Research Paper on Banking in Germany
History
German banking is one of the most fragmented in Europe and was represented with a network of public and private banks, the number of which has not significantly changed over the century. The main approach of the banking system is to provide a range of financial and consultation services for the clients. Banks are divided according to their designation into public-sector banks, saving banks (Sparkassen), municipality banks (Landesbanken), credit cooperatives, and private commercial banks. Commercial banks, always being important players in the market, were experiencing exponential growth at the slowdown period entering new markets and becoming global. However, they did not have much concern about the problems in the domestic market.
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The small- and middle-sized firms also known as Mittelstand were the basis for the German economy for the reasons of export sales, workforce employment, technology adancement, tax payments, and outsourcing by the bigger partners. Mittelstand comprised mostly of the privately owned and not listed companies with less than 500 employees and annual revenue up to 50 million Euros. These companies employed 20 million of population in the country bringing approximately half of country's gross value and investments as well as taxable revenues. The strengths of these companies included strong company identity and history, high quality of products and manufacturing processes with continuous research and development, and flexibility for that they were often run by families.
A big portion of Mittelstand companies were dependent on bank credits and loans, amounts of which varied according to the size of the company during 1980-90s. The role of the bank was crucial for many firms. The relationships were established on the basis of client companies needs and usually performed by a single bank on a long-term stable basis. However, the requirements of some companies were served by several banks at a time. The role of the banks also included educational and consulting purposes aimed at the development and improvement of the small and middle-sized businesses in the country.
After the World War II, Germany was divided into two parts, where the Western part managed to create the so-called "economic miracle" - the intensive growth provided by freedoms and security in the market attracting and stimulating emerging businesses, guest workers, political parties, and social organizations. In 1980s, the downturn took place, and the decision to unite Germany in a solid country took place. Several sharp actions were implemented in the economical sector including privatization, borrowing, currency conversion, etc. As a result, unemployment, taxes and emphasis on social benefits made the country, especially its Western part, one of the most expensive and sophisticated in terms of economical structure and regulations. Besides, it also led to budget deficit and increase in public debt. Hiring employees was not profitable anymore, and it made both the workforce and the businesses suffer.
Range of Problems
The problems began after the year 2000. In 2001, many private firms started reporting loses with future forecasts for deterioration. Many firms were not competitive to operate either locally or internationally. The need in increased cash flows was obvious, although the bank loans were not as affordable. Equity levels were already one of the lowest in Europe and the owners had to search for investors in order to survive. Such intentions put many companies to the choice of becoming more transparent, which was a hard step for most of them. Since 2000, entrepreneurship has not been the main issue in sustaining a business in Germany anymore.
The problems began after the year 2000. In 2001, many private firms started reporting loses with future forecasts for deterioration. Many firms were not competitive to operate either locally or internationally. The need in increased cash flows was obvious, although the bank loans were not as affordable. Equity levels were already one of the lowest in Europe and the owners had to search for investors in order to survive. Such intentions put many companies to the choice of becoming more transparent, which was a hard step for most of them. Since 2000, entrepreneurship has not been the main issue in sustaining a business in Germany anymore.
Germany, which has been sustaining one of the leadership positions in the world economy, started to lose significantly after 2000 and by 2002 had a negative growth in real GDP resulted in a fail of almost 90% in two years (Fear, 2003). In the period of 2000-2002, Germany reported the lowest performance indicators in economics for the last 20 years by that time. Total public dept increased and other indicators declined even though the export of goods was still improving. An effort to stabilize the situation was accomplished in 2001 when the consumer price index and exporting rose and the public debt was partially diminished. However, the budget balance was not in control anymore and it continued to worsen next year, shows Exhibit 1b Economic Statistics (Fear, 2003).
CreditformAG and Euler & Hermes (Fear, 2003) have been forecasting one of the biggest number of insolvencies in 2003 namely in Germany, which in comparison to France, the leader of the negative rating, did not have such performance for the last ten years: bankruptcy would increase by almost 60% in Germany compared to 1996, the first year mentioned in the exhibit, while in France it was forecasted to decline by 29%.
Big commercial banks were implementing mergers and takeovers against interests of customers, and this resulted in problems with corporate governance of the banks. Gaps in communications between banks and shareholders became wide spread and had to be fixed.
The monetary system should also be subjected to changes and not only because of appreciation of Euro as currency but also because the model showed low efficiency within the contemporary environment. Social life and education were also in trouble. What Germany was about to lose was one of the best European infrastructures in the field of high-tech manufacturing.
The main uncertainty about the banking system in Germany was the concern about the upcoming reforms because provision of none could result even in a bigger slowdown. The world's third largest economic system has not suffered so much for the last half a century.
Search for Solution
In 2001, the Bank of International Settlements proposed the issuance of the revised version of Capital Accord Proposal called Basel II. It was supposed to improve the economical situation in the member countries reviewing three main principles: minimum standard of capital adequacy expressed in more precise risk measurement, improved supervision of credit rating and internal risk-weighting models, and raised transparency of banks based on market value. The purpose of the regulations was to stabilize world’s financial systems.
In 2001, the Bank of International Settlements proposed the issuance of the revised version of Capital Accord Proposal called Basel II. It was supposed to improve the economical situation in the member countries reviewing three main principles: minimum standard of capital adequacy expressed in more precise risk measurement, improved supervision of credit rating and internal risk-weighting models, and raised transparency of banks based on market value. The purpose of the regulations was to stabilize world’s financial systems.
The main concern for Basel II in the German economy was the influence on the Mittelstand. As primarily considered, the number of small and middle-sized firms could significantly decline due to the higher risks incurred with the implementation of the new Capital Accord Proposal. Basel II would raise the cost of credit for the firms which are the main supporters of the German economy.
Besides, the proposal to include higher credit weight into long-term credits was evaluated as the one making long-term credits for any types of organization unattractive. This also contradicted the German approach of stable relationships between the company and the bank. Emphasis on bank disclosures twice a year was also opposed by the argument that in order to present the report of the operations for the half-a-year period, a bank has to put too much efforts and costs in it. As a consequence, this requirement was supposed to be exaggerated because many banks would not be able to accomplish it. All these reasons led to the intention to reject Basel II in Germany, and Germany was not the only country to complain on too strict and complex regulations, which were supposed to be introduced with the new system.
However, as the time passed and policies were adapted, the German government has examined Basel II once again and found it advantageous for Germany to certain extent. At first, ratings were also observed as an opportunity to develop a future-oriented business and create a strong structure for it. This allowed for strengthening of the private sector of economics in the country. Besides, ratings could serve as early warning systems controlling the relationships between the bank and the client company and stimulate the movement of capital within the country. The prerequisite for this could be the transparency of the market, which would also allow for the growth in financial markets in the following years. At second, new opportunities emerged. Securitization program became possible and moved risks from the banks' balance sheets. At third, the risk weights were altered to more affordable for all types of companies asking for credits. As one can see, it was an important position in the list of regulations, which was adopted only after some period of time, and probably this was the final reason for Germany to approve the new system. Germany has always been known as the native country of many worldwide known private companies of different sizes providing the best products in the global market. Some of them would not probably stand the downturn if the banks did not perform flexible and allow special conditions of issuing loans and credits. Government had a special interest in these companies because they were virtually the main sources of money and financial benefits in the country.
In whole, several actions were recommended within the new system. Companies were encouraged to go public and issue shares as a result. This was supposed to benefit banks at first. Banks could establish diverse strategies in issuing loans and credits for that new system allowed for a certain degree of flexibility. Within the relationship approach to partnership between the bank and the client company banks could select and design the best option for lending depending on the needs, terms, and type of the company. This concerned virtually all types of banks and all companies that were treated as important clients. Taking into consideration the new rating policies, banks could still determine the amount of loans issued. In order to compensate for bad loans, the financial institutions could simply limit their issuing.
Steps to Avoid Downturns in Future
Finally, Basel II with all the original and reinterpreted reforms has been finally adopted in Germany. However, this was not enough for the German banks to prosper and significant changes still had to follow up.
Finally, Basel II with all the original and reinterpreted reforms has been finally adopted in Germany. However, this was not enough for the German banks to prosper and significant changes still had to follow up.
Several actions were proposed for the long run improvement of the financial sphere. At first, governmentally owned structures like saving banks (Sparkassen) and municipality banks (Landesbanken) had to be restructured to be more reactive and responding to the emerging trends in the market with a purpose of sustaining needy business mostly in the private financial sector. At second, creation of a partnership network within the banks could also be viewed as a nice strategy to alert negative processes in German economics. At third, investment banking should pursue target orientation because entrepreneurs and investors were different business categories in Germany, which did not usually have much in common. The concern of each entrepreneur was to keep the type of ownership whenever the attraction of investors would provide considerable changes in the structure in order to let the business survive. Finally, commercial banking could become more concentrated on relationships with clients. Many commercial banks have been intensively expanding globally but have not contributed much to the development and sustaining of national financial system. Such giants as Deutsche Bank or HVB Group could become determinants in the formation or renovation of the financial structure in the country and help many small and medium-sized businesses survive the downturns.
Conclusion
In order to evaluate the relevant effects of new system introduction, few years may not be enough. Within the world economics, different processes are predominant over certain periods of time that is why one can’t definitely outline the exact effects of either upward or downward trends in the financial system. Germany, being one of the world’s most progressive countries in terms of political, economical and social life, showed on its own example that every single factor could be the cause for a sharp shift, which could lead to instability and high level of uncertainty. The role of the government and its cooperation with the private enterprises is extremely important in order to sustain positions and achieve better results because private businesses make up the infrastructure of the country and promote injections of capital in its economics on the regular basis. However, fast reaction to changes is nearly the main determinant of successful operation of either government or national companies.
In order to evaluate the relevant effects of new system introduction, few years may not be enough. Within the world economics, different processes are predominant over certain periods of time that is why one can’t definitely outline the exact effects of either upward or downward trends in the financial system. Germany, being one of the world’s most progressive countries in terms of political, economical and social life, showed on its own example that every single factor could be the cause for a sharp shift, which could lead to instability and high level of uncertainty. The role of the government and its cooperation with the private enterprises is extremely important in order to sustain positions and achieve better results because private businesses make up the infrastructure of the country and promote injections of capital in its economics on the regular basis. However, fast reaction to changes is nearly the main determinant of successful operation of either government or national companies.
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