Introduction to the German Financial System

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The German Financial System is a model worth emulating in various aspects, especially its stability and developmental orientation.

Between 1960 and 2000, the German economy emerged as the strongest in Europe and its financial system acquired an outstanding reputation for stability.

The strength of the Deutschmark was often said to be the result of certain institutional features of the German financial system, in particular the independence of its central bank, the Bundes bank. This is not the whole story, as explained later. A more fundamental explanation takes us back to Germany’s economic and financial history. More than any other European country in the twentieth century, Germany has suffered the effects of violent currency fluctuations.

At the worst, in 1923, prices rose nearly two billion fold. When stabilization finally occurred in November 1923 the exchange rate was M4.2 trillion per US dollar. At inflation rates of this magnitude, conventional payment systems, based on money, collapse and exchange takes the form of barter, with all the inefficiencies and disruption that follow. Savings in the form of financial wealth, especially where the assets are of fixed nominal value, are also destroyed.

The hyperinflation of 1922-23 though more than 80 years, there was a more recent reminder of its effect, particularly upon savings, in the conversion of the Mark in another post-war setting, in 1948. The Reichsmark, as it had by then become, was virtually worthless.

It is this experience that has made all German institutions and administrations strongly inflation averse (and also perhaps more risk averse) than those of other countries. These aversions predate the Bundesbank’s success. They explain why the Bundesbank was established with such a high degree of independence and they explain why the Bundesbank has had a comparatively simple task in maintaining low rates of inflation: it has enjoyed widespread support throughout German society. The aversions and the low inflation record also explain some other characteristics of the German financial system, particularly the low levels of equity holdings in household portfolios and the correspondingly low levels of equity finance in German firms.

Banks and other deposit-taking institutions

The central bank in Germany is the Bundes bank. It was formally established in 1957 with a constitution that made the stability of the currency its principal objective.

Its constitution also stresses its independence from government, though the Bundes bank is technically owned by the central government, which has the power to appoint the president and other members of the directorate. The Bundes bank is organized along federal lines. Each state (Land) has a central bank (effectively regional offices of the Bundes bank) and each of these has one representative on the governing body of the Bundes bank. So far as the mechanical aspects of central banking are concerned, commercial banks hold operational balances with the Land central bank, which maintains balances with the Bundes bank in Frankfurt. Intra-regional payments are thus reflected in banks’ balances at the Land central dank while net transfers between banks in different regions will be reflected in changed Land central bank balances at the Bundes bank. The Bundes bank is not responsible for supervision of the banking system, this is the job of the Federal Banking Supervisory Office, although the data required for monitoring bank behaviour is collected and published monthly by the Bundes bank as part of a whole series of banking statistics.

With the launch of stage three of economic and monetary union on 1 January 1999, responsibility for deciding and implementing the single monetary policy in the euro area was transferred to the Euro system.

—the ECB and the 11(12 from 2001) central banks of the member...
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