Goodbye and Hello to the Universal Bank

Banking everywhere is being transformed by a financial revolution. The biggest casualty of this, perhaps, is the “universal” bank that has long dominated European finance. Nowadays, however, such banks are increasingly dismissed as dinosaurs. After its emergence in mid-nineteenth century Europe, universal banks saw their greatest successes in Germany and were taken up across Central Europe, Scandinavia, and Italy, as well as by Japanese reformers keen on modernizing their society and economy. The Japanese model, in turn, influenced policymakers across Asia after WWII, notably in Korea and Thailand. In their heyday, universal banks were viewed as “maids for all work.” Combining commercial and investment banking, they often held large equity portfolios. In the classic model, banks lent to businesses for long-term investments, and tried to securitize and sell the debt – either as bonds or as equity – when markets were favorable. They held securities for their customers, as well as on their own account, and voted on these at company annual meetings. The breakdown of the traditional universal bank is occurring for several different reasons. In 2000, Germany’s government reversed a tax system that penalized capital gains on long-term shareholdings. Banks can now easily divest themselves of holdings that have been very profitable (and realize the capital gains). In Japan, systemic banking reform is needed because of the extent of the losses made by banks on real estate and securities as the stock market collapsed over the last decade. Elsewhere in East Asia, excessive lending to favored customers was a major cause of the 1997 crisis. Japanese and other Asian universal banks are doomed because of their losses, German ones because of their profits. For decades, universal banks were seen as the secret of German and Japanese economic success. Leading bankers regarded their mission as serving the fatherland rather than profit-making (which was obviously also needed). Before WWI, the US Monetary Commission – founded to deal with chronically unstable banks – heard how the German system worked and urged its imitation. In 1931, Britain’s Macmillan Commission interviewed leading German bankers and later promoted the adoption of a German-style system that seemed to offer more long-term industrial financing than the short time horizons of British bankers. Arguments about the superiority of the German model were never watertight. The star witness of the 1931 British inquiry was Jakob Goldschmidt, head of Darmstädter Bank (Germany’s first universal bank). The commission’s report was published on July 13, 1931, the day on which Goldschmidt’s bank collapsed, pulling down Germany’s banking system. The Great Depression highlighted the vulnerability of universal banks: that their balance sheets would be undermined by long periods of asset deflation. Such deflation characterized Germany’s problems in the early 1930s and Japan in the 1990s. Universal banks did offer advantages in an age in which information was scarce and expensive. Universal bankers knew with greater precision what was happening in businesses in which they held stakes, and they tailored appropriate responses. Such knowledge was used to transform the industrial structures of their countries. Early in the 20th century, German banks rationalized the electrical-technical industries into two giant concerns, AEG and Siemens. In the 1920s, they promoted mergers in automobiles: most importantly the creation of Daimler-Benz, which came close to absorbing BMW as well. This advantage was greatest in the 19th century, when financial information was patchy, and there were no common auditing standards. Recent internationalization of capital markets, however, has been a powerful force for financial transparency. With transparency, some of the advantages of universal banks disappeared. Secrecy now looks bad. Long-term client relations are shaken rather than consolidated by financial problems. Deutsche Bank had over a century of close contacts with the construction company Philip Holzmann; its bankers were blamed for insensitivity when the company collapsed in 1999. Recently, Deutsche Telekom charged Deutsche Bank with rank disloyalty for executing a large sell order on its stock. The disadvantages of universal banking, which existed from the start, are increasingly obvious. Clustering of financial influence diverts investment into less profitable directions. After 1945, a perennial complaint of start-up firms in Germany and Japan was that they lacked access to capital because universal banks ignored them. One statistical indication that this complaint was well-founded is the high investment levels of Germany and Japan in the late 20th century. The numbers show that a great deal of capital is consumed but with comparatively low capital-output ratios, which implies inefficient usage. Yet it may be too early to sing a requiem for the universal bank. Most observers might have predicted that 1931 would end Germany’s peculiar financial structure, but in fact universal banks survived the Depression (with state help), Nazi dictatorship (in which they were mobilized into a form of complicity with the state), and Allied attempts to impose financial reform. The advantages in information about business that these banks held are nowadays reduced due to the greater (and quicker) availability of financial data. But the combination of investment banking with a big retail base still offers attractions, especially in a time in which wealth is distributed widely. After a long period in the aftermath of the Great Depression – during which America prohibited universal banking as per 1933’s Glass-Steagall Act – universal banks are reappearing. America’s experience seems to indicate that banks with a large customer base, such as Citicorp or Bank of America, still provide larger advantages over narrower investment banks. The most pressing enemy of universal banks is prolonged deflation – hence Japan’s current misery. If monetary policy can be fixed to avoid that, universal finance may still be a business model with a future.