German and Us Banking

Historically, the German and U.S. financial systems operated very differently. German banks were much more concentrated and top management had very close connections with corporate clients. The U.S. was the exact opposite and there was a strong belief that financial institutions should not have close relationships with non-financial institutions. I will briefly discuss the reasons for these differences and then argue which one is better.

German banking was born out of a need to manage short-term deposit and short-term loans for small firms. After the consolidation of many failed banks in the 1870s, several large German banks evolved to facilitate long-term financing as well as the floatation of stock and bonds, which led to the early development of capital markets. As companies required more financing for capital intensive projects, they began to rely on banks for knowledge and expertise around raising the necessary capital. One of the early distinctions between German and U.S. banks was the fact that German banks would commonly hold all of the shares on their balance sheets, whereas U.S. banks would distribute them immediately. Because the German banks we taking on more risk they were entitled to more control in the form of supervisory board seats or proxy votes. This meant that banks would typically influence the strategic directions of a company, as well as provide the financing. Despite the collapse of the German banking system in WWII and foreign attempts to decentralize the financial system, Germany eventually gravitated back towards the universal bank model in the late 1900s.

The American banking system today, at least in principle, it is much less concentrated than the German system. The difference is due to government regulations that sought to limit the formation of universal banks. Large banks were generally accepted during the days of JP Morgan, a time when bankers were ethical and acted in the best interest of the clients. As the finance industry expanded, so did corruption and greed which led to very questionable banking practices. Then along came the Trust Indenture