Banking Survey 2006
Facts, Opinions, Outlook

Manfred Weber
Chief Executive Officer,
Association of German Banks

Press conference

Not checked against delivery

Ladies and gentlemen,

A warm welcome to you all to our press conference today. In our Banking Survey, which we publish every two years, we give an overview of current developments in the banking and financial sector. The survey is divided into three parts: Part I deals with the question of how much freedom and scope for action there is in national economic policy. Our analysis is supplemented by four articles by high-profile economic experts on federalism, consolidation of public finances, demographics and globalisation.

Part II of the Banking Survey looks at the restructuring already achieved and the restructuring still necessary in the banking market. While it includes a European and international perspective, it focuses on the reforms needed in the German banking sector, since it is still, first and foremost, national policymakers who have to set the course for the future.

Part III contains, as usual, a chronological record of the most important events in the banking sector during the past two years.

So you see, ladies and gentlemen, the Banking Survey covers a wide range of topics that can’t be dealt with in detail at a press conference. I could, of course, also report on the state of play on SEPA, the MiFID, Basel II, accounting, the fight against money laundering and more. Instead, I would like to pick out one or two topical issues that are currently occupying the attention of the private banks and the banking association.

I. Use the scope for action
The Banking Survey focuses, as I said, on the question of how much freedom and scope for action policymakers have. Again and again, we hear about the supposed powerlessness of the state in the face of globalisation. This does not stand up to scrutiny. The environment has undoubtedly changed, but the politicians making the decisions at national level have enough scope for creating an efficient economic policy also, and in particular, under globalisation conditions. However, they must use this scope – and do so resolutely. It is vital that the state acts in economic policy to put Germany back on the path of sustained economic growth and higher employment again.

The need to act and to launch reforms is reinforced by the demographic trend. But economic policy responses to globalisation and demographic change must not be backward-looking and geared chiefly – let alone, exclusively – to preserving existing structures. New, forward-looking growth markets have to be developed particularly in the field of modern technologies and in the services sector.

Our country has long had one of the slowest growth rates in the EU. In fact, we have often been the backmarker here. The period of sluggish economic growth that we have had now for over ten years has pushed per capita income below the average of the old 15 EU member countries. The consequences for the labour market and the social protection schemes are well-known. It is obvious that a readjustment of national economic policy is essential. The right political course leads to more prosperity. The wrong one, and this is something we have learned the hard way, leads to less prosperity – and does so faster than in the past. Put differently, national economic policy – like the business sector itself – has to compete internationally. This means that globalisation has increased rather than reduced the responsibility shouldered by national economic policymakers.

II. Improve the general business conditions in Germany
But where does Germany stand today? With estimated growth of 1 ¾ per cent, the economy is picking up noticeably this year. However, this is merely a – welcome – economic upturn; it doesn’t make the longer-term growth curve steeper. As Professor Hans-Werner Sinn points out in his article (on page 22 of the Banking Survey), trend growth in Germany is only around 1 per cent. So there can be no question of a breakthrough. In fact, Germany’s below-average economic performance still acts as a brake on Europe.

The German economy’s comparatively poor showing is due mainly to the general economic conditions. Yet the country’s shortcomings as a business location have been known for a long time. Policymakers were evidently unwilling or unable to tackle the necessary reforms determinedly enough. At the same time, the blurring of responsibilities between the different levels of government also plays a role. And we are also being stifled by a steadily growing layer of regulation and bureaucracy, as well as high taxes. At almost 40 per cent of GDP, the taxation ratio is still higher that that in other countries.

Despite initial efforts in the last parliamentary term, there has been no marked improvement in the conditions for doing business in Germany. One cannot but agree with Professor Charles B. Blankart (see page 12 of the Banking Survey): A reform of federal structures is the basis for Germany’s ability to launch reforms and for its economic future. This includes the still outstanding reorganisation of the country’s “financial constitution” (including financial equalisation between the Länder), without which any federalism reform remains merely a patchwork.

Germany’s inability and in some cases its unwillingness to launch reforms are a drag not only on national but also on European economic development. What is more, they discredit the word “reform” among the general public, as things are repeatedly announced but not followed up by the required action so that, ultimately, the promised progress does not materialise. This is not a strategy that will enable Germany – as targeted by the government – to become one of Europe’s top three economies or allow Europe to achieve the targets it set itself under the Lisbon Agenda of promoting knowledge and innovation, becoming more attractive to investors and employees and creating more and better jobs.

The Grand Coalition got off to a good start particularly on foreign policy, earning plenty of early plaudits in the process. But now it faces the more important – if not to say, vital – economic-policy tasks. Poor compromises to keep one or the other of the coalition partners happy may produce many things but certainly not a consistent economic policy. And there should be an end to tapping ever new sources of revenue. For example, quite apart from its questionable constitutional status, a “health surcharge” won’t solve the problems in our health system. And better regulation can’t mean “gold-plating” the Anti-Discrimination Directive instead of implementing EU rules – as promised – on an “as is” basis.

Politicians also have to make unpopular decisions. Only doing what is accepted by the general public from the outset is not enough. Without political leadership we would have had no Erhardian price reform, no commitment to the West and no euro. Merely preserving the status quo and failing to adapt to the changed environment means passing up opportunities for the future.

III. Modernise the banking market
What goes for politicians also goes for the markets. Any walling-off – I’m thinking here in a European context naturally of the special features of the German banking system in particular – is out of place in the increasingly integrated internal market. It is therefore no surprise that German banks still lag behind their European counterparts. Financial supervisors rightly point out that, despite all the quite successful efforts it has made on its own, the German banking industry is bottom of the European banking league. But this also means that all those concerned – market players, legislators and supervisory bodies – should finally get down to playing an active part in tackling the problems.

Banks have been undergoing a phase of profound transformation for some time. They have overcome the unacceptable situation of a few years ago and recorded first successes. Many banks are now reaping the fruits of their often painful restructuring measures. In some cases, current results actually exceed expectations. That goes particularly for the private banks.

But, nevertheless, German banks are still at the bottom end of the profitability scale – no matter whether Landesbanken or Sparkassen (savings banks), cooperative banks or private banks. Profitability remains stuck at the level of the 1990s. The gap by which German banks trail banks in other European countries and the US has remained more or less the same. Given the growing European and international competition, this gives particular cause for concern.

The successes shouldn’t therefore be allowed to disguise the fact that the measures taken by banks mainly on the costs side have only eliminated part of the problems. Operating expenditure dropped by 14 per cent between 2001 and 2004, for example. But now a marked improvement on the earnings side is called for as well. This requires not only business decisions but also political decisions, as the poor earnings situation is due chiefly to home-made structural problems. Besides the sluggish economic growth we have had for so long, these problems include heavy fragmentation, restrictions on and distortions of competition, as well as the large publicly-owned share of the banking market.

For the first time, the CDU/CSU and the SPD have included a separate section on Germany as a financial centre in their coalition agreement. The government is thus making clear that the financial market can be an important engine of growth and employment for Germany. Nevertheless, the government is not acting consistently enough: On the one hand, it is calling for more cross-border corporate mergers in Europe, but, on the other hand, it is not prepared to create the conditions for opening up the market in the German banking sector as well. Both the International Monetary Fund and Germany’s Sachverständigenrat (Council of Economic Experts) have repeatedly found that the government, which did commit itself to creating growth and employment, is passing up chances here.

IV. Abolish Section 40 of the German Banking Act
A change of thinking is therefore urgently needed. The deadline for submission of government comments to the European Commission on Section 40 of the German Banking Act expires in a few days’ time. We await these comments with great interest.
The Commission regards Section 40, which permits only public banks to use the name “Sparkasse”, as inconsistent with European law. The Association of German Banks has been calling for the abolishment of Section 40 for some time, as it is plainly an obstacle to competition both in the German and the European banking market.

This is demonstrated quite clearly by the example of Berlin. Under the conditions imposed by the European Commission, the state of Berlin is required to sell its shares in Bankgesellschaft Berlin, including Berliner Sparkasse, in an “open, transparent and non-discriminatory” manner by the end of 2007. Any buyer – no matter whether private or public – must thus be allowed to keep the name “Sparkasse”. This is also the only way to ensure that the state of Berlin obtains the highest possible price. Selling the Sparkasse without its name would ultimately not be in the interest of taxpayers there. The discussion on Section 40 of the German Bank Act is by no means limited to Berlin, however, but is of general importance.

The dispute over this issue in the public banking camp has already escalated to such an extent that the Savings Banks’ Association and its member bank, Landesbank Berlin, have sued each other. Should Landesbank Berlin leave the Savings Banks’ Association, it is of course welcome to join the Association of German Banks. Private banks’ home is the Association of German Banks. That goes also for Landesbank Berlin and the Sparkasse that belongs to it.

V. Strengthen banking competition
Regardless of the outcome of the proceedings concerning Section 40 of the German Banking Act, there is no alternative to opening up the rigid boundaries within the German banking sector. We are not against the “three-pillar” banking system, and we are not against Sparkassen. But we want to have pillars that are crossable in both directions and a level playing field for all banks. Not only the Sachverständigenrat but also the European Commission, the European Central Bank and the International Monetary Fund have repeatedly called for the system to be modernised.

The experts agree that such a step would boost growth in Germany. Professor Beatrice Weder di Mauro, a member of the Sachverständigenrat, which assesses overall economic development in Germany, said last year: “Consolidation within the pillars [of the German banking industry] … has done little to bring about greater efficiency. … Legislators must therefore permit consolidation not only within the individual categories, but across them, too.” Bundesbank president Axel Weber also called recently for a systematic liberalisation and flexibilisation of the German banking market. He said that consolidation ought to be possible across the three pillars and that the most important thing for the Bundesbank was strengthening the dynamism and efficiency of German banks.

One cannot but agree with the Bundesbank president: An efficient banking market is created best by market-driven consolidation – across the boundaries of the three pillars. The Sparkassen and their owners would also benefit if the Sparkassen were freed from the constraints imposed by the rigid setup and could face up fully to market competition.

The state of Saarland’s Economics Minister, Hanspeter Georgi, also recently called for further reforms. He said the regional principle (governing the operations of the Sparkassen) was outdated in the age of the European single market. To enable them to hold their own in the future, the public banks had to be given additional development opportunities.

The initiative by the government of the state of Hesse to allow Sparkassen to form nominal capital and initiatives concerning distribution of profits are further proof of this development.

The so-called “public mandate” and the commitment to the public good may be paraded like a monstrance. The fact is, things are different in practice. When it comes to business policy, public banks are no different from private banks. Yet, whilst the owners of private banks receive a fair return on their investment, the owners of the public banks, the local authorities, go more or less empty-handed despite the fact that many are in dire financial straits.

VI. Strengthen the financial marketplace through innovation
So we have clear differences of opinion on the structure of the banking system. In other areas, we cooperate well and make progress. That goes for the long-standing Zentraler Kreditausschuss (ZKA) (joint working committee of the central banking associations) and for the Initiative Finanzstandort Deutschland (IFD) (a financial sector action group), too. But proposals made by the ZKA and the IFD remain ineffective if policymakers fail to create the required legal framework.

An example of this is the introduction of real estate investment trusts (REITs), which has been under discussion for some time. Together with Federal Economics Minister Peer Steinbrück, the banking industry backs this important innovation for the German financial marketplace. The required tax models were tabled long ago, and protection of tenants is guaranteed under German tenancy law also after the introduction of REITs. Inappropriate contributions to the discussion by some SPD members of parliament should not be allowed to rob the German financial marketplace of the chance to benefit from this market of the future. The CDU and the SPD – and the emphasis here is on the SPD – should reach agreement as quickly as possible so that German REITs can be launched on schedule on 1st January 2007. Otherwise other financial centres will profit at our expense.

Action is urgently needed as well to reform taxation of private investment income A flat withholding tax would make the German financial marketplace more attractive in the competition for international investors and thus provide a stimulus to growth. The timing of its introduction should, by the way, also be seen in the context of the reform of company taxation scheduled for 2008.

These examples show that policymakers have enough scope for making the financial marketplace more attractive even in a globalised environment. The private banks will, of course, continue to work on improving their profitability and competitiveness on their own. However, in the end their efforts will only be successful if the general conditions are right.

VII. Consolidate public finances
That goes, by the way, not only for the banking market but also for the business sector and the state as a whole. The public sector in Germany is in worryingly bad shape. Many local authorities no longer have any budgetary leeway, and some Länder budgets are now unconstitutional. This is why much greater efforts to consolidate public finances than those hitherto planned are necessary. The supposedly simple “solution” via higher taxes has been already been used to the full. Mistakes made in the past and the currently still tentative reform efforts are repeatedly explained by the lack of financial room for manoeuvre and existing constraints on action. But this is far from convincing. Nevertheless, there are still calls at present for the state to improve its revenue by way of further tax hikes so that it can perform “its functions” in the long term.

This is a highly problematic approach, as higher taxes threaten growth and employment and ultimately lead to lower revenue. The fact is, the state doesn’t have a revenue problem but a spending problem! Within the past 15 years, the tax revenue collected by the central, regional and local authorities has increased by close to 35 per cent. By 2010 it is likely to increase again by almost 20 per cent, that means by more than € 85 billion. This is the finding of the tax estimate made in May this year. So the state’s lack of room for manoeuvre cannot be explained by pointing to the revenue situation.

Instead, the public sector should do two things: First, it should get its spending under control and, to do so, it should put its spending under scrutiny. And, second, it should become more efficient and use its resources better. The aim of budget consolidation can therefore only be to reduce existing deficits over the next few years and commit the federal government, the Länder and local authorities to avoiding any more debt. For the sake of more growth and employment, we finally also need a national stability pact, since the federal government, the Länder and local authorities are all called upon to do their bit in this respect.

VIII. Reform the tax system
Besides sorting out public finances, our tax system needs to be modernised. The government must be judged by whether it manages to implement its plans for reform as announced in the coalition agreement. That goes, for example, for a tax reform designed to stimulate growth and employment. It is just not enough to change tax rates here. We need a transparent tax system and an internationally competitive tax burden. The Sachverständigenrat and the Stiftung Marktwirtschaft (an economic think tank) have submitted blueprints for a comprehensive tax reform. Only if the reform brings appreciable net tax relief for the business sector will it provide the desired boost to growth and employment. The reform of company taxation is therefore in the interest of both people in work and people looking for work. It is not a present to the business sector. We look forward to finding out which concept the Finance Minister will hopefully present shortly.

IX. Outlook
Both in the banking sector and the economy as a whole, the situation has improved. But this is no reason to lean back and relax, since the real challenges still lie ahead of us.

Banks, for example, have profited so far particularly from the robust global economy, lower provisioning requirements and the positive trend on the capital markets. But these are volatile factors. Interest margins, which promise stable earnings, are still much too low in Germany. Banking supervisors and the Bundesbank have repeatedly drawn attention to this.

It is therefore high time to get the structural change in the German banking sector underway.

The coming weeks and months will bring many tests for policymakers where they will have to demonstrate their willingness and ability to launch reforms. Decisions on the reform of company taxation, the health reform, on REITs and much more will have to be made. This will show whether the government is up to the challenges and makes 2006 the year of change. Otherwise 2007 could become the year of uncomfortable truths for policymakers and the business sector.