The financial crisis has highlighted the importance of deposit protection and has brought this neglected topic to the core of the debate on financial stability (Zimmermann, 2013). Germany was hit harder than most experts and politicians expected. The federal government was forced to take unprecedented steps, including the nationalization of banks and providing an unlimited guarantee on savings deposits. These actions illustrated the necessity to reform the German deposit system, opening a controversial debate on both, the national and European level.
Deposit protection schemes serve two main functions. First, they provide security to depositors and should help to prevent bank runs. Second, they should facilitate bank resolution, shielding depositors from losses. Together with financial regulation and supervision and lenders of last resort, deposit protection represents a key component of financial safety nets, which aim at reducing the occurrence of financial crises and limiting their effects if they do occur. Accordingly, deposit insurance schemes play an important role for individual market participants as well as for the entire economy.
This paper examines the German deposit insurance system before, during, and after the financial crisis. It answers three main questions: First, what was the state of the deposit insurance system before the financial crisis? Second, how did the deposit schemes fared during the crisis? Third, what reforms have been introduced and what is the current state of the system?
This case study argues that the German pre-crisis deposit insurance system was fragmented, complex and lacked transparency. Further, the crisis revealed that it was also undercapitalized. Thus, the federal government had to introduce exceptional support measures to stabilize the banking sector. Depositors’ confidence was maintained because of the government’s commitment to fully protect household deposits. Although the financial crisis generated a debate on the reform of the German deposit insurance system as well as on the need of a EU-wide scheme, opponents were able to impede any significant changes. Due to their close links with local and regional political elites, German savings and cooperative banks were able to block a domestic reform as well as EU proposals quite easily. Consequently, the EU Directive on Deposit Guarantee Schemes, adopted in April 2014, rather represents a step towards harmonization of European deposit protection schemes than the introduction of a EU-wide scheme. Hence, its implementation into national law, with the introduction of new deposit insurance regulations, has brought some improvements, albeit several shortcomings of the system were not addressed. Overall, the structural deficiencies of German deposit insurance persist.
This paper is structured as follows: first, it briefly describes the three pillars of the German banking system. Next, before introducing the German pre-crisis deposit insurance system, this case study will discuss how financial globalization changed the nature of bank deposits. Although the general trend is that financial globalization increased the risk and impeded the security of savings, this applied to a lesser extent in Germany. Finally, after discussing the impact of the financial crisis on the German banking and deposit insurance system, this case study focusses on the new deposit insurance law.
The German Banking System
The German Banking system comprises of three pillars: private commercial banks, public sector banks, and cooperative banks. Accounting for 36 percent of total assets, private-owned commercial banks represent the largest segment of the banking system by assets. They are composed of big banks, medium and small-sized banks, and some branches of foreign banks (IMF, 2011b, 4). The traditional role of big banks, to provide long-term loans for investment to the larger German industrial enterprises, changed in the 1970s. Accordingly, big banks have gradually engaged in investment and trading activities. Other private banks are more regionally-focused or otherwise specialized in real estate and corporate banking (Detzer, 2014, 58).
Public sector banks include 421 locally oriented savings banks – Sparkassen –, nine regionally oriented Landesbanken, and a range of specialized institutions (e.g. Landesbausparkassen). This sector represents 31 percent of total banks assets (IMF, 2011b, 5). Sparkassen are required to serve public interest by offering financial services for all German citizens in all German territories. Consequently, they have a dense network and provide a range of universal banking activities with a focus on retail and small- and medium-sized enterprises (SMEs) relationship banking. Sparkassen are owned by municipalities or rural regions and are subject to a regional principle, meaning that each bank operates within its own region and competes with the commercial banks and cooperative banks but without other Sparkassen. Although Sparkassen should avoid making losses, they are not required to maximize profit (Ibid.).
The Landesbanken originally had two purposes: acting as bankers to the regional state and as central banks of the Sparkassen in their respective regions. However, they have been increasingly involved in recent years in wholesale funding, investment banking, and international business activities, thus directly competing with commercial banks (Detzer, 2014, 58; IMF, 2011b, 5).
The third pillar consists of 1,078 primary cooperative banks, two regional institutions and a range of specialized institutions at the national level, which amount to 11 percent of total bank assets. Cooperative banks are owned by their depositors and borrowers. They are subject to a regional principle similar that of the Sparkassen. The cooperative banks also have a dual objective: they must support the economic undertakings of their customers and at the same time operate as sustainable businesses (Detzer, 2014, 58; IMF, 2011b, 5).
Financial Globalization and Bank Deposits
Deposit insurance refers to a guarantee, frequently by governments but often also by associations of private institutions, that deposits of savers at banks or other savings institutions are insured up to a defined amount. It serves two core functions: ensuring the stability of financial institutions by guaranteeing the value of deposits in the case of liquidity problems and preserving the trust of ordinary savers who can rely on keeping all or most of their deposits in the case of a bank failure (Zimmermann, 2013, 267).
Although bank deposits are usually in a privileged position in cases of bank failures, recent incidents have illustrated that they are increasingly at risk. After the collapse of Lehman Brothers, depositors all around the world discovered that they were not fully protected against potential losses. After the collapse of the Icelandic bank Kaupthing, 160,000 British, 34,000 German and many Dutch savers faced a complete loss of their savings (Ibid., 268). These experiences highlighted that financial globalization not only creates opportunities but also increased risk for deposit holders. In particular, the coverage of foreign deposits was seen as a grey zone of regulation since deposit protection systems were exclusively national.
Another development that affected the security of deposits was the increasing replacement of traditional forms of saving by a new emphasis on riskier assets that make depositors increasingly dependent on the growth and stability of financial markets (see Zimmermann, 2013, 268). This field of literature provides evidence to support this argument. Ertürk et al. (2005) illustrate the increasing prominence of stocks and funds in the household assets of citizens in France, Germany, Italy, and the UK since the 1990s. Similarly, recent studies on the composition of household wealth in eight OECD countries show that the importance of financial assets as a share of household wealth has increased significantly (OECD, 2012). These findings underline the importance of the growing salience of finance for individual wealth accumulation as well as in the management of accumulated assets, which serve as a personal safety net (Zimmermann, 2013, 269).
With 26 percent of GDP, Germany’s savings rate is one of the highest among OECD countries (WDI, 2015). This high level of savings is mainly due to a strong risk aversion among the population. The cautious attitude of Germans and the emphasis on ultra-safe assets is also reflected in the attitude towards financial globalization (Zimmermann, 2013, 269). In contrast to other citizens, German citizens are much less tempted to shift their assets to riskier, more lucrative forms of saving. Most of the shifts that did occur were quickly reversed. From 1992 to 2001, the share of cash and bank deposits in the financial assets of the German population declined from about 45 percent to 34 percent, and shares and investment funds rose from about 15 percent to 25 percent (ZEW, 2005). However, as Table 1 illustrates, bank deposits have continuously risen since 2006 while shares and investment funds show a downward trend (Zimmermann, 2013, 274).