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The German banking system has a special feature which distinguishes it from most other industrialized countries. Modern Germany is home of Allfinz, the system of universal banking which allows all kinds of financial services to exist under one roof, from retail banking to mortgages, from mergers and acquisitions to investment banking. This contrasts with the US banking system which separates retail from investment banking and grants licenses for only one activity or the other (though this has been changing in recent years). The evolution of the German universal banking system was largely due to Germany’s inadequate capital formation facilities and lack of required securities trading set-up at the time of its industrialization. The impact of the system on Germany can be largely debated.Some believe that a universal bank is far better equipped to meet the challenges of global banking in the 90’s. The advantages that universal banking has brought upon the banking industry are the stability created by its diversification efforts and the resulting higher level of deposit security. It is generally less vulnerable to market changes because it is usually either the retail or investment banking sector alone which suffers a downturn at one time, and rarely simultaneously. Divisional cross subsidizing also allows banks to offer services more cost effectively, which is particularly beneficial to small and mid-sized customers. In addition, corporations are able to seek full-service activities from a single source, the notion of one-stop shopping. As universal banks have a wide range of services available, they are also able to provide customers the best products needed for their problems as opposed to the best products within a limit of say commercial banking activities alone. Critics of the universal banking system point largely at the possible conflicts of interest which may arise, particularly as German banks are allowed to hold securities of other corporations. Banks retain strong influence over industries due to their shareholdings, board mandates, and proxy voting. How strong of an influence can be seen by observing the composition of corporate supervisory boards. For example, the head of Deutsche Bank chairs the board of Daimler-Benz AG (now Daimler Chrysler). According to Dieter Kauffmann, president of a lobby group for small shareholders, “German industry is owned by German industry, or, more precisely, by German banks. Because the banks control significant, often veto-yielding minorities in virtually all big industrial groups, it is impossible [for independent shareholders] to place an effective check on management.” (Wadhwa, pgs. 33,34) STRUCTURE OF THE BANKING INDUSTRY The business of banking in Germany is defined in the Banking Act of 1961 which defines a credit institution engaged in banking as any enterprise engaged in the following activities: 1) accepting deposits; 2) making loans; 3) discounting bills; 4) providing securities brokerage services; 5) providing trust services; 6) operating investment funds; 7) factoring; 8) providing financial guarantees; 9) providing funds transfer (giro) services. (Kaufman, pg. 556) There are also general rules for every bank in Germany. There are four main parts which consist of the Central Bank Law (rules about minimum reserve), the Banking Business Law (basics of capital resources and liquidity), the Stock Exchange Law (price fixing and future business), and Deposit Law. In addition, there are also laws pertaining to certain bank groups. They include the Savings Bank Laws of the federal states, Mortgage Banks Law, Security Law, Shipbank Law, Building Society Law, Law of Investment Companies, and Law of banking foundations with special tasks. (http://iaix7/informatik/htw-dresden.de/htw7953/hp98/gbs.htm)There are over 3,500 legally independent banking institutions in Germany, with over 65,000 branches combined. Given a population of over 81 million, there averages approximately one bank office for every 1,200 people in Germany. Germany is one of the most heavily “banked” economies in the world. Germany’s commercial banks can be grouped into three broad categories: private commercial banks, public savings banks and their central banks, and credit cooperatives. Although the 3 groups have different business interests and focuses, there is actually no division of activities between them legally. In addition, there are also specialty banks which act more as niche players within the industry. The private commercial banking sector consists of around 330+ universal banks. This includes the 3 dominant banks in Germany (Deutsche Bank, Dresdner Bank, and Commerzbank), regional and other commercial banks, and foreign banks. The most important common feature of private commercial banks is the predominance of their short-term lending business. A special focus is also on securities-based saving, investment counseling, and asset management. The “Big Three” (Deutsche Bank, Dresdner Bank, and Commerzbank) are all public limited companies. In terms of liable capital, they rank amongst the largest banks in the world. Their dominant position is particularly in the financing of foreign trade, issuing business, and managing customer securities portfolios. The public sector commercial banks consists of approximately 607 savings banks and 13 central giro institutions and accounts for almost half of the combined volume of business of all commercial banks. Originally, savings banks engaged in only savings and lending activities and real estate lending. Today, their activities are more like those of universal banks, although their traditional functions still remain their main line of business. The cooperative banking sector consist of over 2500 credit cooperatives. Some are very small and the number has been steadily decreasing due to the recent increase of merger activity within the banking industry in the past few years. The activities of cooperatives has traditionally been centered around the notion of “help through self-help” (principles of self-responsibility and joint liability) and today offer the full range of banking services, though concentrated particularly on taking deposits, lending to their own members, and long-term loans. Specialist banks also play an important role in the German banking industry. The most significant specialist banks are the 35 or so private and public mortgage banks, which specialize in lending on real estate and to public authorities. These banks raise the funds needed to finance their lending by placing mortgage bonds and municipal bonds on the capital market. There are also private and public building and loan associations which engage in the financing of owner-occupied homes and flats. The attractiveness of saving through these associations lies in the right acquired by the saver. Once the saver has paid a certain percentage of the contract amount, the remainder of the building loan remains at a relatively low interest rate which is fixed over the life of the loan. Approximately 20 guarantee banks and credit guarantee associations also exist which service mostly small and medium sized companies by providing indemnity bonds on behalf of enterprises in the skilled trades, industry, and commerce. In addition, there are also two central securities depositories responsible for the efficient settlement of the banks’ securities business as well as others niche banks. The large number of banks has led to an increasingly competitive banking environment which is becoming increasingly consolidated as well as effected by globalization (i.e. infiltration by foreign competitors). GERMAN CENTRAL BANK – BUNDESBANKEstablished in 1957 via The Bundesbank Act of 1957, the Deutsche Bundesbank is the central bank of the Federal Republic of Germany. It has the responsibility of acting as a currency bank (make sure that the currency remains stable), a note bank (has the right to issue bank notes), the bank of banks (acts as lender of last resort), and the bank of the state (offering credit and helping with refinancing by securities). (http://iaix7/informatik.htw-dresden.de.htw7953/hp98/gbs.htm) In addition to its responsibilities as the central bank, “it also acts as a state bank for the Federal Government and the Lander Governments.” (KPMG pg. 45) With its head office located in Frankfurt, the central bank is comprised of the Central Bank Council, the Directorate, and the nine Land Central Banks. The Central Bank Council is composed of the President and Vice-President of the Bundesbank, the other members of the Directorate, and the Presidents of the Land Central Banks. It has the arduous task of deciding the monetary policy of the Bundesbank. The Directorate, the central executive body of the Bundesbank, is an eight-member group that acts out the Bundesbank’s monetary policy through open market operations. Finally, the Land Central Banks, located in Stuttgart, Munich, Berlin, Hanover, Hamburg, Frankfurt am Main, Dusseldorf, Mainz, and Leipzig, “conduct the Bundesbank’s transactions with credit institutions and public authorities.” (www.bundesbank.de.htm) Through the interactions of these three groups, the Bundesbank carries out its duties to regulate the money and credit supply, safeguard the Deutsche Mark, and “to provide for bank-based execution of domestic and foreign payments.” (KPMG pg. 45) In order to regulate the money supply, the Bundesbank has at is disposal the use of the Lombard loans, discount business, open market operations, and minimum reserve requirements. The Lombard loans are “loans against the collateral of specific securities and debt register claims.” (www.bundesbank.de.htm) In the discount business, “the Bundesbank buys bill of exchange from banks at the discount rate.” (www.bundesbank.de.htm) In its use of open market transactions, the Bundesbank sets targets for the repo rate. The repo rate is the interest rate on repurchase agreements in Wertpapiere, also known as securities repos. Finally, “under Section 16 of the Bundesbank Act, the Bundesbank is empowered to fix, from time to time, amounts of interest-free deposits to be maintained by banks with the Bundesbank.” (KPMG pg. 46)

Although the Bundesbank has such a powerful hand in determining Germany’s economic fate, the Bundesbank has full autonomy and is considerably independent from the Federal Cabinet and political pressure. As a result, the Bundesbank emphasizes exchange rates while the government has concentrated on the social consequences of economic policy. As a result, there have been several clashes between the two. For example in 1973 and again in 1981, when the government hoped to spark economic expansion, the Bundesbank decided to maintain high interest rates to keep the inflation level low. In addition to the Bundesbank, there are several financial sector authorities that work with the Bundesbank to insure the quality of Germany’s banks and banking institutions. These authorities include the Federal Banking Supervisory Authority, the Federal Securities Trading Supervisory Authority, and the Audit Association of German Banks. The Federal Banking Supervisory Authority (BAK), located in Berlin, is also “an independent institution with ultimate responsibility to the Ministry of Finance.” (KPMG pg. 47) Its role is to “supervise the operations of banks, banking groups, financial holding group, and branches of foreign banks in Germany in order to protect the public from unsound banking practices.” (KPMG pg. 47) In order to carry out this role, the Federal Banking Supervisory Authority has the authority to issue and revoke banking licenses to banking operations. Secondly, in cooperation with the Bundesbank, the BAK issues rules on the adequacy of equity capital and liquidity. Thirdly, the BAK collects financial information and conducts periodic audits of credit institutions. (Kaufman, pg. 578) Finally, the BAK has the authority to intervene in the event of a capital inadequacy and endangerment of deposits. As a result, the BAK can conduct surprise audits and force the liquidation of a bank. The Federal Securities Trading Supervisory Authority, located in Frankfurt am Main and given power via the Securities Trading Act, “is the central institution for market supervision of stock exchanges and over-the-counter trading in securities and derivatives.” (KPMG pg. 55) Its key duties are to “supervise the prohibition to carry out insider trading, supervise the ad-hoc publicity requirements for quoted companies, control adherence to reporting and information requirements for transactions regarding significant investments in quoted companies, supervise the reporting requirements of banks and other entities admitted to stock exchange trading regarding all their securities trading transactions, act as a collection center for sales prospectuses, and co-operate internationally in the area of supervision of securities trading.” (KPMG pg. 55) Similar to the BAK, the Audit Association of German Banks was created to reflect public confidence in the banking system. Created voluntarily by German banks in order to provide its customers with a deposit protection system, the association has some 300 member banks with its primary goal to “eliminate or minimize typical risk for depositors.” (KPMG pg. 57. By levying an “annual charge of 0.3% of the balance sheet position entitled ‘liabilities to customer’” the association is able to finance its fund. (KPMG pg. 58) This fund will insure customers’ deposits “amounts to 30% of the bank’s core capital plus other liable equity capital, provided the latter does not exceed 25% of core capital.” (KPMG pg. 58) Central bank actions since 1993 Since 1993, the Bundesbank has rarely taken action to lower or raise interest rates. After its initial move to decrease interest rates from 1993 to 1996, its main interest rates have steadied and have seen rare instances of slight movement (Appendix 2). For example, after the discount rate was gradually decreased from 5.8% in 1993 to 2.5% in 1996, it has unchanged for nearly two years (International Financial Statistics p 313). In addition, the money market rate and interbank deposit rate has risen a mere 0.3% and 0.2% respectively since 1996. Although the Bundesbank’s actions have been fairly predictable since 1996, in a surprise move in 1997 the Bundesbank lifted its repo rate 0.3% to 3.3% for two weeks while keeping other key interest rates steady in a pre-emptive strike against a fear of inflation (Investing, Licensing & Trading in Germany p 8). In addition, in an effort to prepare for the arrival of the Euro, Germany, in conjunction with other members of the Euro, lowered its interbank deposit rate to 3.0% in December of 1998.As a result, of the Bundesbank’s actions prior to 1996 and its reluctance to make major moves since, Germany has experienced a low rate of inflation of approximately 1.4%. However, although it seems to have a strong control over inflation and the Deutsche Mark has weakened considerably against the dollar over the past 5 years. Due to the low interest rates, the German Mark hit an all-time low of 1.80 DM/$ in July of 1997 from a strong 1.43 DM/$ in 1995 (International Financial Statistics p 312). However, there have been signs of a resurgence as the Deutsche Mark is currently around 1.61DM/$. FINANCIAL MARKETS IN GERMANY Germany’s financial markets include stock markets, bond markets, money markets and futures and options markets. Capital markets play an important role in the financing of business investment, though bank lending is also a prominent method. The financial markets of Germany have had a unique development in the early 1990’s. In 1993, the Deutsche Borse AG was established. The German financial markets are largely under the control of this organization which is an administrative body covering the Frankfurt Stock Exchange, Deutsche Terminborse (the futures and options exchange), Deutsche Wertpapierdaten-Zentrale (the systems house of Deutsche Borse), and Deutscher Kassenverein AG (the central custodian for domestic and foreign securities). (They are fully owned subsidiaries of the Deutsche Borse.) (Wadhwa, pgs.79,80) The role of the money market in Germany is somewhat odd. The opportunities for households, businesses, and public enterprises to even out their short-term liquidity surpluses and deficits are extremely limited. The monetary policy of the Bundesbank is conducted mostly through short-term fixed income instruments. It is felt that new money market instruments and techniques would only increase competition for funds for banks already facing fierce competition for loans. (Dufey, pgs. 66,67) The German stock market consists of eight technically independent stock exchanges – Frankfurt, Dusseldorf, Munich, Hamburg, Berlin, Stuttgart, Hanover, and Bremen – but they actually work closely together amongst themselves along with the DTB (futures and options exchange). Three market segments compose the German stock markets: the official market (Amtlicher Handel), the regulated market (Geregelter Markt), and the OTC market (Freiverkehr). These markets are now integrated in the trading of the Deutsche Borse. Stock trading volume for 1997 totaled DM3,717.5 billion, an increase of 43.5 from the previous year reflecting the growing importance of equity markets in Germany.The German bond market is composed of five major categories, listed in order of highest to lowest fractional component. These categories are: communal bonds, direct placement of public authorities, mortgage bonds, noncommunal and nonmortgage bank bonds, and the bonds of special-purpose banks. In addition, a sixth category, the industrial bond, accounts for only half of one percent of the entire bond market. A very significant component of the bond market is the Schuldscheine market or the market in “certificates of indebtedness.” These can be considered negotiable promissory notes with private placement. This market accounts for more than two-thirds of Germany’s bond market, and with a minimum denomination of DM 1 million, are used mainly by institutions. The German Financial Futures and Options Exchange (DTB), started in 1990, offers fully computerized trading of futures and options. It has not been as influential as the other markets, as trading volume is significantly lower.Of the financial markets in Germany, the bond market is most significant source of financing. It has over eight times the new issuance volume than the stock market. This is not to say that equity markets are not important. The German stock market is the fourth largest equity market in the world. However, the function of equity has traditionally been more a vehicle of control than raising finance. OVERVIEW Germany possesses a unique banking system that consists of universal banking, high autonomy of central banks, and strong financial markets. The Bundesbank has been able to effectively deal with monetary policy through its open market actions, similar to that of the United States. The challenges that the German banking system will face will be largely due to the European Union and effectively integrating it into their system. There is likely to be an increase in the mergers and acquisitions of the banking sector as the European Union will bring about more of a free movement of goods, services, and capital throughout Europe. The German banking sector will also find itself in a good competitive position internationally as they will be able to offer full-service activities in an increasingly global and consolidated industry.


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