The German Financial System - Coursework Example

The German Financial System According to Levin, an established financial system is critical in enabling effective and efficient capital allocation in a country (2005, p. 873). A developed financial system will therefore will not only raise the standard and growth of the national economy but the regional development as well. Mostly, the configuration or structural setting of financial systems is traditionally categorized through characteristically differentiating between a country’s available bank and market based systems (Levine 1997, p. 690). For instance, Germany financial system is usually categorized as bank-based systems since banks are the ones which partake most of the financial intermediation processes as well as execution of cooperate governance. Unlike Germany, the financial systems of the United States of America (U.S.A) and the United Kingdom (UK) are usually categorized as market-based financial systems (Hackethal 2004, p.83). This is because in U.S.A and UK, it is the duty of the capital markets to partake the capital allocation process as well as cooperate governance. Nevertheless, in spite of the major differences between these two financial systems, it has not been established and proven whether one system is better than the other (Beck et al., 2009). Besides, Beck points out that both of these financial systems were similarly affected by the 2007 and 2008 worldwide economic and financial crisis (2012). In order to have a clear insight of a country’s financial system therefore, this paper will focus on the main features of the German financial system and the extent to which this financial system needs to be modified and reformed fundamentally. The German financial system is divided into three pillars which include the private commercial banks, public-sector banks and co-operative banks which are mainly differentiated by their legal structures. It is however worth noting that this financial system is hugely dominated by the universal banks which majority of them do not focus solely on the profit maximization aspect. To begin with, the private commercial banks comprise the large banks, relatively smaller local banks, privately owned banks and a couple of foreign banks outlets (Hartmann-Wendels, Pfingsten & Weber 2010, p. 29). Therefore, whereas the these huge universal banks carry out retail and corporate banking and investment banking undertakings, the smaller regional commercial banks are characterized by a relatively local presence and familiarity, thereby making them to mostly engage in distinctive activities like offering of mortgage activities and housing finance. Comparatively, the smaller private banks are mostly concerned with financing the German industries and dealing with wealth management. The public sector financial institutions are composed of the savings banks, which are usually possessed and maintained by the German government through municipalities, and the Landesbanken, that are possessed jointly by both the German government and the other saving banks (Bundesbank 2009, para. 7). Hence, the savings banks offer a relatively huge range of banking services and activities thereby providing citizens with the appropriate banking services. For instance, they are supposed to open bank accounts for each of the applicants to facilitate transactional processes. In addition, these Savings banks may also be the universal banks restricted by the regional principle, to perform regional activities (ECB 2008, para. 9). Therefore, universal banks mostly compete with the regional cooperative and private banks rather than other savings banks. Thus, the main duties the universal banks is to provide retail banking activities to the individual account holders and relationship banking activities to the Small and Medium Enterprises. Equally important, German has the Landesbanken whose main role is to act as central institutions that governs all the other savings banks (Allen & Gale 2004, p. 457). For instance, the Landesbanken is not only responsible for clearing the other banks and financial institutions but is also mandated to hold their surplus liquidity reserves. In addition, this central bank also enables investors to access the capital markets services such as getting involved with the foreign exchange markets and obtaining of credit on a large scale. The Landesbanken hence acts as the principal bank of Germany and is responsible for overseeing all the other activities taking place in the smaller financial institutions such as the savings bank. It is however worth noting that the roles of the Landesbanken more so that of acting as the central institutions for other key financial institutions have dwindled over time since nowadays, the Landesbanken similarly operates like the private commercial banks, only that this time it is on an international scope. As a result of their public ownership, Landesbanken and investment banks previously enjoyed a guarantee by the public establishment entity which enabled the investors to become sure that the bank they have invested or saved in can be able to meet their financial obligations at all times (Kotter & Wedow 2009, p. 1527). This therefore implies that the investors are guaranteed their investments and that whenever the bank is threatened by insolvency, they will not lose their money. However, since the savings bank are mostly refinanced by the deposits made by customers, the guarantee seemed of less importance for the savings bank and more of value to the Landesbanken which depend upon market refinancing. Due to this factor therefore, private banks instigated campaigns against this guarantee system in 1998 and in 2002, the system of guarantee obligation was abolished (Fischer and Pfeil 2004, p. 310). This therefore implies that presently, unlike in many countries, the German financial system is characterized by the inexistence of the system of guarantee. According to IMF Country reports, In the German financial system, the credit co-operative banks, among other banking groups, has the largest number of institutions (2003, p. 343). Thus, the credit co-operative banks, together with other banking groups, account for a large percentage of the overall financial markets in the German financial system. It is however worth noting that even though these institutions are largely owned by the registered members who are entitled to receive a portion of the profits as dividend, there main aim is not to act as profit maximization entities but rather to provide support the businesses of their members and clients. Schmidt and Tyrell points out that, the key difference of these credit co-operative banks from a normally established corporation is that there is only one voting right to each member regardless of how much they have invested in the co-operative bank (2004, p. 56). Therefore, similar to the Landesbanken, these two essential institutions of the co-operative banking group offer a large variety of services to the distinct co-operatives. The financial system in Germany is therefore comprised of a universal banking system since the financial institutions in Germany are allowed to participate in all forms of financial and banking activities. Stolz and Wedow Point out that, in addition to universal banks, the German financial system is also comprised of several special banks which due to historical motives, their activities are limited to single forms of business (2009, para 9). Generally speaking, these special banks could include the likes of saving banks, building financing societies, and direct banks among others. In Germany, Commercial banks are usually considered to be part of the private sector since the local government and municipalities do not usually hold stakes and shares in them. Quite contrary though, the savings bank segment in Germany which includes the savings banks and the central bank, Landesbanken, are usually owned and maintained by the local or regional governmental associations which include states and municipalities. According to Hau and Thum, apart from their legitimate form and commercial objectives, the chief difference in the kinds of universal banks is in the number of the independent legal institutions that they have and also the amount of available branch locations (2009, p. 720). For instance, the commercial banks that do not necessarily have geographic boundaries on the regions that they serve, have much less lawfully autonomous institutions as compared to the savings and cooperative banks which are restricted to serving certain geographic region. Comparatively, whereas the German commercial banks have small number of branches which are mostly located in the urban centers, on the other hand, the cooperative banks and savings banks are mostly situated in rural regions and small towns. According to Aglietta and Breton, the German three-pillar financial system has transformed over time since mergers have been seen to transpire inside every pillar (2001, p. 452). For example, whereas the banks in the private sector are not allowed to hold stakes in the banks in the public sector, public sector banks are not restricted to take over the stakes in the private banks. Furthermore, the German financial system has made it difficult for takeovers of credit co-operative banks due to the fact that an individual only possess one voting right, regardless of the investment amount. The German economy is highly characterized by a high percentage of SMEs which are collectively referred to as the “Mittelstand” (Bundesbank 2007, para. 14). These enterprises therefore even though they are usually small in size and employ a small number of employees, they are responsible for most jobs in Germany. Greatly important, a relatively large number of Mittelstand companies have been largely successful as a result of producing products which are of high value quality (Ayadi, Schmidt & Valverde 2009, p. 245). Therefore, this implies that Germany exports high quality capital goods and services to all parts of the world evident from the high number of companies that are business and world market in many sectors. This factor has therefore enabled the German financial system to maintain and improve its prominence and prestigious position as a highly industrialized economy unlike many other westernized countries whose industrial and commercial bases have constantly deteriorated. Beck identifies that the automotive, electronic, manufacturing, engineering and biochemical industries make up the largest portion of the “industrial sectors in Germany (2012, p. 192). In addition, the German industrial sector accounts for a relatively large percentage of the overall economic output. Notably important, the German service sector that comprises of finance, accounting, advertising, and customer services among others is progressively gaining prominence. In addition to their vast economic and financial output, the Mittelstand are highly important in the German financial system more so in terms of providing employment, training and innovation to the German people. Furthermore, these Mittelstand although they seem to be less superficial, they have clearly been seen to partake an importantly major role in the German’s economic growth. Accordingly, Vitols points out that, “Broad-based, diversified, and granulated” economic and financial systems have been established to be more flexible and resilient to financial crises as opposed to the “one-trick pony” economies that are subjugated by one segment or sector(2004, p. 366-367). This can be particularly observed during the tempestuous and turbulent economic times when these enterprises really exposes its strength. Consequently, it is important to note that over last few decades, both financial spheres and the world’s economy has been hardly hit by economic crisis (Boot 2000, p. 16). However, during the whole of this period, the economic condition of the German Mittelstand was unaffected and in fact it is largely arguable that these enterprises have astonishingly played an important role in in stabilizing many economic areas therefore helping to strengthen the overall economic state. Even though the German financial system is observed to be one of the best in the modern economy, it contains some structural weaknesses and therefore it needs to be modified or reformed fundamentally. According to the Organization for Economic Co-operation and Development, that the structural weaknesses that are found in the financial system have contributed to the economic crisis and thus they have to be addressed (2010, p. 16). Due to this it is therefore important to first and foremost the German state owned Landesbanken which is as a matter of fact one of the most affected financial institution as a result of its viable domestic business model. For this reason therefore, the German financial system should therefore be subjected to adequate fundamental reforms more so in the Landesbanken sector that needs wide consolidation and restructuring. Moreover, even though the capitalization of German financial systems are doing relatively well as compared to other countries more so on a risk weighted basis, it performs equally poorly on a non-risky weighted basis and due to this factor therefore, the German financial system is structurally vulnerable (Brunner, et al. 2004, p.127). This financial system therefore needs to undergo regulatory reforms in order for it to be consistent with other international systems. Thus, whereas the amplified focus on leverage ratio that is used to deliver additional information is welcomed as a strategy to prevent financial institutions from becoming excessively leveraged, the German financial experts should consider to make their financial system binding. Furthermore, in as much as the cooperative banks together with the savings bank have been applauded for being a source of stability during the economic instability period, the German financial system has remained highly fragmented. In this respect therefore, consideration should be put in place to moderate and unstiffen the dividing lines between the three pillars of the German financial system, which are saving banks, private banks and cooperative banks, that remain very strict in comparison to other nations. According to the BIS reports, one way in which this can be achieved is to allow the private banks to be able to hold stakes in the saving banks (2009, para 16). Doing this may thus require the German authorities to reform the savings bank structure to be in line with those of other European countries that have allowed the private sector ownership to a certain degree. The German financial system that contains the three pillar structure, that is, the saving banks, private banks and the cooperative banks is an ideal system more so in terms of the business structure in Germany. In addition to that, Germany is characterized by numerous small and medium sized enterprises (SMEs) together with indigenous hometown banks that are efficiently structured to support the Mittelstand. Therefore, the German economy benefits largely from having a financial system and a banking structure that work effectively, efficiently and dependably with each other. This financial system has also come out strongly and proved to be an ideal financial structure more so during the times of economic instability, whereby the savings banks and cooperative banks have enabled economic stabilization. Works Cited Aglietta, M., Breton, R. (2001): Financial systems, corporate control and capital accumulation, Economy and Society, 30 (4), p. 433–466. Allen, F. and D. 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Wedow (2009), “Extraordinary measures in extraordinary times – Bank rescue operations in Europe and the US”, ECB Occasional Papers, forthcoming. Vitols, Sigurt. 2004. Negotiated Shareholder Value: The German Variant of an Anglo-American Practice. Competition and Change 8 (4), p. 357-374. Read More