German banking: The quest for a German national champion

IT SAYS MUCH about Germany that almost two decades after reunification, and several years after the creation of the eurozone, states of the German federation such as Baden-Württemberg feel that they need to maintain individual embassies in the German capital, while the sovereign nations of Denmark, Finland, Iceland, Norway and Sweden get by with a shared building. Then again, the economy of Baden-Württemberg is so different to that of Berlin that it might as well be a foreign country.

Baden-Württemberg is chock-full of world-class exporters, one of which, Porsche, is now under fire for paying its chief executive a package worth €70 million. Since Bayer’s acquisition of Schering last year, Berlin, by sad contrast, is no longer home to a single DAX30 company. Nor does it have much to offer by way of Mittelstand companies. According to the Bonn-based Institute for Mittelstand Research, while 97 of Germany’s largest 500 medium-sized companies are based in Baden-Württemberg, just seven are located in Berlin, only two of which are in the top 100. As your tour guide will tell you, Germany’s capital city’s promotional spin now revolves around the questionable claim that it is Arm aber Sexy (poor but sexy).

The fragmentation of the German economy, local bankers say, is pivotal to an understanding of the German banking system. Unlike in virtually all other European countries, the Mittelstand companies that make up the backbone of the German economy are dispersed like confetti throughout the country. That has had a number of important consequences for the evolution of German banking. Above all, it has created extremely tight bonds between local bankers – predominantly from the savings bank sector – and the companies in their immediate backyards. The strength of those relationships, cultivated over many generations within remarkably close-knit communities, has almost certainly been underestimated by outsiders. They have also been misunderstood by those who have assumed that the vast majority of Mittelstand borrowers can be lured away from their long-standing relationships with snazzy products. "I think that some people looking at Germany from a traditional Anglo-Saxon banking perspective don’t quite realize how dependent this economy is on the Mittelstand, or how central micro-relationships between bankers and their customers are to the economy," says Markus Pflitsch, head of corporate development at LBBW in Stuttgart.

The strength of highly localized micro-relationships explains why foreign banks have been frustrated in their efforts to penetrate all but the very largest Mittelstand companies. However, it also helps to explain why it has been so difficult to create what German bankers describe as a "national champion" capable of building a meaningful market share throughout the country and exporting its expertise from one region to another. According to the Association of German Banks, the country’s five largest banks command a market share of just over 18% (by total assets). "Despite the falling number of banks," it says, "there is evidently still very little concentration in the German banking sector. No other country in Europe has such a fragmented banking industry."

Whether or not any of this matters is a moot point. Indeed, whether or not Germany’s banking industry is the over-banked, over-fragmented, supremely inefficient and poorly designed jigsaw that many would have us believe is also open to debate. That view is certainly not held by Karl-Peter Schackmann-Fallis, executive member of the board of the Deutscher Sparkassen und Giroverband (DSGV), the association that represents Germany’s 457 savings banks, which have total assets in excess of €1 trillion. The basic figures, he insists, do not support the widely held assumption that Germany is over-banked.

"We’ve clearly made progress but our argument is that competition in the German banking industry remains distorted by the three-pillar system" Manfred Weber, Association of German Banks

Striking improvement

Champions of reform concede that the improvement in the performance of the German banking sector over the past two years has been striking. One of the most vocal proponents of change is Manfred Weber, chief executive of the Association of German Banks, which represents the country’s private sector banks. He says that in 2003, the average return on equity of German banks was a feeble 0.7%, which compared very unflatteringly with the 8.6% posted by UK banks. In 2005, Germany’s ROE before tax had climbed to 13% compared with the UK’s 11.8%, and by 2006 it was at 9.3%, compared with 8.9% in the UK. "We’ve clearly made progress but our argument is that competition in the German banking industry remains distorted by the three-pillar system," he says. "And most experts that I know agree." The three pillars system refers to the industry’s rigid sub-division into public sector banks, cooperative institutions and commercial banks.

Sceptics might argue that measurements of banks per capita have more to do with population density than with industry efficiency, and that in any case European Central Bank figures indicate that with 39,500 inhabitants per bank in Germany (compared with a eurozone average of 75,300) some empirical evidence suggests that the country is indeed over-banked. The Association of German Banks says with some justification that this data counts every savings bank and mutual bank as an independent entity, which it says is a misleading approach. Nevertheless, sceptics could also argue that if productivity is rising in Germany and Japan faster than elsewhere, it is because it is coming from such a low base.