The german financial system

1. Introduction

As widely recognized, financial systems play an important role for economic growth. The German as well as the American economy seemed to be both very successful over the last decade in terms of GDP growth. Although both economies are successful, their financial systems differ widely. While the American system is strongly capital market-based, banks play the dominant role in the German financial system. As it was for a long time a purely bank-based system, it represented a unique financial system around the world.

In this paper, I will point out the main features of the traditional German financial system. I will mainly focus on the role and structure of the financial sector, financing patterns of firms, and the German corporate governance system. So far, most academic literature has concentrated on the peculiarities of the “old” German financial system. In the following paper, recent developments will also be included. Major changes and trends of the German financial system since the beginnings of the 2000s will be outlined, leading to the question if the system underwent a process of transformation from a bank-based to a capital market-based financial system.

I will begin with a brief summary of the basic definitions, concepts and classifications that are necessary to describe and analyze the German financial system. In chapter 3, the “old” German financial system, called an international prototype of a bank-based system, is outlined. After ex- plaining the main elements of the “old” German financial system focusing on the financial sector, financing patterns of firms and the corporate governance system, recent changes and develop- ments since the 2000s will follow in chapter 4. Within chapter 4, the current state of the German financial system will be described with an emphasis on developments that could have led to a transformation to a capital market-based system. This description leads to the conclusion in chap- ter 5 that the German financial system has not transformed to capital market-based system and kept its unique peculiarities but is no longer a purely bank-based financial system.

2. Definitions, Concepts and Classifications

The German financial system has long been characterized as a purely bank-based system with a remarkable degree of stability. In order to understand the importance of financial systems, the specific characteristics of the German financial system and its possible transformation over time, the basic definitions and concepts of financial systems are introduced in this section.

2.1 Definitions & importance of financial systems

According to Rose and Marquis, the term financial system “refers to the collection of markets, institutions, laws, regulations, and techniques through which bonds, stocks, and other securities are traded, interest rates are determined, and financial services are produced and delivered around the world”. An analysis of financial systems focuses on how people accumulate wealth and trans- fer income over time and how businesses obtain financing for projects (Schmidt & Tyrell 2003). The primary function of a financial system is the channeling of funds from savers to investors so that the economy can grow and the standard of living is increasing. Therefore, as shown by the well-known paper of Levine, financial systems play an important role for economic growth. Dur- ing the following paper, I will focus on three important elements that distinguish financial sys- tems: the financial sector, financing patterns of firms and the corporate governance system.

2.2 Bank-based & capital market-based financial systems

A common classification of financial systems distinguishes between bank-based and capital mar- ket-based financial systems. In a bank-based system, banks play the dominant role in attracting savings of households, in external financing of businesses and corporate governance (Levine 2002). Germany is said to be a prime example for a bank-based system where capital markets do not play a major role. In contrast, capital-market based systems such as the American financial system are characterized as systems where capital markets are crucial for household savings, financing of businesses and corporate governance (Vitols 2004). Hence, non-Bank financial in- termediaries have a considerable impact while banks are less relevant for the functioning of the financial system.

2.3 Outsider & insider controlled corporate governance systems

Corporate governance systems ensure the functioning of financial systems and therefore are an essential part of every financial system. According to Shleifer & Vishny, corporate governance is defined as "the totality of mechanisms which assure that managers’ decisions are made in the interest of shareholders and other providers of capital so that these can expect a return on their investment”. Anglo-Saxon financial systems are often classified as outsider controlled systems that rely on market mechanisms and focus on shareholder value. The reduction of agency prob- lems is achieved by a functioning market for corporate control, aligned executive compensation and competitive factor and product markets (Hackethal et al. 2006). Insider controlled systems that are very common in Continental Europe are based on internal mechanisms and focus not only on shareholders but also on other stakeholders of the corporation. Agency problems are reduced through the supervisory board, active involvement of employees and equity participations of banks.

2.4 Evolution of financial systems over time

In academics, the evolution of financial systems over time is widely discussed. According to the most common view, shaped by Rajan & Zingales, financial systems and the role of banks and governance systems within these systems develop along a “natural progression” from bank-based and stakeholder-oriented systems to capital market-based and shareholder oriented systems. Germany has long been classified as the international prototype of a stakeholder oriented and bankbased system. Several changes in the business, legal and financial environment of German banks, businesses and the financial systems as whole have led to the question if there was a natural progression to a capital market-based and outsider controlled system. This question will be at the center of the analysis that is following in the next chapters.

3. The “traditional” German financial system until the 2000s

Until the 2000s, the German financial system was truly a bank-based and insider controlled finan- cial system. Banks played the dominant role in the financial sector while capital markets were relatively unimportant. Businesses obtained financing through internal sources or bank loans and the corporate governance system was clearly stakeholder oriented (Hackethal et al. 2006). In the following, the main characteristics of the “traditional” German financial system will be described in more detail.

3.1 The financial sector

The financial sector consists of financial intermediaries, which can be splitted into banks and non- bank financial intermediaries (NBFIs), and financial markets as well as their rules and structures. Since World War II, banks were the main element of the German financial sector as the primary vehicle for the accumulation of savings of households and the sourcing of funds for businesses. Germany had a so-called three pillar banking system composed of private commercial banks, public savings banks and cooperative banks (The Economist 2012). Most banks were organized as truly universal banks with very close client-relations (“housebank principle”). Regional savings banks and cooperative banks were committed to their region’s public interest and therefore not strictly to profit maximization, catering local businesses. As the following table shows, the Ger- man banking system was characterized by a low degree of concentration and a huge number of institutions compared to other developed countries (Suechting & Paul 1998).

Table 1: Structure of the German Banking Sector in 1995

Abbildung in dieser Leseprobe nicht enthalten

Source: Schmidt & Tyrell 2003

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