Many Germans view finance as a servant of industry rather than an industry itself. But transforming Germany from a combustion-engine driven economy into something fit for a greener and more digital world requires a dynamic banking sector that can fund investment in technology and offer savers better choices.
Companies are more dependent on bank lending in Germany than anywhere else in Europe. There is a huge number of smaller lenders, strongly influenced by local politicians, that can be used to serve entrenched interests and protect inefficient companies. German banks are among the least profitable in Europe with the slimmest capital bases.
They suck up more of savers’ money than banks elsewhere while offering poor returns and leaving less funding available for companies to grow via stocks and bonds or venture capital funds.
They also aren’t strong enough to face competition within Europe, let alone on the global stage. Until they are, there is little hope for efforts to open a true single market for financial services in the European Union. Until that happens, the EU will never create robust and internationally attractive capital markets to replace the U.K. as its main financial center.
Optimists will note that the Social Democrats, led by Olaf Scholz, the likely next Chancellor, want to promote the European Banking Union project — which would open up national borders. The Green Party, its probable coalition partner in a new government, has a similar agenda. Germany is the EU’s largest economy. It should have been leading the way toward banking union. It hasn’t.
Reform in Germany needs to start with consolidation, especially at the level of small, local savings banks. It must also pursue cost cutting throughout the industry by trimming staff and branches. Finally, it must end local political influence over what smaller banks do.
Other European markets have dysfunctional banking systems, but even Italy is pursuing major restructuring, not least to tackle its bad-loan problem, though it is far from finished. Germany is the least reformed market in Europe, says Nicolas Veron of the Peterson Institute for International Economics and Bruegel think tanks.
Uniquely, the country has lots of small, state-backed banks. These may be individually insignificant, but they form a huge mutually-dependent conglomeration, sworn to bail each other out in times of trouble. Collectively, they are practically as big as Europe’s largest bank, BNP Paribas of France. Total assets of what is called the Savings Banks Finance Group were 2.38 trillion euros ($2.78 trillion) at the end of 2020, versus 2.49 trillion euros for BNP.
Most savings banks in Germany are chaired by a local elected official like a mayor, according to a Bruegel study, making them tools for political patronage. They also operate away from oversight by the European Central Bank. Such lenders spread pain through unhealthy competition. The European Central Bank’s top regulator, Andrea Enria, said this month that persistently unprofitable lenders drive down loan prices to levels that erode profits for all, making the sector more risky. He was talking about Europe broadly, but Germany is the champion of the practice.
Jan Schildbach, the Deutsche Bank analyst I referred to at the start, produced a frank and clear-eyed critique of his home market, pointing out that German banks have the worst returns on equity in Europe and the highest costs per euro of revenue. Added to this, the fact that many can’t raise money on capital markets in an emergency means they have weak capital bases and are “a permanent, latent threat to financial stability in Germany,” he wrote in German. He didn’t add that large listed banks, like Deutsche, are so poorly valued in stock markets that they struggle to raise money, too.
That was too forthright for his bosses at a sensitive time. They slapped him down, pulled his note and disowned his views — which is a shame because he is dead right. To be fair, he probably embarrassed his bosses by criticizing Germany’s financial regulators for failing to stop several scandals, some of which involved his own bank.
To improve the economics of German banking, a new government should start by consolidating the smaller banks as well as shrinking the number of branches and staff. This will likely dilute the influence of individual politicians on the boards of savings banks, says Valeriya Dinger, economics professor at the University of Osnabrueck. It could lead to better lending decisions.
Banks have too much power in Germany. About 40% of savings are in bank accounts (versus 13% in the U.S., where most savings are in pensions and investment funds), according to New Financial, a London-based research group. This explains why Germany has such small pools of long-term capital to invest in companies through markets. Insurance, pensions and other assets in Germany are worth just 1.3-times gross domestic product versus 2.6-times in the U.K. and 4.7-times in the U.S.
A push for European Banking Union – and Capital Markets Union after that – is the most promising pathway for reform. It can’t happen without Germany: And German banks can’t cope with wider competition without better profits and balance sheet strength.
Ground-up reform is the only way for European finance to truly punch its weight globally. And it has to start with its largest economy: Germany.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Paul J. Davies is a Bloomberg Opinion columnist covering banking and finance. He previously worked for the Wall Street Journal and the Financial Times.
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