Why is Germany's private investment so low? New research by Mathias Hoffmann (University of Zurich), Iryna Stewen (University of Mainz) and Michael Stiefel (University of Zurich), which analyses a sample of around one million German firms, points to ‘crowding out’ in Germany’s locally segmented banking markets as a key driver of the country’s low private investment rate.
German banking system is geographically segmented
Germany’s local banks, the Sparkassen (savings banks) and Volksbanken (cooperative banks), have designated geographical areas of business in which other banks of the same type (savings or cooperative) are not allowed to compete.
This institutional backdrop – the so-called ‘Regionalprinzip' (regional principle) – makes German banking markets segmented along regional or municipal boundaries. At the same time, local banks traditionally dominate lending to small and medium firms (SMEs) in Germany.
This dominant role of local banks in local markets, coupled with the relationship lending model make it hard for local SMEs to switch bank when banks tighten loan terms, e.g. by charging higher interest rates.
Local public banks have a statutory mandate to lend to municipalities
With public sector borrowing rates in steady decline over the last decade, the spread between banks' refinancing costs and the return on local public debt has been narrowing, making it virtually impossible for banks to generate profits from municipal lending.
This is a particular problem for Germany's local public banks (the savings banks), which by their statutory mandate have to provide financing to their local municipalities.
What does this mean for the investment of small and medium firms?
The study shows that savings banks with higher shares of municipal lending on their balance sheets charge their private customers higher interest rates, a correlation that is absent for cooperative banks. In other words, savings banks make up for the low returns on their high holdings of municipal debt, by charging higher interest rates on their SME borrowers. Hence, local public lending effectively crowds out private borrowing in Germany’s locally segmented banking markets.
The researchers show that this crowding-out effect is stronger in highly indebted communities where saving banks were under pressure to lend more to local municipalities as fiscal consolidation at the state and federal level increased the pressure on municipal budgets after the introduction of debt brakes in the federal and state constitutions after 2010.
Does it matter for the macro-economy?
Yes. The local crowding-out effect lowers investment for the average firm in the sample by about 6%. From 2012-2015, this means that aggregate investment could have been €30 billion per year (or roughly 1% of German GDP) higher. Note also that low private investment is an important factor behind Germany’s current account surplus that has recently started to attract considerable international criticism.
ENDS
Contact:
Mathias Hoffmann: mobile: +41-79-430-6251 e-mail: mathias.hoffmann@uzh.ch
https://www.econ.uzh.ch/en/people/faculty/hoffmann.html
Iryna Stewen: mobile: +4915140152457 e-mail: stewen@uni-mainz.de
https://www.international-macro2.economics.uni-mainz.de/
Michael Stiefel: e-mail: michaelstiefel@outlook.com