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Universal threat


A recent DB Research article explains why universal banks are optimal for clients and for financial stability and why it would be wrong to follow proposals to split them up. The arguments are well-known: (1) Universal banks offer a broad range of services. (2) They are able to exploit economies of scale and scope which result in lower costs for customers and the economy. (3) Diversification of operations allows them to realise more stable returns than specialist banks, and (4) broader coverage enables them to better monitor the financial health of clients and to “spot unsustainable risk accumulation across financial markets”. In the current environment, however, in particular for German banks many of these advantages do not fully materialise and, at the same time, there are shortcomings which threaten to undermine global financial stability and to prevent an effective crisis policy.


Universal banks offer a broad range of services. This enables them to provide customers with comprehensive financial solutions in a “one-stop shop” (DB Research), but also gives them considerable economic and political influence to pursue their own interests. Banks lend to firms, take equity stakes, exercise proxy voting rights for clients at shareholders’ meetings, provide underwriting services and send their representatives to firms’ supervisory boards. At the same time, there is their retail business with millions of households and savers (and voters) which ensures them almost unlimited public and policy attention. Furthermore, they are omnipresent at advisory boards and in committees, in the media and in public dialogues.

Firmly anchored in both networks of small and large businesses and the consciousness of the proverbial man in the street universal banks have more channels to make their voice heard than their competitors, and the special interwovenness with some of the world’s largest economies – including the dominant ones in Europe – provides them with a solid home advantange that adds an extra quality to the global too-big-to-fail problem: Policymakers in these countries appear constantly aware of possible devastating effects of even rumours of  failures of individual banks on public opinion, and the looming threat of a system crisis – an argument which at times seems to come handy to fend off unwanted policy measures – severely constrains their scope of action. This holds especially for Germany where historically fears of bank runs and financial instability are high.

As a result, long before there is an acute need for bank bailout policy is prepared to act – the long “can kicking” in the current euro crisis which allowed financial institutions to adjust to the changing environment (despite denials when the first cases became known)  is the best example –  and, usually, in a perceived emergency, officially orchestrated rescue operations are smooth and noiseless, and banks are bailed out without having to bear the full consequences of their actions. All this leaves the impression that universal banking is favouring crisis solutions which (1) benefit the financial sector at the expense of broader public interests and (2) are nationally-oriented at the expense of multinational achievements and requirements.

Scale economies

The generation of scale economies is a function of size. Fixed unit cost of a product declines with growing business. Scope economies are generated in a multiproduct context and refer to a cost advantage of developing a variety of related products. Whether these advantages can be realised depends not only on a firm’s strategy but also on the business environment. In Germany (to stay with the example) growth and diversification of banks are restricted in several ways.

The first one is competition. As the following table illustrates, Germany is highly overbanked. The sheer number of financial institutions hampers the generation of profits and exploitation of scale economies.

Table 1

The problem is aggravated by the complex and fragmented nature of the German financial system which is based on three pillars: private banks, saving banks (with their three-tier system of DekaBank Deutsche Girozentrale at the top followed by the state savings banks or Landesbanken and the local savings banks at the lower end), and cooperative banks. All three are represented by powerful organisations. To cite the IMF:

The Association of German Banks (Bundesverband Deutscher Banken, BdB) represents more than 210 private commercial banks and 11 member associations. The private commercial banks affiliated include the largest German banks (e.g., Deutsche Bank and Commerzbank), various regional and private banks, as well as the local subsidiaries of foreign banks active in Germany.

The German Savings Banks Association (Deutscher Sparkassen- und Giroverband, DSGV) is the umbrella organization of the Sparkassen-Finanzgruppe, one of the largest banking groups in the world with 50 million customers. It is funded by the regional savings banks associations together with the Landesbanken. It represents the interests of the Sparkassen-Finanzgruppe on banking policy, regulatory law, and other banking industry issues on a national and international level. It also organizes decision making and stipulates strategic direction within the group, acting in cooperation with the regional associations and other group institutions.

The National Association of German Cooperative Banks (Bundesverband der Deutschen Volksbanken und Raiffeisenbanken, BVR) is the central organization of the Volksbanken and Raiffeisenbanken, a cooperative banking group with over 16 million members and 30 million customers. The BVR functions as a promoter of, a representative for, and a strategic partner of its members.

Furthermore, the banks compete with 700 financial services institutions, approximately 600 insurance undertakings and 30 pension funds as well as around 5,900 domestic investment funds and 77 asset management companies under BaFin supervision for financial business.

Strong competition and fragmentation leave not much room to generate sufficient growth and diversification to benefit from scale and scope economies internally. As a result, many financial institutions turned to international markets where competition is no less fierce and the hurdles they face are even higher. Markets are more varied and competitors have greater financial strength. Furthermore, financial “cultures” differ and few German financial institutions seemed prepared to truly overcome the heritage of backwardness Germany has long been notorious for:

At first glance, this argument may come as a surprise given the achievements of the “Finanzplatz Deutschland”, and in particular the role of Frankfurt as an international financial centre, with its broad spectrum of foreign banks, its role as financial hub for continental European business, home of the European Central Bank, and the “asset” Deutsche Börse. Many of these achievements, however, are of recent nature. As I described elsewhere, they are in contrast to historically grown financial practices and institutions which favoured the development of relationship banking and credit as main source of business finance at the expense of professional trading, organised exchanges and financial innovation (or, as Yves Smith put it, citing Michael Hudson: Germany is more oriented towards industrial capital than financial capital.). The “Finanzplatz Deutschland” was forced onto this tradition, born out of the necessity to cope with both the dramatic rise in government’s funding needs in the wake of German unification and the growing competition German financial institutions faced with the introduction of the euro.

For a while, some of the banks were highly successful. For example, ten years ago, Deutsche Bank, HypoVereinsbank, Dresdner Bank and Commerzbank were found among the world’s 25 largest banks ranked by assets. These days, Deutsche Bank is the only German bank which is considered “systemically” important internationally. And even “Deutsche” seems to struggle to generate sufficient profits and realise economies of scale and scope. Stable returns, to come back to the argument, may be an advantage of the universal bank model, but only if these returns are high enough to provide for risks and survive and prosper in a competitive environment. A glance at bank profitability in Europe demonstrates that in recent years returns of universal banks have been neither stable nor high:



Spreading risks and compensating weaknesses in some business areas by strong results in others is one of the key arguments in favour of the universal bank model. A glance at the headlines these days, however, raises doubts whether the banks live up to what they preach.

Activities of universal banks in Germany show a high concentration of risks. For example, exposures to individual sectors such as global shipping and international commercial real estate were arguments for recent downgradings by Moody’s, the rating agency.

Furthermore, German banks are heavily exposed to the crisis-ridden countries of the European periphery. While some focus on European neighbours may be explained by a natural “home bias”, the strong concentration of lending to the weakest economies which took place after the introduction of the common currency is highly questionable.

To the bewilderment of outside observers, in Germany, the general awareness of this situation seems low. The German public appears more concerned with the tax evasion practices of Greek millionaires than the dire state of their own banks, and even for many authorities in this field the debtor countries are the main “culprits”. Take, for example, the following excerpt from a statement of the German Council of Economic Experts explaining the impediments to an implementation of a banking union in Europe:

“Currently, two main obstacles prevent the introduction of a banking union. The first are bad assets on banks’ balance sheets. During the crisis, the share of nonperforming assets on banks’ balance sheets, in particular in the crisis countries (my emphasis), has increased quite significantly. Dealing with these legacies from the past should remain the task of national governments. The second obstacle is the lack of an appropriate legal and institutional framework for a functioning banking union. For these reasons, the German Council of Economic Experts has developed a three-stage plan …”

A glance at the PwC estimates in the following table reveals that this statement is a misrepresentation of the facts. True, the increase of non-performing debt in recent years has been particularly marked for crisis countries. However, it is not the periphery but Germany which tops the league tables as Europes’s bad-debt Goliath with €196 billion loans outstanding in July 2012. And this is only the tip of the iceberg in what Euromoney refers to as “Europe’s quiet banking crisis”. As Euromoney’s Louise Bowman points out, so far, German authorities have shown little sign of addressing the problem, short of transferring huge amounts of assets (€273 billion from just two lenders: WestLB and Hypo Real Estate) into state-owned bad banks.

Table 3

This accumulation of risks leaves the impression that the banks did not truly internalise the concept of diversification. At least, as universal banks, they should be able to compensate resulting losses from their lending business by profits in other areas. But given their overall poor performance and low profitability, this must be doubted, too.

The problem of risk accumulation is aggravated by a limited loss absorption capacity (Moody’s). Leverage of German banks is high in European comparison, as the following table shows. Remarkably, Deutsche Bank stands out here: According to data compiled by Bloomberg, Deutsche’s total assets exceeded Tier 1 capital by 44 times as of December 31 2011, making it the second-most leveraged among the 10 biggest European banks, behind France’s Credit Agricole.

Table 4

The consequences are stretching far beyond the prospects of individual failure. Given the vast networks and influence of universal banks, they are felt in every corner of the world. For example, Observers regard the dire state of German (and other European) financial institutions as an indication as to why, in the current euro crisis, policymakers are trying to keep the common currency alive by all means. If they are right, universal banking has developed into a universal threat to all depending on the soundness and functioning of the European economy.

Risk monitoring

Excessive lending and concentration of risks raises the question whether universal banks actually have comparative advantages in risk monitoring – and whether the implications of its results are put into action. The rescue operations and emergency measures of the German government in the recent years speak another language.

German banks were hit hard by the Lehman debacle and the resulting US crisis. In reaction, in 2008, the Financial Market Stabilisation Fund, SoFFin (Sonderfonds Finanzmarktstabilisierung), was established with the purpose to stabilize the German financial system. The fund could grant guarantees of up to €400 billion and had €80 billion for recapitalisation (i.e. to buy stakes in banks). In addition, it could enable banks to establish their own resolution agencies, or “bad banks”, under the auspices of the Federal Agency for Financial Market Stabilisation (FMSA).  Reuters wrote:

“Germany was forced to rescue a raft of lenders between 2007 and 2009, bailing out Hypo Real Estate, WestLB, Commerzbank and IKB after the collapse of the subprime debt market led to an inter-bank lending freeze and heavy portfolio losses.”

As at the end of 2010, the FSMA had granted a total of €63.73 billion worth of guarantees, extended €29.28 billion worth of capital measures and established two special-purpose vehicles or “resolution agencies” to which structured securities, non-performing loans and other risk exposures – and even “whole business lines the banks no longer viewed as strategic” (FMSA) – were transferred. One was Erste Abwicklungsanstalt (EAA), the bad bank of WestLB, the other was FMS Wertmanagement for the HRE Group.

Initially running until December 2010, SoFFin was revitalised in March 2012 and extended until the end of 2014, “until the uniform European restructuring guidelines enter into force” (German Ministry of Finance). This time, the fund is thought as a precautionary measure in order to ensure that systemically relevant banks have enough capital during these difficult times (German Finance Minister Wolfgang Schäuble cited here).

Bailouts and precaution come at a price: SoFFin makes losses on bank stakes and from writedowns on the debt of the bad banks.  From its establishment in October 2008 to September 2012 these losses accumulated to €23 billion.

The figures in the following list are from Wikipedia:

Table 5

After what was written before, an attentive reader may miss Deutsche Bank in this list. Actually, the German Number One prides itself that it never had, and never will have, state aid. But, as observers point out, this refers to the German state. To cite Deutsche Bank Risk Alert, a US site:*

“But how do you define “bailout” and “taking state money”? … Deutsche Bank, unlike its smaller rival Commerzbank, did not receive an equity infusion from the German government. Nor did it receive funds directly from the US Troubled Asset Relief Program (TARP.)

But that doesn’t mean it didn’t accept government rescue money during the financial crisis. Consider the following:

– As one of the largest counterparties of failed insurer AIG, Deutsche Bank received $11.8 billion of the funds used to bail out AIG.

– The Federal Reserve made emergency low-cost funds widely available to foreign as well as US member institutions through its discount window.  Deutsche Bank was the second heaviest user of such funds, borrowing more than $2 billion. 

– The Federal Reserve also created a program known as the Term Asset-Backed Securities Lending Facility, which allowed banks to use their assets, including troubled or hard-to-value assets, as collateral for short term loans. Deutsche Bank was the largest user of the program, sending the Fed more than $290 billion worth of mortgage securities

To most people, who don’t make fine distinctions among the particular government programs that funneled their tax dollars to financial institutions, this probably looks an awful lot like a bailout.”


The above quotation points to the dimensions of another alleged advantage of the universal bank model which is cost. Even if customers would benefit from diversity and scale economies, as tax payers they bear the burden of bank bailouts and government support which is neither limited to national borders nor to explicit government funding. How much state money has flown through which channels to the banks in recent years both in Europe and worldwide cannot be guessed. Furthermore, when it comes to cost for the economy as a whole the burden of austerity programmes, and delayed or inadequate policy decisions, which in a highly interdependent world leave hardly any country unaffected, must be kept in mind as well, even if it is hard to quantify.

The overall impression of all this is that the advantages of universal banking are grossly overstated. Whatever politics will decide concerning the future shape and role of the financial sector, there should be no justification to postpone or dispense with necessary reforms.


*The site of Deutsche Bank Risk Alert is maintained by UNITE HERE, the international union for 250,000 hotel, gaming, and food service workers in North America. UNITE HERE Nevada affiliate, Culinary Workers Union Local 226, represents casino workers in Las Vegas, including 2,400 employees of the Deutsche Bank-owned Cosmopolitan of Las Vegas, making it the largest union for Deutsche Bank employees in North America.

From → Markets

  1. great job really well done

    I add only two things

    these banks are many and small but have no capital as demonstrated by ‘oecd
    are needed in a few years hundreds of billions to the German/france financial sector

    nice to be banker without capital

    I think that the main problem is the amount of assets that these banks hold vs. other countries

    As you can see from the graphics suddenly run away with hundreds of billions then decide to come back …

    I think you know well this problem

    in addition to Germany’s trade surplus remuneration of this capital is higher (deposits in spanish banks, investments in east europe) than the rate paid by German banks vs. foreign credits

    the imbalance is huge

    Sorry for my bad english I hope we understand each other 🙂

  2. Thank you for your comment and links. I am sorry to be late with my answer. True, the current dimension of the imbalances is a problem. On the other hand, I think the fundamental arguments for and against universal banks hold in other circumstances, too. Deposits in Spain and investments in Eastern Europe: In theory, this should be one of the advantages of functioning integrated financial markets. I see the problem here in the fundamental flaws of the euro system rather than in the nature of banks.

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