Europe’s small and medium-sized enterprises face a financing gap of €39bn per year. This is partly a function of the overwhelming reliance of European businesses on bank loans, rather than capital markets, which increases the procyclicality of credit provision and constrains financing opportunities for new businesses.
The spate of recent policy advancing capital markets union does little to address this problem. Given the reliance of European firms on bank loans, legislators wishing to make credit for SMEs cheaper and more abundant should consider the European Secured Note.
The ESN is a nascent asset class envisioned as a dual-recourse bond collateralised by loans to SMEs. ‘Dual recourse’ means investors are protected twice over: first by claims on the issuing bank, and second by priority claims on a legally segregated pool of SME loans. If the bank issuing the ESN fails, investors in the note are then entitled to the cash flows from this segregated pool of loans.
This proposed structure mirrors covered bonds – ultra-safe dual-recourse instruments used extensively in Europe to refinance mortgages. Covered bonds are distinct from mortgage-backed securities, often maligned for their role in the 2008 financial crisis, in that the issuing bank rather than the investor bears the credit risk of the underlying assets.
Slow progress on ESNs
While there have been some pilot schemes of ESN-like instruments, they have failed to gain traction. The instrument is caught in a vicious circle with legislators and market participants both waiting for the other to move first. It is an intensely European story of stasis begetting stasis.
Since 2017, the European Commission has been ‘considering’ the introduction of a pan-European framework for the ESN. It commissioned a report to assess the capacity of such a framework to strengthen CMU by enabling banks to access more funding, thereby supporting lending to the real economy. This report, published in 2018, was broadly supportive of the instrument.
Nonetheless, the initiative has continued to languish. The most recent official advice on the matter, issued in September 2025 by the European Banking Authority, recommended ‘a review of the topic in the medium term’. But the medium term is inappropriate for immediate problems.
Turning a problem into an opportunity
The reliance of European business on bank loans, which comprise 85% of the stock of outstanding debt, in comparison to 45% in the US, presents immediate problems. Bank reliance ties the cost and availability of credit to SMEs closely to the cost of bank capital and the availability of balance sheet space. It also increases the procyclicality of credit provision. In a crisis, credit availability for SMEs tends to diminish precisely when it is most necessary as banks face funding pressures and capital constraints.
However, Europe can turn this problem of bank reliance into an opportunity. If the European Commission proposed regulation to develop the ESN as a dual-recourse instrument backed by loans to SMEs with favourable regulatory treatment, it could alleviate two problems simultaneously.
First, capital markets finance would be channelled to SMEs; one estimate places the potential size of the ESN market at €1.2tn. Such a market would reduce the cost and increase the availability of capital for firms that comprise around two-thirds of European employment.
Second, ESNs could serve as a reliable funding instrument allowing banks to generate liquidity in times of stress. This could shield the real economy from the vicissitudes of bank funding markets as well as providing a countercyclical balance during real-economy shocks, where banks could use ESNs to finance continued lending to SMEs. SMEs would be better off, while the system would be made safer.
There are few easy wins in the development of CMU. Many solutions, including recent policy advancements, are little more than tinkering incrementalism. While the ESN would not be entirely without challenges, it is comparatively low-hanging fruit. The legislative template already exists in the form of the Covered Bond Directive. All that is required for progress is the will of the Commission to break the stasis.
Conor Perry is an Economist at OMFIF.
This article featured in the February 2026 edition of the OMFIF Bulletin. Download ‘Europe’s place in a divided world’.
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