5.1 A Brief History of German Commercial Banking

The German banking system is commonly characterized as comprising of three sectors, or “pillars”: the credit cooperatives, the commercial banks (private and joint-stock banks), and the savings banks (Sparkassen). The credit cooperatives developed in the eighteenth century as providers of bank services to members of local guild- or workplace-based cooperatives. Sparkassen, with origins in the early nineteenth century, were often owned or with close ties to local municipality authorities. The private bankers, some with roots back to the seventeenth century, were run by families or a small group of partners, servicing merchants and local businesses. The joint-stock banks emerged in the middle of the nineteenth century but grew in numbers and market share throughout the rest of the century (Krieghoff 2013). The banking system took form over the nineteenth century alongside the German industrialization, which took off during the second half of the century. The stepwise unification was naturally a key factor to Germany’s economic and financial development. The toll-free “inner-market” created with the 1834 customs union boosted more trade in goods and services, and also provided considerable opportunities for cross-state investments in the new industries (Guinnane 2002). However, until the unification of 1871, most private banks remained local in their operations—servicing local merchants, business men, and the wealthy upper classes. They were organized as partnership firms, often under the control of one or a network of families. Branch networks were basically limited to the banks’ home cities. Several new banks, established in the 1850s, became the large and significant commercial banks by the early twentieth century. These banks, including the Darmstädter, Disconto-gesellschaft, and Berliner Handelsgesellschaft, would build their success on forming close and lasting ties to companies of the industrializing economy. A common denominator of the commercial banks that would become the “Big Five” was that they developed into universal banks. Universal banks were able to provide their company clients with all the banking services in need. Several of these banks were founded as partnership banks, but with the enactment of the first joint-stock company act in 1868, many banks, including the Big Five, shifted to the joint-stock company form. Deutsche Bank and Dresdner Bank, created in 1870, became joint-stock banks and soon proved themselves better suited to grow with their customers in the industrializing economy of the time (Tilly 1986).

In contrast to the UK banks at the time, funding by note issuing was not common among German commercial banks of the nineteenth century. Nor did German banks depend on retail deposits, while the individual deposits taking was the savings banks’ and the credit cooperatives’ key source of funding. The three-pillar division of German banking remained fairly intact after the unification. The commercial banks instead relied on funding from the partners or shareholders (in the case of the private banks and the joint-stock banks, respectively). From the 1870s, commercial banks also issued bonds for funding. With the creation of the German central bank, the Reichsbank, in 1876, the option of funding by note issuing was removed from the commercial banks (Guinnane 2002).

The overall strong economic development after the unification in the 1870s contributed to the strong development of the German banking sector. By the turn of the century the banking sector comprised of 118 joint-stock banks, 1,386 private banks, 39 mortgage banks, 2,685 savings banks (Sparkassen), and 12,140 credit cooperatives (Krieghoff 2013). In addition to these banks, there were also a number of state-owned niche-banks: Staatsbanken, Landesbanken, Girozentralen as well as the commercial bank Reichs-Kredit-Gesellschaft—one of the six largest banks (Schnabel 2004: 828).

Germany experienced a banking crisis in 1907–1908, and many of the large universal banks encountered difficulties due to failures of large customers of the banks and tight liquidity in the international capital market for the banks to borrow. However, the German commercial banking sector recovered rapidly after the crash. The recovery in part came by a greater market concentration when comparatively sound banks took over weaker ones (Tilly 1986).

From the start of the First World War until the reforms in 1924 that put an end to the post-war hyperinflation, the joint-stock banks decreased in numbers but grew in terms of branch offices and market share. The number of provincial credit banks dropped from over 100 in 1913 to less than 70 in 1925. By the end of the decade, the total assets of “the big six” commercial banks amounted to 50% of all banks’ assets (Krieghoff 2013; Schnabel 2004). During the same period the 9 largest banks grew from operating 550 offices to more than 1230. Many new private banks and niche joint-stock banks were created during the hyperinflation-period to act on the business opportunities that the market volatility offered. As soon as the hyperinflation ended in 1924, many were closed (Krieghoff 2013).

While the reforms in 1924 brought greater stability to the German banking system, it also spurred on competition within and between the different banking segments. The merger trend continued as competition for depositors and business clients was intensified (Bebenroth et al. 2009). The commercial banks complained to the regulators about unfair competition from the publicly owned Sparkassen. At the same time, the largest commercial banks had the advantage of a renewed access to the international capital market, albeit only for short-term foreign credit. Of course, the large banks’ dependence on international funding and its short-term nature would be one of the causes of the severe German banking crisis in the early 1930s (Schnabel 2009).

The German banking crisis was triggered by the collapse of the Austrian bank Creditanstalt in May 1931, after which several German commercial and savings banks were subject to runs by depositors. At the same time, the large commercial banks were no longer able to roll over their international funding as investors sought to reduce their exposure to the German economy. In June 1931, the stock exchange was closed to stop a fire sale of shares, and in the same month the Danatbank, the second largest bank in the country, closed its offices to stop the deposit withdrawals of worried depositors. However, the runs on banks continued and forced the government to intervene. After a country-wide bank two-day holiday, the government announced that it had taken over the Danatbank and bought a controlling stake in the near-failed Dresdner bank (Bitz and Matzke 2011).

Before the year was over the German federal government had become a major shareholder of three largest commercial banks, as well as a key creditor. While the government control of the commercial banks was intended to be temporary, many managers were replaced by “caretakers” appointed by the government (Krieghoff 2013). When the Nazi-government came in power in 1933, the government’s control over the German banking sector was kept. In practice the commercial banking sector would remain under political control until after the Second World War (Nathan 1944).

5.2 Commercial Banking Regulation in Germany

The regulation of commercial activity underwent significant changes in connection to the unification of the German states in 1871, with the freedom of establishing a joint-stock company embodied in the “Gewerbeordnung” of the same year. Before 1871, many German states and cities were quite restrictive in permitting joint-stock companies in general, since the owners’ limited liability could open up for irresponsible businesses. In some states, such as Prussia, the local government granted more joint-stock companies from the 1850s and onwards. Yet, this was exceptional, and the major shift came after the unification, when all German joint-stock companies, including joint-stock banks, came under the same regulation (Fohlin 2002; Büschgen 1998: 253). Under the 1870 Company Act, neither the private banks nor the joint-stock banks were subject to charter requirements.Footnote 1 Other banks, such as the Preussian publicly owned Sparkassen and the mortgage banks, were subject to regulatory requirements under the supervision of the local authorities. For private and joint-stock commercial banks, the “free enterprise” character of the 1870 Company Act meant no specific regulation or supervision (Bitz and Matzke 2011). Although the Act permitted companies to start branches around the country, few banks created large branch networks. Instead, commercial banks preferred to cooperate in groups formed under one of the largest Berlin banks (Bebenroth et al. 2009).

After the 1907–1908 banking crisis a committee was formed to investigate the need for banking regulation. However, the committee, supported by the Reichsbank, argued for maintaining control via banks’ self-regulation and “gentleman’s agreements” to maintain sufficient liquidity and to operate with prudence. The large joint-stock banks volunteered to publish their balance sheets every other month, and in 1910, this practice was mandatory by law for all joint-stock banks listed on the stock exchange. Yet, the requirement to publish balance sheets was suspended with the start of the First World War (Krieghoff 2013).

The deep recession after the war was accompanied by hyperinflation as the German government used the printing press to pay for fiscal expenses as well as for the war reparation funds set out in the Versailles treaty. Commercial banks mostly remained profitable thanks to business opportunities offered from the market volatility throughout the hyperinflation period, although the size of the banking sector shrunk considerably. Even after the reconstruction of the Reichsbank in 1924 and the accompanying currency reform and credit controls, the commercial banks remained unregulated. The issue was subject to parliamentary debate, but with the recovery in the last half of the 1920s the matter fell off the agenda until the banking crisis in 1931 (Nathan 1944).

The banking crisis of 1931 led to the introduction of banking regulation in Germany. A number of moratorium laws were enacted to facilitate the government’s intervention in the failing banks, including the 1931 “Verordnung über Aktienrecht, Bankenaufsicht und über Steueramnestie” for the first time to be bound commercial banks to bank-specific requirements as well as the provisions for banking supervision by the federal government. With this ordinance the formalization of banking supervision began in Germany. However, it would take several more years until this process was finalized. During the crisis, which lasted between 1931 and 1933, many of the major commercial banks were brought under government control, and banking supervision in the modern sense was not conducted on a day-to-day basis during this period. With the Nazi-party in power from 1933, and under their direct control of the banking system, this stage of incomplete formalization remained even after the re-privatization of the rescued banks in 1934.

Nevertheless, the moratorium laws signified the introduction of regulations specific for commercial banks. In December 1934, these moratorium laws were replaced by the Credit Act of 1934, the Reichsgesetz über das Kreditwesen (Bitz and Matzke 2011). A license requirement was introduced as well as minimum capital- and liquidity provisions. The bank’s major owners and managers should meet fit-and-proper criteria. The Act also introduced standardized credit procedures and documentation, as well as regular, standardized reports on the business and financial standing of the bank (Bruckhoff 2009; Bitz and Matzke 2011).

The crisis also led to the credit cooperatives to form an association that offered deposit insurance in case a member bank failed. For the savings and commercial banks, similar industry-organized deposit insurance schemes were introduced in the 1960s and 1970s, respectively (Bebenroth et al. 2009).

Under the Nazi-regime the banking sector came to focus on activities that were in line with the economic policies of the government. By invoking the “leadership principle”, Hitler had the power to appoint all board members since coming to power in 1933. The formal independence of the central bank gradually disappeared over the 1930s, culminating with the 1939 Reichsbank Act that made it a part of the government (Krieghoff 2013).

5.3 Creation of the German Banking Supervisors

As mentioned above, the 1931 moratorium act established the legal basis for introducing banking supervision in Germany. However, the question of who should supervise the banks became a matter of political debate. While the Reichsbank was recognized as the supervisor based on competence and experience in banking matters at the federal level, the idea also received criticism after the crisis for being too closely allied with the banking sector (Krieghoff 2013).

The organization of the supervision was clarified with the 1934 Credit Act. Two government entities were created to regulate and supervise the banking sector. The Supervisory Board for the Credit SystemFootnote 2 was created within the Reichsbank to set the overall rules for the banking sector, and the federal Commissioner of the Credit System (Reichskommissar) was in charge of the rule implementation and day-to-day supervision (Bitz and Matzke 2011).

In September 1939, the government closed the Supervisory Board and transferred its powers to the Ministry of the Economy. At the same time, the Office of the Commissioner was renamed the Reich Supervisory Office for the Credit System, and organized under the Ministry of Economics and its President appointed by Hitler himself. In 1944 the banking supervision was transferred to the Minister of the Economy. The Reichsbank, a part of the government at that time, carried out the operational supervision (Krieghoff 2013).

After the Second World War, the allied countries decentralized the banking supervision to the level of the new Länder-governments. The local authorities regularly met in a special committee for banking supervision, namely “Sonderausschuss Bankenaufsicht,” which included the reformed German central bank (Bank deutscher Länder) as well as (from 1949) ministers of the federal government. The new central bank was also organized with branches in each of the Länder, and conducted the day-to-day supervision (Bitz and Matzke 2011). The decentralized structure of the central bank and the banking supervision was promoted by the Americans who had a similar state-level arrangement. And just as in the US, one motive behind the decentralization was to prevent the concentration of the government power (Bruckhoff 2009).

After the occupation years, the supervision was centralized once again. Although the work to reform the 1934 Credit Act commenced soon after the end of the war, it was not until 1961 that the new act was fully implemented. This meant that the differences between Länder in terms of regulation and supervision were removed. The central bank, now called the Bundesbank, remained responsible for the day-to-day examination of banks as well as the collection of banking data. However, a new federal agency responsible for implementation and enforcement was created with the 1961-decisions. The agency was called the Bundesaufsichtamt für das Kreditwesen, or BAKred for short, and became ultimately responsible for the supervision of some 13,000 credit institutions.Footnote 3 The 1961 Act also defined the purpose of the regulation and supervision—to ensure the public’s trust over the banking system as well as to ensure that banks were commercially viable in line with the interest of its shareholders and employees. While the 1961 act did not change the overall supervisory or regulatory regime, it ended the decentralized system implemented under the US occupation (Krieghoff 2013).

5.4 German Banking Supervisors’ Functions

The Office of the Commissioner established in 1934 was responsible for the implementation and enactment of the Credit Act of 1934, as interpreted by the Supervisory Board (see above). The Office received monthly reports from all credit institutions. The reports were to include information about new loans and to list all borrowers with liabilities exceeding one million Reichsmarks. Disciplinary actions would be taken against a bank if the bank’s individual exposures were too large. The Commissioner could request for any information from the banks and could issue fines. Moreover, the Commissioner was empowered to close a bank or a bank office with considerable discretion (Nathan 1944).

The 1934 Act gave the Reichsbank and the Supervisory Board for the Credit System mandate to set interest rates and fees for the banks as well as other business conditions. Banks were required to report monthly on their business, and large exposures to individual clients were limited. All requirements imposed on banks by the Reichsbank and the Supervisory board aimed to reinforce the impact of the central bank’s monetary policy. In addition, they focused on limiting credit expansion as well as maintaining the foreign exchange control introduced in 1931 (Krieghoff 2013).

While the 1934 Act introduced a set of banking regulation, a supervisory authority and the provisions for day-to-day supervision, de facto government control over the most of the banking sector under the Nazi-regime makes it problematic to date the formalization of banking supervision. In our view, it is more correct to date the introduction of centralized uniformed supervision with proper prudential purpose until after the Second World War—that is, enactment of the 1961 Act with creation of the supervisory agency, BAKred.

After that, the Banking Act was reformed several times between the 1970s–1990s. Especially after the Herstatt Crisis in 1974, the reformed acts clarified and expanded the jurisdiction, responsibilities, and powers of the bank supervisor (Mourlon-Druol 2015; Bitz and Matzke 2011).

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In summary, the German case was triggered by a financial crisis at the turn of the 1930s. However, the formalization process was prolonged due to the political control over the banking sector under the Nazi-regime. Thus, while our criteria for formalized banking supervision (with banking act, a supervisory agency, and day-to-day supervision) were introduced in the mid-1930s, the fact that the banking sector did not operate on market-term until after the Second World War—we date the full formalization of German banking supervision until this time. Day-to-day banking supervision work commenced under the US occupation, but the banks operated under public control as well as the decentralized banking supervision system lasted until 1961.