to ignoring these issues. There is the issue of the funding gap, which one cannot attract the attention enough to, as it means that businesses are not created or go bust due to lack of accessible finance. It means also that precious financial innovation does not take place, which is invaluable in understanding how to enhance and renew our welfare systems. It means also that a large number financial organisations that nevertheless choose to exist do so illegally. It means that also that those financial organisations that do decide to make the big leap to start as a bank from scratch are doing so at increased risk than if hey had been allowed to start small.