In developed countries, particularly in Europe, investment has been sluggish since the 2008 crisis. And yet, money is abundant and there are many needs, especially in regard to long-term, growth-enhancing investments. But private investors are paralyzed. Is there any way out of this down-beat economic environment? Institutional investors are at the center of the game. Among them, public banks and deposits funds can play a significant role. How have these secular institutions returned in the spotlight?
Even though on a global level, the world is flush with liquidity, investment dynamics are very different depending on geographical areas. As observed during the past fifteen years, there is a marked contrast between developed and emerging economies. Investment reaches 33% of GDP in India and 49% in China, against 20% in the US and 17% in the UK (2013 figures).
This trend is expected to continue during two or three decades: it reflects an economic catching up characterized both by an investment effort and the hope of better returns – a phase of expansion, similar to the one experienced by Western Europe after 1945. But this explanation isn’t enough. The 2008 crisis further increased the gap, causing a real failure of investment in a number of developed countries.
This is especially true in Europe. According to Eurostat, between 2008 and 2013, investment decreased by 11% in the 28 member states of European Union and by 12% in the eurozone. European countries most affected by the crisis have suffered a violent contraction in gross fixed capital formation: Italy (–25%), Portugal (–36%), Spain (–38%), Ireland (–39%), Greece (–64%). Against this bleak backdrop, France is an exception, with a stable and relatively high investment rate (22% of GDP). As for Germany, which stood out in the early 2000s by a low rate of investment, it is one of the few European countries where investment has increased since the crisis (+7% in value, 2% in volume).
This weak investment severely undermines economic growth, both in the short and long term. In the short term, less investment translates into less demand addressed to firms. In the long term, it accelerates the aging of infrastructure and production facilities, i.e. the production potential fading out, and thus erodes competitiveness. Economic uncertainties always slow down private investment and public investment is stopped in most countries, because of the focus on reducing deficits and reorganizing public spending.
And yet, there still are many investment needs. Major transitions are at work in many fields – energy, demography, the economy – and call for new investments: energy efficiency and environmental protection, adaptation of living spaces (including housing for an aging population), but also investments in the human capital, R&D and innovation. In the United States and Germany, economists regularly point out the investment shortfall in public infrastructure. Elsewhere, other projects suffer from a lack of capital. When the Juncker investment plan was adopted on December 18, 2014 at the European Council, over 2,000 projects awaiting 1,300 billion euros of funding were identified.
Where and how will the necessary resources to fund these investments be found? How can savings be transformed into long-term investment when savers’ profitability requirements are increasingly short-sighted and when the evolution of prudential regulations has led some long-term investors, such as insurance companies, to withdraw from markets such as real estate? How can investments be made for future growth when everyone, households, businesses, governments, think first about resolving their immediate challenges?
The model offered by deposit funds and national public banks offers an answer to these questions. For their mission is to invest by serving economic growth in the long term.
An original model
Caisse des dépôts et consignations, in France, and Cassa Depositi e Prestiti, in Italy, are public financial institutions responsible for managing regulated savings deposits. They were created in 1816 for the first and in 1850 for the second. Like insurers and pension funds, they drive household savings towards growth-generating projects.
Their missions are similar to those of the national public banks as seen in several European countries, which have most often been created in a particular context: reconstruction, development effort. The Kreditanstalt für Wiederaufbau (KfW, “Credit institution for reconstruction”) has been created in Germany in 1946 to manage the aid received from the Marshall Plan. The Instituto de Credito Oficial (ICO) was created by Spain in 1971 to support the country’s economic boom. The Bank Gospodarstwa Krajowego (BGK), a Polish State bank created in 1924 to support the reconstruction of the country, was mothballed in 1948 and reactivated in 1989. Also in Europe, theEuropean Investment Bank (EIB) is the public bank of the European Union created by the Treaty of Rome in 1957.
These models have spread and continue to do so. Morocco created a Caisse de dépôt et de gestion in 1959, Tunisia created its Caisse de dépôts et consignations in November 2011. There are also CDCs in Gabon, Senegal and Cameroon. In Benin, Equatorial Guinea and the Republic of Congo, they are called Caisses d’amortissement(Amortization funds). In Mauritania, it’s a Caisse des dépôts et de développement. In Brazil, the Caixa Econômica Federal was founded in 1861 and also assumes the role of a retail bank for individuals (with 80 million accounts) while playing a role of intermediation for long-term investments and social projects. China, on the other hand, has chosen a public bank (China Development Bank), founded in 1994. Finally, we mustn’t forget to mention the Canadian Caisse des dépôts et placements du Québec, founded in 1965 to manage the fund of the Régime de rentes du Québec (a universal pension plan established by the Quebec government) that, by 1974, already managed the largest portfolio of Canadian stocks.
Following Kuwait, other countries have eventually created sovereign wealth funds, financed mostly by trade surpluses. But these sovereign wealth funds generally target assets abroad, following a mainly financial logic which aims at creating annuity. The deposit funds and public banks are part of a very different logic: they aim to support the industrial development of their countries of origin.
These institutions share a common basis: to intervene in areas suffering from long-term funding gaps and prioritize projects driving externalities, especially environmental or social: social housing, infrastructure, funding of innovation and development of SMEs but also, especially in Europe, thermal renovation of buildings, renewable energies, climate policy… They fund investments profitable for the community but neglected by private investors. Following the same logic, some have developed complementary specialties: tourism, digital technologies, territorial engineering, forestry, cultural industries, management and prevention of of natural disasters.
Since economic development is always a territorial question, these institutions also contribute, directly or indirectly, to the financing of local authorities and of their projects. In Europe, most of them – with the exception of Caisse des Dépôts – manage, on behalf of the government, part of the European Structural Funds (European Regional Development Fund, European Social Fund), that they can complete with loans from their own resources.
Finally, most of these institutions support the exportations of domestic firms. This is particularly the case of the German public bank, the KfW, which primarily funds large SMEs and middle-market companies. Up to 2014, Caisse des Dépôts wasn’t part of the French export policy, but its relevance is now expected to increase with, firstly, the development of export loans in Bpifrance, a subsidiary owned in equal parts by Caisse des Dépôts and the French government, and also with the creation of an export bank to refinance large international contracts.
These public financial institutions are particularly useful to respond to financing needs not covered by the market. To do this, they are often source of financial innovation.
With its counterparts, Caisse des Dépôts is also responsible for the financial innovation of “project bonds,” designed to facilitate the funding of infrastructure by issuing bonds.
As one can see, these public institutions, sometimes over two centuries old, offer a great flexibility in order to address the immediate economic challenges and they actively contribute to the priorities of public authorities. This flexibility stems from an economic model focused both on the long term and effective governance.
A sense of long-term
The economic model of funds deposits, focused on long-term investment, allows a different strategy from most market players.
Take the French Caisse des Dépôts. Its liabilities consist mainly of regulated savings (for 242 billion euros) and deposits of legal professions (for 37 billion). The relatively stable level of these assets enables Caisse des Dépôts to overcome, at least partially, liquidity constraints in the short term. Indeed, the structure of its liabilities leaves it enough room to transform these deposits into loans and long-term investments. On the same model, the Italian CDP also transforms stable flows of short-term liabilities into long-term assets.
Unlike deposits funds, national public banks have little or no regulated deposits. Their resources consist mainly of long-term borrowings, issued on international markets. Benefiting from a high credit rating and a public guarantee granted by the State in return for their general interest missions, they can finance themselves at low cost and lend on favorable terms. This is particularly the case of the German KfW, the European Investment Bank and (to a lesser extent) of the Spanish ICO.
Like sovereign wealth funds – and unlike many private investors – deposits funds and national public banks have substantial equity, that comes from the patient pooling of results accumulated over the years. They are not subject to the prudential rules of private banks (such as Basel ratios). However, in Europe, they apply them on a voluntary and appropriate basis. In France, the prudential model of Caisse des Dépôts even leads to more demanding solvency ratios than those required by the Basel III rules.
With a small proportion of short-term current liabilities and a high level of equity, financial institutions can partially overcome constraints related to the volatility of asset prices and develop an investment strategy on a long-term basis. They are able to keep assets in their portfolio over the medium or long term and favor a valuation based on the modeling of future revenues generated by the assets (mark-to-model, more faithful to the economic reality) rather than a valuation based on the market price at each moment (mark-to-market). Within the Long-Term Investors’ Club, they also argue that this specificity should be recognized in the prudential and accounting rules applicable to long-term investors.
This ability to mitigate risks over time has several advantages. Firstly, it confers a comparative advantage to invest in less liquid assets (with an illiquidity premium) and which, moreover, meet social expectations: greenfield infrastructure in developing countries, seed capital, venture capital, new technologies, etc.
Secondly, it allows to optimize the portfolio of assets in a long-term profitability approach that, which favors investment in infrastructure and real estate (two assets offering a relative protection against inflation) as well as investment in listed shares, which risk/return couple is higher than that of bonds and monetary securities over a long period.
Finally, deposits funds and national public banks can play a countercyclical role by increasing their investment in risky assets at the bottom of the cycle. In Europe, they have also been heavily used by governments to contribute to the economic recovery plans implemented to overcome the 2008 crisis. These institutions play a bridging role for public policies.
A knock-on effect on private actors
Beyond their characteristics as long-term investors, these public institutions have a leverage effect on private money. Their creditworthiness and their image of seriousness with financial markets confer them a credibility that helps attract private co-financing for most projects. According to the financial arrangements and the risks they take, they can generally attract from 5 to 15 euros from private sources for each euro spent. This money is dedicated to long-term, growth-promoting projects, to which other players would not commit alone.
The 2008 crisis, by freezing investment and by shedding light on the shortsighted management of most private financial actors, has placed these institutions at the center of the game.
First of all, for the purpose of the vision they defend. By founding the Long-term Investors’ Club in 2008, Caisse des Dépôts, CDP, KfW and EIB endeavor to promote their practices internationally and to create a convergence of views between institutional investors, including insurers and pension funds.
Secondly, for their firepower. In the Eurozone in particular, these institutions have become an essential tool for boosting investment.
They will be among the main players of the Juncker plan adopted in late 2014. At the heart of this plan, the European Fund for Strategic Investment (SIEF), opened within the EIB and endowed with 21 billion euros, will draw on funds deposits and national public banks to trigger up to 315 billion euros of investment i.e. 24% of the European GDP, over a period of three years. These State funds will be used to quickly stimulate private investment, through guarantee formulas or pre-financing projects. For example, on the eight billion euros that France has committed to bring as part of this investment stimulus plan, five billion will come from Caisse des Dépôts and three from its Bpifrance subsidiary.
The added value of these institutions in the Juncker plan is based not only on the potential for additional financial contributions, but also and above all, on their capacity of project appraisal, their knowledge of local issues and their networking capacities, between themselves and with external partners.
This plan reflects a new vision of recovery policies. Monetary policy is not enough. The quantitative easing led by the European Central Bank is flooding the market with liquidity. But what about long-term growth, the only growth really capable of paying down the huge public debt? To finance this growth, private investment needs to be awakened. It is no small paradox for deposits funds and public banks to be called to redirect new liquidity towards the real economy, bringing in their wake private investors who have not only lost the sense of the long term, but also their appetite for risk.