German banks - a declining industry? : [Version March 2003]

This paper is a draft for the chapter German banks and banking structure of the forthcoming book The German financial system . As such, the paper starts out with a description of past and present structural features of the German banking industry. Given the presented empirical evidence it then argues that great care has to be taken when generalising structural trends from one financial system to another. Whilst conventio nal commercial banking is clearly in decline in the US, it is far from clear whether the dominance of banks in the German financial system has been significantly eroded over the last decades. We interpret the immense stability in intermediation ratios and financing patterns of firms between 1970 and 2000 as strong evidence for our view that the way in which and the extent to which German banks fulfil the central functions for the financial system are still consistent with the overall logic of the German financial system. In spite of the current dire business environment for financial intermediaries we do not expect the German financial system and its banking industry as an integral part of this system to converge to the institutional arrangements typical for a market-oriented financial system. This Version: March 25, 200

German banks - a declining industry?

This paper is a draft for the chapter "German banks and banking structure" of the forthcoming book "The German financial system" edited by J.P. Krahnen and R.H. Schmidt (Oxford University Press). As such, the paper starts out with a description of past and present structural features of the German banking industry. Given the presented empirical evidence it then argues that great care has to be taken when generalising structural trends from one financial system to another. Whilst conventional commercial banking is clearly in decline in the US, it is far from clear whether the dominance of banks in the German financial system has been significantly eroded over the last decades. We interpret the immense stability in intermediation ratios and financing patterns of firms between 1970 and 2000 as strong evidence for our view that the way in which and the extent to which German banks fulfil the central functions for the financial system are still consistent with the overall logic of the German financial system. In spite of the current dire business environment for financial intermediaries we do not expect the German financial system and its banking industry as an integral part of this system to converge to the institutional arrangements typical for a market-oriented financial system

Multi-bank loan pool contracts

EFM classification: 330, 350We show that multi-bank loan pools improve the risk-return profile of banks’ loan business. Banks write simple contracts on the proceeds from pooled loan portfolios, taking into account the free-rider problems in joint loan production. Thus, banks benefit greatly from diversifying credit risk while limiting the efficiency loss due to adverse incentives. We present calibration results that the formation of loan pools reduce the volatility in default rates, proxying for credit risk, of participating banks’ loan portfolios by roughly 70% in our sample. Under reasonable assumptions, the gain in return on equity (in certainty equivalent terms) is around 20 basis points annually

How unique are US banks? : the role of banks in five major financial systems

Initiated by the seminal work of Diamond/Dybvig (1983) and Diamond (1984), advances in the theory of financial intermediation have sharpened our understanding of the theoretical foundations of banks as special financial institutions. What makes them "unique" is the combination of accepting deposits and issuing loans. However, in recent years the notion of "disintermediation" has gained tremendous popularity, especially among American observers. These observers argue that deregulation, globalisation and advances in information technology have been eroding the role of banks as intermediaries and thus their alleged uniqueness. It is even assumed that ever more efficiently organised capital markets and specialised financial institutions that take advantage of these markets, such as mutual funds or finance companies, will lead to the demise of banks. Using a novel measurement concept based on intermediation and securitisation ratios, the present article provides evidence which shows that banking disintermediation is indeed a reality for the US financial system. This seems to indicate that American banks are not all that "unique"; they can be replaced to a considerable extent. Moreover, many observers seem to believe that what has happened in the US reflects a universal trend. However, empirical results reported in this paper indicate that such a trend has not manifested itself in other financial systems, and in particular, not in Germany or Japan. Evidence on the enormous structural differences between financial systems and the lack of unequivocal signs of convergence render any inferences from the American experience to other financial systems very problematic

German banks – a declining industry?

This paper is a draft for the chapter "German banks and banking structure" of the forthcoming book "The German financial system" edited by J.P. Krahnen and R.H. Schmidt (Oxford University Press). As such, the paper starts out with a description of past and present structural features of the German banking industry. Given the presented empirical evidence it then ar-gues that great care has to be taken when generalising structural trends from one financial system to another. Whilst conventional commercial banking is clearly in decline in the US, it is far from clear whether the dominance of banks in the German financial system has been significantly eroded over the last decades. We interpret the immense stability in intermedia-tion ratios and financing patterns of firms between 1970 and 2000 as strong evidence for our view that the way in which and the extent to which German banks fulfil the central functions for the financial system are still consistent with the overall logic of the German financial sys-tem. In spite of the current dire business environment for financial intermediaries we do not expect the German financial system and its banking industry as an integral part of this system to converge to the institutional arrangements typical for a market-oriented financial system.Commercial banking, Germany, disintermediation, financial system

Share buy-backs in Germany overreaction to weak signals? : [Version: Dec. 2003]

This paper investigates the magnitude and the main determinants of share price reactions to buy-back announcements of German corporations. Based on a sample of 224 announcements from the period May 1998 to April 2003 we find average cumulative abnormal returns around -7.5% for the thirty days preceding the announcement and around +7.0 % for the ten days following the announcement. We regress postannouncement abnormal returns with multiple firm characteristics and provide evidence which supports the undervaluation signaling hypothesis but not the excess cash hypothesis. In extending prior empirical work, we also analyze price effects from an initial statement by management that it intends to seek shareholder approval for a buy-back plan. Observed cumulative abnormal returns on this initial date are in excess of 5% implying a total average price effect between 12% and 15% from implementing a buy-back plan. We conjecture that the German regulatory environment is the main reason why market variations to buy-back announcements are much stronger in Germany than in other countries and conclude that initial statements by managers to seek shareholders’ approval for a buy-back plan should also be subject to legal ad-hoc disclosure requirements. EFM classification: 330, 35

Share buy-backs in Germany overreaction to weak signals? : [Version April 2004]

This paper investigates the magnitude and the main determinants of share price reactions to buy-back announcements of German corporations. For our comprehensive sample of 224 announcements that took place between May 1998 and April 2003 we find average cumulative abnormal returns around -7.5% for the thirty days preceding the announcement and around +7.0 % for the ten days following the announcement. We regress post-announcement abnormal returns with multiple firm characteristics and provide evidence which supports the undervaluation signaling hypothesis but not the excess cash hypothesis or the tax-efficiency hypothesis. In extending prior empirical work, we also analyze price effects from initial statements of firms that they intend to seek shareholder approval for a buy-back plan. Observed cumulative abnormal returns on this initial date are in excess of 5% implying a total average price effect between 12% and 15% from implementing a buy-back plan. We conjecture that the German regulatory environment is the main reason why market variations to buy-back announcements are much stronger in Germany than in other countries and conclude that initial statements by managers to seek shareholders’ approval for a buy-back plan should also be subject to legal ad-hoc disclosure requirements

Signaling power of open market share repurchases in Germany

This paper shows that abnormal stock price returns around open market repurchase announcements are about four times higher in Germany than in the US (12% versus 3%). We hypothesize that this observation can be explained by country differences in repurchase regulation. Our empirical evidence indicates that German managers primarily buy back shares to signal an undervaluation of their firm. We demonstrate that the stringent repurchase process prescribed by German law attributes a higher credibility to such a signal than lax US regulations and thereby corroborate our hypothesis

Complementarity and Financial Systems

Individual financial systems can be understood as very specific configurations of certain key elements. Often these configurations remain unchanged for decades. We hypothesize that there is a specific relationship between key elements, namely that of complementarity. Thus, complementarity seems to be an essential feature of financial systems. Intuitively speaking, complementarity exists if the elements of a (financial) system reinforce each other in terms of contributing to the functioning of the system. It is the purpose of this paper to provide an analytical clarification of the concept of complementarity. This is done by modeling financial systems as combinations of four elements: firm-specific human capital of an entrepreneur, the ability of a bank to restructure the borrower's firm in the case of distress, the possibility to appropriate private benefits from running the firm, and the bankruptcy law. A specific configuration of these elements constitutes one financial system. The bankruptcy law and the potential private benefits are treated as exogenous. They determine the bargaining power of the contracting parties in the case that recontracting occurs. In a two-stage game, the optimal values for the other elements are determined by the agents individually - by investing in human capital and restructuring skills, respectively - and jointly by writing, executing and possibly renegotiating a financing contract for the firm. The paper discusses the equilibria for different types of bankruptcy law and demonstrates that equilibria exhibit the sought-after feature of complementarity. Three particularly significant equilibria correspond to stylized accounts of the British, German and the US-American financial system, respectively

Structural change in the German banking system?

This paper starts out by pointing out the challenges and weaknesses which the German banking systems faces according to the prevailing views among national and international observers. These challenges include a generalproblem of profitability and, possibly as its main reason, the strong role of public banks. These concerns raise the questions whether the facts support this assessment of a general profitability problem and whether there are reasons to expect a fundamental or structural transformation of the German banking system. The paper contains four sections. The first one presents the evidence concerning the profitability problem in a comparative, international perspective. The second section presents information about the so-called three-pillar system of German banking. What might be surprising in this context is that the group of pub lic banks is not only the largest segment of the German banking system, but that the primary savings banks also are its financially most successful part. The German banking system is highly fragmented. This fact suggests to discuss past, present and possible future consolidations in the banking system in the third section. The authors provide evidence to the effect that within- group consolidation has been going on at a rapid pace in the public and the cooperative banking groups in recent years and that this development has not yet come to an end, while within-group consolidation among the large private banks, consolidation across group boundaries at a national level and cross-border or international consolidation has so far only happened at a limited scale, and do not appear to gain momentum in the near future. In the last section, the authors develop their explanation for the fact that large-scale and cross border consolidation has so far not materialized to any great extent. Drawing on the concept of complementarity, they argue that it would be difficult to expect these kinds of mergers and acquisitions happening within a financial system which is itself surprisingly stable, or, as one cal also call it, resistant to change