Handelsblatt Explains

How Germany’s three-tiered banking system works

Banken im Netz
Germany's complex web of finance, explained. Source: Frank Rumpenhorst / DPA

As head of a network of 400-odd German savings banks, Georg Fahrenschon often complains that the bureaucrats in Brussels just don’t understand Germany’s banking model; he even muses half-seriously about moving there to talk sense to them. For once, however, that is being unfair to Eurocrats. That’s because almost nobody outside of Germany understands its banking system. In important ways it is unique.

The system is made up of nearly 1,800 banks in total — about 1,000 more than any other country in Europe has. But those banks are divided into three distinct tiers. The first consists of about 200 private banks, led by the famous and often infamous Deutsche Bank. The second tier contains some 400 publicly-owned savings banks. And the third is made up of 1,100 member-owned credit unions, which are fiercely independent, proud and rooted in local communities. Together these three “pillars”, as they are called, support the German banking system. These days, unfortunately, they look brittle.

09 Germany’s Many Banks-01

The first tier, private banks, should look familiar to bankers elsewhere. But the second and third tiers – public savings banks and credit unions – are in fact German inventions, even if they have been copied in other countries. Start with credit unions. These have their origins in the 19th century when bad harvests, poverty and inequality drove some communities to form collectives for mutual support. One pioneer was Wilhelm Friedrich Raiffeisen, who, starting in the 1840s, founded cooperatives to help poor farmers who had resorted to loan-sharks to help buy seed, then expanded from there. Even today, many credit unions are named after him, as so-called Raffeisenbanken.

The idea was and is for customers – both depositors and borrowers – to have a say in the bank’s running. In the case of community-based credit unions, that includes local residents. With cooperatives such as Apobank, which finances the health sector, the stakeholders are pharmacists and doctors. (Credit unions and cooperatives are in essence the same thing, though cooperatives tend to be larger).

In Germany today some 18 million people, or one in four adults, belong to a credit union. And the idea has spread. Some 800 million people around the world belong to cooperatives, and there are even about 6,000 scattered around the United States. Reinhard Siebel of Frankfurt’s Goethe University says that German credit unions have also inspired today’s micro-financing projects in developing countries.

The savings banks in the second tier have been copied less and remain more uniquely German, although Cuba and Ireland are interested in importing the concept. They’re sometimes compared to savings-and-loans in the United States. But the difference is that Germany’s savings banks are publicly-owned – either by municipal governments in the case of local Sparkassen or by federal states in the case of the regional Landesbanken.

Credit unions and savings banks have a few things in common. Both are part of networks of cross-guarantees to protect savers in the event that one of them goes bust. And both have mandates that emphasize maximizing the welfare of their members or stakeholders rather than making profit. In the case of savings banks, this means giving back to the municipality that owns the bank. Savings banks typically sponsor local festivals, finance local hospitals and universities and so forth.

Creating an altruistic financial system was part of the founders’ motivation. But it hasn’t always played out in practice.

All this might sound like a leftist dream – putting communities or democratically elected governments in charge of money-lending rather than greedy private bankers. Creating an altruistic financial system was indeed part of the founders’ motivation. But it hasn’t always played out in practice.

Take the 2008 financial crisis. Some of the culprits were private banks like Commerzbank and Deutsche Bank. But the state-backed Landesbanken had also strayed beyond their allegedly conservative remits, investing in shady American mortgage-backed securities and pouring money into Greece, Spain and Portugal during their boom years. Those exposures were considered risks to the whole banking system and therefore required billions in taxpayer bailouts.

So being public instead of private didn’t make them better banks. In fact, it may have made them worse, argues Wilhelm Schmundt, a German financial analyst for the consultancy Bain & Company. He thinks the Landesbanken got in trouble precisely because they were being watched over by public officials who had no real expertise in banking.

Now a more chronic malaise ails the savings banks and cooperatives. Proudly traditional, they are not exactly fast innovators. They have no convincing answers to nimble new “fintech” start-ups, to digitalization generally, or to protracted low interest rates and new regulations.

09 Germany’s Low Banking Profitability-01

The credit unions have instead responded by pooling their resources. As of last year, 1,000 of them have formed a single national cooperative, called DZ Bank, which acts as a sort of central bank for them. They have also formed a single insurer (called R&V), a single asset manager (Union Investment) and a single mortgage bank (Schwäbisch Hall). The community savings banks have done less consolidating, but have also formed eight regional mortgage banks, eleven insurers and one asset manager (DekaBank).

But Germany remains vastly overbanked. For its financial system to function properly, about one third of banks need to disappear in the next decade, according to estimates by Bain. This could mean that an entire tier will collapse or merge, or that each tier shrinks. The nudge  may even come from outside. European rivals like France’s BNP Paribas, the Netherlands’ ING and Spain’s Santander are all interested in gaining market share in Europe’s largest economy.

The excess capacity in Germany’s system depresses bank profits. On average, return on equity is lower in Germany than in any other major country (see graphic). The missteps of national players like Deutsche Bank or Commerzbank are well-documented. But it doesn’t help that their home market is so fragmented. Germany’s three-tiered system may be a great idea – that has outlived its time.

Christopher Cermak is an editor with Handelsblatt Global based in Berlin, covering primarily finance and economics. To contact the author: Cermak@handelsblatt.com

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