Politics 8 May 2012 German banks, British lessons Britain's sprawling giants aren't the best way to run a banking system Print HTML Since the financial crisis in 2009, a blame-game has raged between Britain’s large banks on the one side, and British politicians and businesses on the other. Last year, the Government launched "Project Merlin", warning the banks that a failure to meet lending targets would be met with reprisals. When it later transpired that the banks had missed the target for lending to SMEs, the Federation of Small Businesses said that the project had "failed". The banks replied that "the business demand for credit remains weak" and the Government sat on the fence protesting that "it's going to take some time before the banking sector is back to normal". Businesses argue that the banks aren’t lending; the banks retort that businesses don’t want to borrow. The problem with the entire debate is that it ignores the real issue: why does Britain have to rely on banks that were crippled by the crisis? That banks aren’t lending is not disputed: Bank of England figures show that total lending to businesses, not including property lending or to financial firms, fell by 11 per cent between 2008 and 2010 and the evidence since then suggests it has continued to fall. While some of this can be attributed to falling demand, more important is the fact that Britain’s large banks are rebuilding their tattered balance sheets by cutting credit. In a more competitive market, rivals would step in and capitalise on the weakness of the embattled institutions; unfortunately for the UK’s businesses, Britain’s banking market is far from competitive. If only they were based in Stuttgart rather than Stockport. German businesses do not face the same hurdles in accessing credit as their British counterparts because they are served by a far more diverse and competitive banking system. In Germany, commercial banks, such as Deutsche Bank and Commerzbank, compete with a large cooperative banking sector and, more importantly, a large local savings bank sector. In 2011, total loans by the savings banks or Sparkassen stood at €322 billion whereas the total loan stock of Germany’s large commercial banks was only €177 billion. Like Britain’s large banks, Germany’s large commercial banks cut credit during the financial crisis; lending fell by 10 per cent between 2006 and the middle of 2011. In contrast, the Sparkassen increased lending by 17 per cent and continue to do so; when their competitors were flagging they cleaned up. If it were not seriously hampering the British economy it would be amusing to reflect upon the irony that Germany and its social market possessed a far more efficient and competitive banking system than Britain, birthplace of laissez-faire capitalism. It is also interesting that the Sparkassen, who currently have the edge, were once derided as uncompetitive and inefficient. The Sparkassen are governed by Federal and state law in Germany. According to the Banking Act of the Federal Republic of Germany they must restrict their activities to their local area. Furthermore, profit is not the main purpose of their business; rather their success is tied to that of their local economy. These restrictions were once viewed as anachronistic and antithetical to an efficient market economy and for years the Sparkassen were forced to fend off attacks from the European Commission and Germany’s commercial banks. Representatives of the banks often muse that the financial crisis saved them: their local focus and commitment to local businesses re-emphasized the contribution they make to the stability and prosperity of the German economy. British businesses and consumers perhaps hope that the crisis will produce a similar epiphany amongst British policy-makers. The Government needs to remove the significant regulatory barriers that hamper new entrants, encourage entrepreneurial local authorities that wish to institute local banks in their communities, and support credit unions as they look to use their new powers to compete with commercial banks. These are all steps that must be taken if a more competitive and diverse banking sector is to be created, but first we need to take a good look at what’s going on beyond the Rhine. › Why the failure to elect regional mayors is bad for business. Credit cards for a Sparkasse. Photograph: Getty Images Selling Circuits Short: Improving the prospects of the British electronics industry by Stephen L. Clarke and Georgia Plank was released yesterday by Civitas. It is available on PDF and Amazon Kindle Subscribe More Related articles Leader: On capitalism and insecurity No economy is an island: why Britain's finances now depend on Europe Cabinet audit: what does the appointment of Philip Hammond as Chancellor mean for policy?