Evolutionary History and Structural Patterns of Investment Banks in Germany

The most salient characteristics of the development of investment banks in Germany is that investment banks have always been integrated with commercial banks and are engaged in mixed operation. This model was formed under some special conditions. American investment banks influenced the development of the financial industry, but only to a certain point. American banks started as independent entities and then developed into a hybrid of investment banks and commercial banks. German investment banks, on the other hand, have been integrated with commercial banks since the very beginning and are marked by an unmistakable tint of government architecture.

The three major reasons behind the creation and development of the mixed operation investment bank model in Germany are as follows:

1. High dependence of German enterprises on banks provided the basis for the development of multiservice banks.

2. The special interest relationship between major German banks and political parties and the special political system of Germany also played a role in the consolidation and development of multiservice banks. In an election in Germany, it is the political party, rather than the candidate who plays the major role. Therefore, despite some politicians' opposition to multiservice banks, the special interests between major banks and political parties tend to reduce any dissidence.

3. The rigorous regulatory measures adopted by the government are the fundamental guarantee for the survival of multiservice banks.

Multiservice banks in Germany experienced many crises during their formation and development processes. In particular, during the global economic depression of the 1930s, some multiservice banks were closed down after the bankruptcy of industrial enterprises. Other multiservice banks had to shift their business focus from start-up of new enterprises and securities-related business to the deposit business. After the Second World War, Germany was stranded in a very difficult economic situation. Compounded with pressures from the allied forces for economic democratization, it greatly constrained the development of multiservice banks in Germany. It was then that the German government rose to the occasion, making a great effort to improve the multiservice banking system and strengthen regulation. Those measures enabled multiservice banks to survive, grow stronger, and finally serve as the most powerful engine for the rise of the German economy.

Banks under the multiservice model are also called universal banks. Mixed banking/securities operation and mixed management are their quintessential characteristics. Powerful universal banks do not only dominate the commercial banking business, but also hold a leading position in investment banking business such as securities underwriting and securities brokerage. Deutsche Bank leads all other German banks in terms of the total deposit and loan amounts, liquidation services, and other commercial banking fields. It also controls the issuance and transaction volumes of most securities in the country. As a combination of an investment bank and a commercial bank, it enjoys convenient access to various financial markets.

Compared with the separated service model, the biggest advantage of the multiservice model is that it does not constrain the development of banks in terms of their business scope. Specifically, the multiservice model has the following advantages:

The multiservice model helps banks scale up their operations. As a combination of an investment bank and a commercial bank, a universal bank can take full advantage of limited financial resources to realize economies of scale, reduce costs, and improve profitability.

- The multiservice model can help reduce risks for the bank itself. This is manifested in two aspects:

1. Diversified business ensures stable profits for the bank. If the bank's income from the deposit business drops, the securities investment business can make up the difference, maintaining profit at a stable level.

2. Compared with a pure commercial or pure investment bank, a universal bank has a better and more complete grasp on the operational condition of an enterprise. It is therefore able to reduce the ratio of bad debt and risks associated with the underwriting business.

- The multiservice model strengthens competition between banks, which helps select the superior and eliminate the inferior. On one hand, this improved the strength and competitiveness of operational entities at the microscopic level in the financial industry. On the other, it improved the profitability of the whole society. The disadvantage of the multiservice model is that it may bring great risks to the entire financial system. The closure of a single bank may trigger a chain of reactions in many banks, which can lead to a credit crunch. A serious credit crunch may give rise to a crisis. It is just because of this flaw of the multiservice model that after the Great Depression in 1929-1933, most countries in the world adopted the separated service model for their banking system.

The Deutsche Bank model is exemplified by Deutsche Bank and adopted by Dresdner Bank, Credit Suisse First Boston, USB Warburg, Barclays, BNP Paribas Euronext, and the Royal Bank of Scotland. This is the major development model of local investment banks in Europe. The investment banking division is affiliated to a universal bank instead of existing independently. The investment banking business is not clearly separated from, but rather is closely connected to, the commercial banking business. It is most often referred to as the universal bank model.

In fact, the Deutsche Bank model had been the dominant model for investment banks until 1930. The universal bank model disappeared in such countries as the United States and Japan only because the U.S. government forced the separation of investment banks and commercial banks through legislation after the Great Depression in 1930 and other countries followed suit. However, European countries, especially Germany and Switzerland, are still holding on to the universal banking system. That explains why the two biggest German banks, Deutsche Bank and Dresdner Bank, as well as the two biggest Swiss banks, Union Bank of Switzerland and Swiss Bank, have always been among the most well-known banks in Europe, playing an important role in the global investment banking industry. In mid- and late 1980s, other big banks in Europe such as BNP Paribas Euronext, ABN AMRO, and the Royal Bank of Scotland also chose to pursue the path of universal banks. Looking at Europe alone, the universal bank model is the dominant model for investment banks.

Most investment banks of the Deutsche Bank model are in an absolutely dominant position in their domestic capital markets. For example, the three biggest German banks, Deutsche Bank, Dresdner Bank, and Commerzbank, have monopolized the German capital market and penetrated deeply into the industrial capital market. In Switzerland, the powerful Credit Suisse First Boston and USB Warburg leave other institutions in the capital market far behind. In the Netherlands, ING is the dominating leader of the capital market.

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