Comparative Analysis of the English and the German Banking System with Special Regard to Bank-Industry Relations and their Implications on Companies' Performance

Table of Contents

List of Abbreviations

List of Figures

List of Tables

1 Introduction

2 Presenting the Two Alternative Financial Systems
2.1 The German Financial System and Its History
2.2 The British Banking System and Its History

3 Structure of the Banking Systems
3.1 Germany
3.1.1 General Information
3.1.2 Universal Banks
3.1.2.1 Private Commercial Banks
3.1.2.2 Savings Bank Sector
3.1.2.3 Cooperative Sector
3.1.3 Specialised Banks
3.2 UK
3.21.1 The Banking System in General
3.2.2 Authorised Banks
3.2.2.1 Retail Banking in the UK
3.2.2.2 Wholesale Banking
3.2.3 Listed Discount Market Institutions
3.2.4 Other Financial Institutions

4 Features of the Banking Systems
4.1 Provision of Capital and Funding for Industry
4.1.1 Funding Possibilities
4.1.2 Special Needs of Small and Medium-sized Companies
4.2 Short - termism
4.2.1 How to Define Short-termism ?
4.2.2 Institutional Investors Requirements as the Major Cause for Short-termism
4.2.3 Consequences of Short-termism: R&D
4.2.4 Consequences of Short-termism: Take-over Activities
4.2.4.1 Take-over activities: Definition, Targets and Risks
4.2.4.2 Hostile Take-overs
4.3 Corporate Governance
4.3.1 The English and the German System of Corporate Governance
4.3.2 Supervisory Boards
4.3.3 Shareholding

5 Performance of Companies
5.1 Selected Factors of Influence on Economic Performance
5.1.1 The Macroeconomic Environment
5.1.2 Education and Training
5.1.3 The Company Management
5.1.4 Innovation
5.1.5 Funding Costs
5.2 Evaluation of the Companies’ Performance

6 Résumé
6.1 Differing opinions concerning the banking systems
6.1.1 Five types of universal banks
6.1.2 Subordinate importance of banks in the German financial system
6.2 Current Tendencies and Future Perspectives
6.3 Conclusion

Appendix

Bibliography

List of Abbreviations

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List of Figures

Figure 1: the German banking system (source: Klein, D. R. 1998 p.78)

Figure 2: subdivision of private commercial banks (source: Becker, H. P. 1994 p. 62)

Figure 3: levels of the savings bank sector (source: Becker, H. P. 1994 p. 64)

Figure 4: levels of the cooperative sector (source: Becker, H. P. 1994, p. 66)

Figure 5: the UK financial system (developed by author)

Figure 6: Structure of liabilities of non-financial businesses, Germany (developed by author, data from: Fischer, Edwards 1994 p.50)

Figure 7: Structure of liabilities of non-financial businesses, UK (developed by author, data from: Fischer, Edwards 1994 p.50)

Figure 8: risk return trade-off (source: Henderson, 1993 p. 266)

Figure 9: inflation (3-year moving-average), (percentage change in consumer price index) (source: Eltis, W., D. Fraser and M. Ricketts, 1992, p.4)

List of Tables

Table 1: Combined balance sheet of UK retail banks at the 31 December 1996 (source: Bank of England Statistical Abstract)

Table 2: tendencies of influences on economic performance in the UK and Germany (developed by author)

1 Introduction

The era of the 20th century can generally be characterised by a globalisation of markets and thus increasing international competition. Concerning the implications for the companies, this internationalisation means, that they have to keep pace not only with their national but also with their international competitors. In order to do so, it will after a while become necessary to expand to foreign countries as these may have comparative advantages the company wants to make use of. This expansion may happen by foreign direct investment in the target country, by corporations with national companies of the target country or by acquiring a national company.

However, expanding to another country means, among others, to be informed about the prevailing business environment and its implications on the company’s performance. One part of the business environment is the financial system of the country. Generally speaking, there exist two different kinds of financial systems. The first one is the universal bank system and the second one, the specialised bank system. The topic of this survey will be to analyse and compare the two alternative banking systems, using Germany as an example for the universal bank system and the UK as an example for the specialised bank system. The analysis will comprise the structure, features and implications on companies’ performance of the banking systems. Finally, the question which of the two systems is more suitable for banks and companies, shall be answered as this may be a decisive factor in the discussion of expanding.

The first chapter of this survey, defines the meaning of the terms universal and specialised bank system and furthermore, gives a short insight to the historical development of both systems. In the following chapter, the structure of the English and the German banking system will be described in great detail, giving an impression of how these systems work. Consequently, as the features of a banking system depend to a great amount on the system’s structure, the next chapter describes the features of the two alternative financial systems and links them to the structure. After the foundation is complete, the following chapter will try to assess the implications of the two alternative banking system’s on the company’s performance and evaluate one as superior. The last chapter will briefly mention some criticism of the described systems and current development tendencies.

Within this survey the terms UK, England, Great Britain and Britain are used synonymous, implying no difference concerning the included countries. Furthermore, the terms banking system, financial system and bank system are synonyms as well.

2 Presenting the Two Alternative Financial Systems

To start with, this chapter will explain the term universal and specialised banking system. Furthermore, this chapter will provide some general information about the history of the banking systems.

2.1 The German Financial System and Its History

In the German financial system banks play a major role. This is caused by the fact that they are universal banks which means they are involved in all kinds of banking operations. The German banks provide a large quantity of the capital needed by companies and furthermore do they “monitor the performance of firms closely, and restructure firms and their management where necessary” (Edwards, J. and K. Fischer 1994 p.1). This close relationship is often mentioned as the so called “Hausbankbeziehung”. Every German company has a Hausbank which carries out all its financial transactions and furthermore is closely involved in the company’s internal affairs (Edwards, J. and K. Fischer 1994 p. 1-2). The features and effects of this close relation between banks and companies will be considered later on in more detail.

The development of the German universal bank system began in the late nineteenth century with the industrialisation of the German economy. The foundation of industrial enterprises which were very capital-intensive created the need for high borrowings. Until then private banking houses had been the most important institutions in providing capital, but due to the big amount of capital needed, they could not supply it any longer. The only ones that could provide the capital were the newly incorporated big banks, the so called “Großbanken”, as they had access to the stock market (Perlitz, M. and F. Seger, 1994, p.51). These banks are the Deutsche Bank AG and the Commerzbank AG which were founded in 1870 as well as the Dresdner Bank AG, founded in 1872.

During the following years, technical development went on rapidly. Companies grew bigger and bigger and, therefore, demanded more and higher loans. In order to satisfy this demand, banks also had to grow, and within the years, they became more and more influential. Since the first private commercial banks thought of themselves as agents between investors and industry and offered all kinds of banking operations, a constant capital flow between banks and the industries was created. Over the time this initial relationship between companies and banks developed towards a mutual trust, as it still is nowadays (see Gall, L., G. D. Feldman, H. James, C. L. Holftrerich and H. E. Büschgen, 1995, p. 30).

2.2 The British Banking System and Its History

In contrast to the German system the English banks are referred to as specialised banks which means that they do not offer all kinds of financial services but concentrate on some. Analysing the relation of English banks and companies in more detail, it becomes quite obvious that it is neither very close nor long-run orientated. On the companies’ side this is caused by many big companies running treasury departments that are concerned with finding the cheapest and most favourable form of financing their investments. As a consequence of this behaviour companies, in some extreme cases, use more than 200 banks (see Charkham 1999, p. 82). However, this tendency is caused by the banks’ policies as well. They are not interested in getting too closely involved in their client companies’ affairs as, in the case of bankruptcy, they do not at all want to be affected neither in financial nor in reputation respects. As the British banks try to avoid close relations they do as a matter of fact not buy their client companies’ shares.

The English financial system is originated in 1545 when the Usury Laws were annulled partially. With this repeal, bankers could start business in London and the London goldsmiths were able to take deposits, pay interests and give loans to the state and to individuals in order to finance their economic activities (see Charkham 1999, p. 79). During the years before the industrial revolution, the banks’ main customers, besides individuals, were farmers and landowners as well as the related industries. Due to the industrial revolution, a lot of manufacturing firms emerged, and the banks added them to their clientele.

3 Structure of the Banking Systems

After generally having found out, what the differences between the two alternative banking systems are, they shall now be analysed more detailed.

3.1 Germany

At the beginning, the German financial system as a whole will be considered. To have a complete insight in the structure of the German banking system, all parts will be presented. Even if some of them are not relevant for the further development.

3.1.1 General Information

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Figure 1: the German banking system (source: Klein, D. R. 1998 p.78)

As mentioned before, the German system is mainly determined by universal banks which are involved in almost every kind of banking actions. But there are as well specialised banks which concentrate only on certain parts of the banking business. However, as shown in figure 1, universal banks clearly dominate the German banking system with 3457 universal banks compared to 220 specialised banks.

Universal banks can be divided into three different groups: private commercial banks, public financial institutions and cooperative financial institutions, all of which concentrate on different focuses. The main objective of the private commercial banks is to generate high profits and high profitability. In contrast to this, public savings banks and cooperative financial institutions are not mainly concerned with maximising their profits but concentrate on realising other targets. Whereas the savings banks contribute to the public benefit, cooperative banks traditionally concentrate on supporting their members by means of common business operations (see Becker, H. P. 1994, p.62). As this are very broad definitions, the following paragraphs deal with these objectives and the banks’ structure in more detail.

3.1.2 Universal Banks

As the German financial system mainly consists of universal banks, it is called universal bank system. There exist as well some specialised banks but they are very little in number and importance. This is why the universal banks are described first.

3.1.2.1 Private Commercial Banks

The private commercial banks can be divided into the following four groups:

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Figure 2: subdivision of private commercial banks (source: Becker, H. P. 1994 p. 62)

The big banks or “Großbanken” are the most important ones in the group of the private commercial banks. Even if there are only three big banks, which are the Deutsche Bank, the Dresdner Bank and the Commerzbank, the big banks have a share of 9.2% of the balance sheet of all banks. This clearly points out their importance (see Klein, D. R. 1998, p.77).

All of the big banks are stock companies and offer nearly all kinds of banking services without concentrating on a certain group of customers. Furthermore they operate in different countries all over the world. The Deutsche Bank AG, for example, had about 162 offices in Germany and further 800 offices in more than 50 countries in 1996. The Deutsche Bank AG employs 74,400 people whereof one third works in a foreign branch (see Klein, D. R. 1998, p.79).

In order to be able to cope with the large amount of clients big banks have a large network of branches and subsidiaries not only in Germany but as well abroad. Generally speaking, the big banks are multinational enterprises and, therefor, are as well able to handle all their clients’ international payments. This, however, creates the need of hedging the arising currency exposures which is done by forward exchange operations or other financial derivatives (see Süchting, J. 1998, p. 66).

Another real big group of the private commercial banks , the regional banks and others, comprises more than 100 institutions of different corporate forms and duties (see Becker, H.P. 1994, p.63). However, the term regional already shows that these banks operate only in a limited area, typically one or several Federal States. Only some bigger ones have expanded their business to Germany as a whole and even to foreign countries so that their structure is quite similar to that of the big banks.

As the branches of foreign banks and the private banking houses are relatively small in importance and number they shall be neglected in this context.

3.1.2.2 Savings Bank Sector

Most institutions of this sector are public enterprises. The liabilities of these enterprises are held responsible for by public institutions such as municipalities, districts or joint bodies (see Becker, H. P., 1994, p.64). Furthermore, there are a few independent savings banks.

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Figure 3: levels of the savings bank sector (source: Becker, H. P. 1994 p. 64)

Figure 3 shows that the sector of the savings banks consists of three levels. At the lowest level are the savings banks located which concerning to figure 1 are the most in number in this sector. The savings banks are interested in the public benefit, and they are mainly concerned with providing credits for people of their area as well as for small and medium-sized enterprises. Furthermore, they are supposed to provide a possibility for wealth formation and investment without risk. The gains of each savings bank are used to strengthen the own reserves. The savings banks are allowed to participate in all kinds of usual banking actions but not in risky securities or foreign exchange transactions (see Becker, H. P., 1994, p.65).

At the next level of the savings bank sector are the Central Savings Banks, so called “Landesbanken” or “Girozentralen”. Acting as Landesbanken these institutions attend to the banking actions of the Federal States and municipalities as well as they support their economy. In their role as Girozentralen they are acting as a clearing house and liquidity manager to the savings banks. This means that they are responsible for their clearing and refinancing activities. Additionally, these institutions act as usual banks concentrating mainly on investment-banking and the allocation of large-scale loans to industrial enterprises (see Klein, D. R., 1998, p. 85). A competitive advantage of the Landesbanken/ Girozentralen is the fact that they are allowed to issue bonds in order to bring up the capital needed.

The Deutsche Girozentrale representing the highest level of the savings bank sector is concerned with running the contributions of the regional Girozentralen, trading actions at the money market, and the allocation of municipal credits. Furthermore, the Deutsche Girozentrale provides all the services of a universal bank concentrating on big business (see Becker, H. P., 1994, p. 66).

3.1.2.3 Cooperative Sector

The structure of the cooperative sector is quite similar to that of the savings bank sector and with 19,530 the number of domestic cooperative bank offices is quite high. There are again three different levels which correspond to different areas of activity. The credit cooperatives act on a local basis, the central cooperative banks on a regional basis and the German Cooperative Bank operates nationally, as shown in figure 4.

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Figure 4: levels of the cooperative sector (source: Becker, H. P. 1994, p. 66)

The credit cooperatives strengthen their equity by selling stakes. In buying these stakes a membership of the credit cooperative is acquired (see Becker, H.P., 1994, p.66). However, being a member of the credit cooperative does not provide any basic advantages. Effects of this membership are that the members receive a dividend at the end of each financial year, and they have the right of codetermination, nevertheless the credit cooperative offers the same services to members as well as to non-members. Furthermore do they enlarge their clientele to retail banking and wholesale banking in general. This is just a recent development due to increasing competition since traditionally credit cooperatives concentrated on supporting cooperatives.

A very close partner of the credit cooperatives are the central cooperative banks which are allowed to carry out all kinds of banking actions, but they mainly concentrate on offering investment and refinancing possibilities to the credit cooperatives as well as handling national and international payment transactions for them.

The German Cooperative Bank operates as the top institution of the cooperative sector and as well as a universal commercial bank. Furthermore does it take over the functions of a central cooperative bank in areas without such a bank. The German Cooperative Bank is bound by law to support the whole German cooperative sector. This means that it sets up surplus liquidity and generates capital by means of issuing debentures, for example. Additionally it connects the cooperative banks with foreign financial markets and completes the product range with stakeholding (Becker, H.P. 1994 p.67). However, the German Cooperative Bank also offers their services, for example syndicate business, money transactions, foreign exchange transactions and securities transactions to large clients.

3.1.3 Specialised Banks

Even if the German banking system is referred to as a universal bank system, specialised banks exist in Germany and carry out about 25% of all banking actions (see Klein, D. R., 1998, p.89). Specialised banks do not offer all kinds of banking transactions but concentrate on specific ones. As a consequence there are different groups of specialised banks:

- Mortgage banks
- Building societies
- Capital investment companies
- Guarantee banks and
- Financial institutions with special tasks.

The mortgage banks can further be subdivided into two groups. The first one is made up by 29 private mortgage banks (including two ship mortgage banks) and the second one contains five public mortgage loan institutions, originated in the 18th century. Both groups offer first mortgage loans for house building or whatever may be related to it (see Klein, D. R., 1998, p. 89) and lend to local authorities. The funding of these institutions is done by issuing debentures.

The next group of the specialised banks consists of the building societies. 22 belong to the private and 13 to the public sector. These institutions, whose capital is kept at big banks, finance all kinds of actions related to housing, for example house building or purchase of building land (see Becker, H. P., 1994, p. 69). However, as a matter of fact saving with building societies is very attractive because with this a right for a state-sponsored building loan at a favourable and fixed rate of interest is acquired (see Klein, D. R., 1998, p. 90).

Capital investment companies offer various investment funds to their investors. The investment funds can be divided into security funds, property funds, retail funds and special funds (see Becker, H. P., 1994, pp. 70-71). The capital which is left to these institutions by their investors has to be invested under the principle of risk spreading which means into securities, stakeholding and land.

Another kind of specialised banks are the guarantee banks. They stand surety for business start-ups, medium-sized and small enterprises and freelances. These institutions are state-sponsored, and it is their aim to compensate the disadvantageous poor capital base of their customers by granting a certificate of indemnity at comparatively low costs (see Klein, D. R., 1998, p. 90). Usually the sureties total one million German marks maximum and are allowed to amount up to 80% of the loan whereas the remaining 20% need to be covered by the borrower through other securities in line with banking practices (see Becker, H. P., 1994, p. 72).

The last group, the financial institutions with special functions, is a generic term for various institutions with differing objectives. All of these institutions offer additional services which other banks do not or only scarcely provide. Furthermore, can they be divided into private ones, for example the Ausfuhrkredit-Gesellschaft mbH or the Liquiditäts-Konsortialbank GmbH, and public ones, such as the Kreditanstalt für Wiederaufbau and the Deutsche Ausgleichsbank. The Ausfuhrkredit-Gesellschaft mbH is a joint foundation of the German banks with the objective of medium- and long-term funding for exports of enterprises. The Liquiditäts-Konsortialbank GmbH supports other financial institutions which are having liquidity problems (see Becker, H. P., 1994, p. 74). The loans provided by the Kreditanstalt für Wiederaufbau and the Deutsche Ausgleichsbank in most cases are made available to the borrower via its house bank and not directly through these institutions. The Kreditanstalt für Wiederaufbau is aimed to support the German economy and especially the East German economy whereas the Deutsche Ausgleichsbank offers secondary long-term interest-subsidised loans to freelances in order to compensate their shortage of equity.

3.2 UK

In contrast to the German financial system, the English system comprises several specialised banks. The structure of the English banking system shall be analysed more detailed in the following and differences to the German financial system shall be pointed out.

3.2.1

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Figure 5: the UK financial system (developed by author)

After having familiarised with the German financial system, this section analyses the English system and points out the differences to the German system. Figure 5 shows that the British financial system is divided into authorised banks, listed discount market institutions and other financial institutions.

This distinction is made due to the fact that a bank has to be authorised by the Financial Services Authority (FSA) to be allowed to operate as a bank (see Buckle and Thompson, 1998, p. 54). All authorised banks underlie the UK deposit protection scheme which protects depositors and requires the banks to place 0.15% of its eligible sterling liabilities in a non-interest bearing account at the Bank of England. Furthermore, the British banking system does not distinguish between universal and specialised banks, as the German system does, but between retail and wholesale banks. This distinction is made even though it is loosing its practical relevance as firms whose main business is not banking enter the market and offer retail banking services and products. As a consequence banks loose their monopoly position, but they “can use their core competencies to diversify into providing other services” (Buckle and Thompson 1998 p. 53).

Speaking of numbers, the British banking system consists of 148 British banks whereof 24 are retail banks, 22 merchant banks, 95 other British banks and seven listed discount market institutions (see Klein, D. R., 1998, p.196). Even if some of these banks are controlled by banks operating abroad, they are no typical foreign banks. The number of foreign banks, which means banks that operate in the UK only by branches or subsidiaries, more than doubles the number of British banks to 340.

3.2.2 Authorised Banks

As mentioned above, the English financial system distinguishes between authorised banks, listed discount market institutions and other financial institutions. The first group, the authorised banks, shall now be looked at in more detail.

3.2.2.1 Retail Banking in the UK

The business of retail banking is a large-volume and low-value business. This means that the number of deposits taken and loans provided is high but the value of the same is comparatively low. One of the reasons for this is that retail banks mainly concentrate on individuals and small firms.

The group of retail banks can be divided further into the London Clearing Banks, the Girobank and others. The London Clearing Banks are the National Westminster Bank, Barclays Bank, Midland Bank and Lloyd’s Bank. However, as this distinction is not essential in considering the differences of the English and the German banking system it shall be neglected and retail banks as a whole shall be analysed. In order to do this, table 1 shows the combined balance sheet of UK retail banks.

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Table 1: Combined balance sheet of UK retail banks at the 31 December 1996 (source: Bank of England Statistical Abstract)

Looking at table 1, the main activities of retail banks can be discerned. On the liabilities side deposit-taking (sterling deposits as well as foreign currency deposits) makes up approximately 80 per cent of all liabilities. The sterling deposits, coming mainly from the private sector, constitute approximately 45% of the sight deposits, this means that they need to be repaid on demand. Another relatively big item on this side is the “items in suspense and transmission plus capital and other funds”. Whereas items in suspense and transmissions are, for example, cheques drawn and in the course of collection, capital and other funds refer to the bank’s issued share capital, long-term debt and reserves.

The biggest item on the assets side of the combined balance sheet is “advances” which make up almost 50% of all assets and approximately 65% of the sterling assets. Traditionally overdraft facilities to business borrowers built the main part of the advances, but their market share fell from 2/5 to 1/10 during the last years (see Klein, D. R., 1998, p. 197). Since the mid-1970’s the number of term loans at a fixed or floating interest rate to businesses is increasing. Due to competition with building societies long-term mortgage lending and unsecured term loans to customers in the private sector are as well gaining importance (see Buckle and Thompson, 1998, p. 56) since the late 1980’s. The next big item on the assets side are the market loans which are short-term loans generated at the money market. The last relatively big item is “other currency and miscellaneous assets”. 20% of these “other currency assets” consist of advances whereas the rest consists of market loans and investments. Miscellaneous assets are mainly the bank’s physical assets such as premises and equipment (see Buckle and Thompson, 1998, p. 56).

3.2.2.2 Wholesale Banking

Wholesale banking is a generic term for a very heterogeneous group of banks. Following the Bank of England’s statistical analysis these banks can be divided into UK merchant banks, other UK banks, US banks, Japanese banks and other overseas banks. The group of the foreign banks as a whole generates the highest amount of total assets which is 25 times the volume of total assets of the UK merchant banks (see appendix 1).

However, the term wholesale banking refers to deposits and loans of large size. Consequently their number is smaller than in retail banking. Typically the minimum value for sterling deposits and loans is £250,000 and £500,000 respectively (see Buckle and Thompson, 1998, p.71). As a consequence the wholesale banks’ main customers are medium and large corporations as well as large organisations.

The business of wholesale banking is mainly concerned with international wholesale customer business, short-term lending business, advising companies as well as funding take-over activities. Additionally, many wholesale banks operate in underwriting and the property business (see Klein, D. R., 1998, p.202). A close analysis of the banks’ deposits reveals that their structure is different to that of the retail banks’ deposits.

The number of sight deposits which make up about 45% of the retail banks’ sterling deposits is much lower in the wholesale banking sector than in the retail sector. The largest proportion of sight deposits in the wholesale banking sector is 26% at the US banks (see appendix 2). Approximately 22% of the wholesale banks’ sterling deposits refer to inter-bank deposits which are deposits of one bank placed with another. The remaining part of the sterling deposits mainly refers to time deposits from private UK and overseas companies and banks (see Buckle and Thompson, 1998, p. 71).

Another big difference between retail and wholesale banking is the fact that wholesale banking is largely extended to foreign currency business. In contrast, in the retail banking sector approximately 24% (see table 1) of all deposits are foreign currency deposits. The US banks, for example, have a share of 82% of foreign currency deposits (see appendix 2).

Beneath these activities the wholesale banks also are involved in a large number of off-balance-sheet activities. According to Buckle and Thompson “off-balance-sheet business refers to business undertaken by a bank which generates a contingent commitment and generally an income to the bank without the business being captured on the balance sheet under conventional accounting procedures” (Buckle and Thompson, 1998, p.77). In the 1980’s off-balance-sheet-business grew rapidly in scope and volume due to different reasons. First of all the banks were interested in the fee income generated by these activities, and they wanted to diversify their operations. Furthermore the entrance to new areas of business was made possible by the liberalisation of financial services in recent years (see Buckle and Thompson, 1998, p. 80).

Off-balance-sheet-business can be divided into four different types which are loan commitment, swap and hedging transactions, guarantees, and securities underwriting. The term loan commitment refers to any advance commitment made by a bank in order to provide credit. Examples for this are overdrafts, revolving lines of credit and note issuance facilities. The latter means that a bank provides a credit only if others are unable to do so. The next type of off-balance-sheet-business is guarantees, for example acceptances and performance bonds. In the case of granting a guarantee the bank is involved in underwriting the obligations of a third party. Another type are swap and hedging transactions which involve the bank in a transaction using one of the derivative instruments, for example swaps, forward contracts and options. These transactions can be hedged or remain unhedged. The last type of off-balance-sheet-business is securities underwriting. The banks “are involved in underwriting issues of securities, whereby they agree to buy a set amount of the securities which are not taken up in an issue” (Buckle and Thompson, 1998, p. 78). Banks involved in loan commitment, guarantees and securities underwriting receive a fee income for the provision of their services.

3.2.3 Listed Discount Market Institutions

The number of listed discount market institutions also called discount houses is comparatively low. Only seven of them exist. Nonetheless their importance is quite high. Discount houses act as an intermediary between the Bank of England and other banks. This means that these institutions do not have direct contact with each other but only with the discount houses. On the one hand the Bank of England buys bills (treasury bills, eligible bank bills and local authority bills) from the discount houses or makes loans to them in order to even out instability in the discount market (see Buckle and Thompson, 1994, pp. 176-177). On the other hand retail banks invest excess liquidity at the discount houses or, if necessary, become indebted with them. In the case that a discount house has refinancing problems, the Bank of England acts as the lender of the last resort.

In February 1997 the discount houses lost their unique status as the Bank of England since then involves more than 100 participants in its money market operations (see Süchting, J., 1999, p. 93).

3.2.4 Other Financial Institutions

The term other financial institutions comprises various institutions such as finance corporations, finance houses and building societies.

Finance corporations and finance houses try to become authorised by the Bank of England which would consequently mean that they could enlarge their business to different areas since they are very specialised at the moment (Buckle and Thompson, 1998, p. 118). Whereas finance corporations provide long-term credits mainly to small and medium-sized enterprises finance houses concentrate on instalment credits, leasing and factoring. Nevertheless, finance houses make up only a very small proportion of total lending by financial institutions. The lending of finance houses amounted in 1996 £1.6 billion in contrast to the lending of building societies which totalled £300 billion. This example shows that the building societies are of greater importance than the finance houses and finance corporations.

The building societies are mutually owned which means that they belong to the savers and borrowers (see Klein, D. R., 1998, p. 204). In contrary to the German building societies the English savers may withdraw their deposits instantly or with a short period of notice. Equally to Germany building societies, however, they provide long-term mortgage loans on a floating rate basis, and recently even on a fixed interest rate basis.

As the building societies are no banks they are not supervised by the Bank of England but by the Building Societies Commission. Since the late 80’s building societies developed into three different directions. First of all they merged or entered into alliances as, for example, Halifax and Leeds Permanent did in 1985. Another possibility is that they were bought by banks which happened in 1995 when the Lloyds bank bought Cheltenham & Gloucester (see Klein, D. R., 1998, p. 205). The last direction of development was made possible by the 1986 Building Societies Act which under certain circumstances allows building societies to transform into banks. After the publishing of this Act many building societies converted into banks following the example of the Abbey National in 1989 (see Buckle and Thompson, 1998, p. 101).

4 Features of the Banking Systems

In the previous chapter, the two banking systems have been presented. In this chapter some features of these systems shall be analysed. Furthermore, the reasons for these features will be looked at.

4.1 Provision of Capital and Funding for Industry

One of the features of every system, is the possibilities that companies have, to bring up capital. These different possibilities shall be looked at in more detail within this paragraph. Furthermore, the special case of funding small and medium-sized enterprises will be considered.

4.1.1 Funding Possibilities

After having looked at the structure of the German and the English banking system more detailed, the features of these systems and their implications shall be analysed. The first aspect to look at are the different funding possibilities in both countries.

In terms of bringing up the capital needed for an investment there are different ways to do so. In general, a company can choose between

- internal or external funding,
- bank, or non-bank lending,
- short- , medium-, or long-term funding.

The decision about internal or external funding is a decision about where the capital needed shall come from. Internal funds, for example, refer to undistributed profits whereas a decision for external funding implicates the question whether the capital shall be brought up by bank lending through credits or in the way of non-bank lending, for example, by capital markets (see Henderson, 1993, pp. 260-261). Short-, medium- or long-term finance refers to the period of time for which the capital is provided. A typical example for short-term finance for example is by way of overdraft facility or so-called short-term loan.

Even if different possibilities for funding investments exist theoretically, the available possibilities practically depend enormously on the size of the company. This implies that there are differences in financing small and medium-sized companies and large companies. Further differences exist between the countries concerning the nature and frequency of using the funding alternatives.

As mentioned before every company in Germany has its own Hausbank which is closely involved in the company’s internal affairs and therefor is more often prepared to lend money to the company. Due to this relationship banks play a major role in providing external finance basically consisting of loans and equity (see Edwards and Fischer, 1994, p.1). Figure 6 underlines the importance of banks as the companies’ liabilities consist of 81% debt which mainly is made up by bank loans.

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Figure 6: Structure of liabilities of non-financial businesses, Germany (developed by author, data from: Fischer, Edwards 1994 p.50)

In contrast to the German situation, British banks are not interested in having a close relationship with their clients and thus being heavily involved in their affairs. As a consequence of this attitude British banks do not provide long-term capital nor do they regularly take equity stakes, i.e. they only take equity stakes if these are the only possibility to get the capital provided back which otherwise would be lost (see Charkham, 1997, p.341). Moreover the unwillingness of British banks to provide long-term capital causes a closer involvement of capital markets concerning the bringing up of capital. As can be seen in figure 7, 49% of companies’ liabilities are made up by equity capital which among others comprises capital brought up by the stock markets.

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Figure 7: Structure of liabilities of non-financial businesses, UK (developed by author, data from: Fischer, Edwards 1994 p.50)

4.1.2 Special Needs of Small and Medium-sized Companies

Large companies in Germany as well as in the UK face no difficulties in financing their investment activities because they have access to the stock market in most cases and are furthermore heavily supported by banks. Small and medium-sized companies in contrast are in most cases financed by the entrepreneur’s personal equity stake. In the late 1970’s different studies in Germany and the UK found out that small and medium-sized companies have to face difficulties and even enormous disadvantages in using external funds. This disadvantages refer to a limited availability and high costs. The reasons for these problems can be found in the poor equity base, a low amount of retained profits, and in Germany, limited access to stock markets for small and medium-sized enterprises (see Henderson, 1993, p. 273).

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