This week the 10-year German bund yield hit a new record low of -0.33% in the wake of Draghi’s Sintra speech which had echoes of his 2012 “whatever it takes” declaration. Why so dovish? Manufacturing data from the eurozone has been universally bad lately, and inflation expectations are collapsing. The core inflation rate is now just 0.8% and the ECB’s 2% target looks an impossible goal. The market expects that, on top of the previously announced TLRTOs (cheap money for banks to encourage them to lend) and dovish forward guidance, the ECB may cut the deposit rate further from -0.4% and restart quantitative easing.
Germany had been a bright point of eurozone growth until a year ago. Annual GDP growth hit 2.8% at the end of 2017 with its export-led economy benefitting from strong global activity. However, as China slowed, Trump’s trade wars began, and with a perfect storm of factors leading to the stalling of auto sales, that annual growth rate has fallen to just 0.7%.
In the “good years”, the German unemployment rate fell sharply. It remains around 5%, down from over 8% a decade ago, and wage growth has been strong (+4.6% year on year). Yet consumption growth has been mediocre. The German household is famously a saver, not a spender. Private consumption growth has averaged just 1% per year since 2006, well below wider economic growth.
Back to the ECB. One of the factors that it has identified as holding back economic growth in the eurozone is the weakness of the region’s banks. In this paper from earlier this year, the ECB says “clearly, bank profitability matters for financial stability. Profits are the first line of defence against losses from credit impairment. Retained earnings are an important source of capital, enabling banks to build strong buffers to absorb additional losses. Those buffers ensure that banks are able to provide financial services to euro area households and businesses, even in the face of adverse developments, thereby smoothing rather than amplifying the impact of negative shocks on the real economy. Euro area banks have certainly improved their profitability in recent years. Their return on equity reached 6% at the end of 2018, up from 3% two years earlier. But their profitability remains below their long-run cost of capital, which most banks estimate to be in the range of 8-10%. Low profitability prospects translate into low bank valuations, as observed in price-to-book ratios well below one, hindering the ability to raise capital, where needed. Why do eurozone banks have lower profitability than their global peers? In part, there are way too many of them. This paper from the European Parliament says that “large European banks only earn half to three-quarters of what their American peers do relative to their asset base. Competition dynamics limit banks’ ability to charge fees”. In Germany, just 31.4% of total assets are at the 5 largest credit institutions; this is the second lowest percentage in the eurozone. Germany is arguably overbanked.
So, we have weak household consumption, and too many lowly profitable banks in Germany. What could kill two birds with one stone? Demutualising the German public savings banks, the Sparkassen.
There are over 400 German savings banks, with 50 million customers. These are run as commercial operations, but tend to be owned by cities, regional governments and charitable foundations. Some suggest that the low emphasis on profits, and “clubby” relationships with the businesses they lend to, result in a reluctance to deal with loss-making enterprises – a “zombification” of industry. Whether you think this is good or bad will depend on whether you think that keeping loss-making businesses alive holds back other ventures with higher growth/job creating potential. Their total assets are around €1 trillion, around 15% of Germany’s total banking assets. Politicians tend to be heavily involved in the running of these savings bank – in fact the Bruegel think-tank found that in North Rhine-Westphalia, politicians who chair a Sparkassen board receive an average of 12% of their income for doing so.
What would the demutualisation of the Sparkassen achieve? The UK gives some lessons, both good and bad. As a reminder, the 2007 Building Societies (Funding) and Mutual Societies (Transfers) Act (the Butterfill Act) allowed the UK’s 59 building societies to merge or demutualise. Around 15 of them did so, including Abbey National, C&G, Alliance & Leicester, the Halifax and Northern Rock. Savers in those institutions received a “windfall” of cash or shares. If you were in the Lambeth you got £500, whilst 7.5 million Halifax customers got 333 shares each, which were worth over £2000. This operated a little like helicopter money, although arguably the economy wasn’t in need of the stimulus at the time. The move from mutual to private ownership of the “builders” allowed many of them to merge or be acquired (the Woolwich went to Barclays for example). So there was less fragmentation in the banking market, and consumers received a boost, which is significant to many.
As well as being overbanked, Germany has a very weak equity culture. Only 13% of the population own shares (2014 data), compared with nearly half of American households – and the German number has been falling (down a third since 2001), meaning that households have not participated in the wealth effect of rising stock markets in recent years. Many Germans were frustrated by taking part in the popular Deutsche Telekom flotation, and as a result never bought shares again.
So, demutualisation of the Sparkassen could a) release windfall gains for German consumers and boost growth, b) provide less competition and boost profits for the banking sector (a double-edged sword this one, I know) and thus the wider economy, c) economies of scale and consolidation would improve banking efficiency, and d) there would be an equity market participation boost for German households.
So, did it work out well for the UK building societies? Up to a point, Lord Copper. Not one of the demutualised societies still exists as a separate entity, and some, like Northern Rock, went bust spectacularly. This excellent post-mortem from Phillip Inman suggests that only the CEOs benefitted from the demutualisations. And it is likely too that reduced competition in German banking, and higher fees, would reduce some of the macro benefits of a stronger banking sector, as well as eroding some of the “windfall” consumer gains.
A final thought. Does Germany “need” bright ideas to help it grow? In my years in bond markets, economists and strategists have been coming up with bright ideas to help Japan out of its terrible plight. This plight involves an almost negligible unemployment rate, low crime, high education, social cohesion and high levels of wealth per capita. That’s not much different from Germany today. Is low growth such a bad thing? Discuss.