Guinnane on Burhop, _Die Kreditbank en in der Gründerzeit_

[eh.net-review at eh.net]

Published by EH.NET (February 2008)

Carsten Burhop, _Die Kreditbanken in der Gründerzeit_. Stuttgart: 
Franz Steiner Verlag, 2004. 279 pp. ¤38 (paperback), ISBN: 
3-515-08413-4.

Reviewed for EH.NET by Timothy W. Guinnane, Department of Economics, 
Yale University.


Ever since their appearance in the 1850s, Germany's large, universal 
banks have been the object of admiration, fascination, and sometimes 
fear. Throughout the nineteenth century they grew in size and 
influence, provoking worries that they were responsible for an 
unhealthy concentration of wealth and power. A long tradition assigns 
to these banks a central role in Germany's late but rapid 
industrialization. Most economic historians have at least heard of 
them via the work of Alexander Gerschenkron, although for some 
reason, Anglo-Saxon scholars are only aware of Gerschenkron's 
admiring comments. He, too, was skeptical of their power in the 
Germany economy, a point that usually gets lost in secondary accounts.

Despite all the interest, many discussions of the Kreditbanken, as 
they are known, rested on a weak scholarly basis. Most accounts 
relied on close knowledge of a small number of banks, usually the 
very largest. Richard Tilly began to remedy this weakness in the 
1960s (Tilly 1966, 1986). More recent studies have been even more 
skeptical of earlier claims about the banks; Edwards and Ogilvie 
(1996), for example, effectively demonstrate the implausibility of 
most admiring claims about the Kreditbanken. In an extended project 
that began with her dissertation, Caroline Fohlin has zeroed in on 
several of the main claims about these banks' distinctiveness. Her 
recent book (Fohlin 2007) extends her original focus on the bank's 
role in firm governance to broader questions, including the 
connection between the banks and the performance of German securities 
markets.

The book under review here is part of this re-assessment. _Die 
Kreditbanken in der Gründerzeit_ was originally a doctoral 
dissertation completed at the University of Bonn in 2004, but has 
served as the starting point and basis for a great deal of 
subsequent, detailed research on this theme. The dissertation itself 
reports the basic results of extensive, well-conceived primary 
research on the banks. The later papers draw on this research to 
examine several specific features of the way the banks operated. Not 
all of the later papers have been published yet, but I expect them to 
appear in due course in international journals. The dissertation 
itself will probably never appear in English. Given its quality, it 
warrants extensive comment.

The book has four substantive sections. The first section provides an 
outline of the economics of banking and the German economy in the 
period of this study, usually 1870-1879. Burhop is to be commended 
for a clear, cogent explanation of the central role of informational 
asymmetries in banking structure. The second section works through 
the basic accounting measures of bank size and performance, 
illustrating how different business strategies led to different types 
of risks and returns. Many readers will find this dry, but its 
clarity makes it worth close reading. The third section traces the 
early days of selected Kreditbanken. The strength of this section is 
to demonstrate, as only a series of case studies can, the great 
diversity in the origins, strategy, and early results of the several 
banks. The fourth substantive section focuses on the defining feature 
of universal banks, which is their role in underwriting securities. 
Here Burhop again relies on a selection of specific bank histories to 
make his points about the role of the banks in German securities 
markets.

The dissertation per se has two great strengths, both of which will 
spill over into the later research. The first is the care with 
selecting the banks for study. Burhop starts with a "universe" of all 
credit banks defined by earlier studies, but is unusually careful in 
accounting for the fact that some are missing crucial information, 
and some exit the sample before the end of his period because they 
failed. By augmenting this information with archival material for a 
selection of banks, he has achieved a good representation of the best 
of both worlds: completeness of coverage, but also depth on some 
banks. The second strength is his ability to bring to bear on the 
German banking literature what in another context might be viewed as 
simply good accounting. Burhop carefully and clearly explains how 
different banking strategies, and experiences, led to different 
returns on invested capital, and difference sources for those returns.

The dissertation is long on specifics and short on generalizations. 
But two themes run through the results. First, two historical events 
combined to produce the Gründerboom in which the early Kreditbanken 
flourished. The first was France's quick payment of the indemnity 
imposed after the Franco-Prussian War; many German governments paid 
off most of their debts, leaving investors looking for new places to 
park their money. Bankers were happy to oblige. The second, and less 
emphasized, event was the introduction of general incorporation. 
Prior to 1867, entrepreneurs could not form a joint-stock firm 
without the specific permission of the state. Prussia and other 
German states had been very tough about granting this concession. 
With liberalization many new firms were formed, some of them Burhop's 
banks. Just as importantly, founding new firms was an important 
activity for the new banks. The literature on German banking history 
has always stressed the role of the French indemnity, but has had 
less to say about the important change in company law.

Burhop also is fond of noting some ironies in the timing of bank 
formation. Banks that were started in 1870 and quickly got involved 
in the securities business often just as quickly regretted it -- the 
equity market crashed in 1873, leaving some banks with securities 
they had underwritten and could not sell. Banks that had the 
"misfortune" of a late start actually did better than those who got a 
head start.

Two articles that emerged from the dissertation project give a sense 
of the range of questions these banks raise. One article uses the 
methods of time-series econometrics to ask whether the banks 
"caused," in the statistical sense, Germany's industrialization 
(Burhop 2006). What one thinks of such exercises is partly a matter 
of taste; for my money, this kind of research has a useful but 
limited role to play in developing our understanding of the way 
financial institutions contribute to economic development. Burhop 
(2004) digs into the way the banks compensated their executives, more 
than a few of whom were among the bank's founders. Many readers will 
be amazed to learn that the banks often devoted large proportions of 
their net revenues to incentive schemes for managers. In the early 
1870s the managers (Vorstand) of the Därmstadter Bank, for example, 
took around ten percent of bank profits in their capacity as 
managers, and not as share owners. These incentive payments were a 
huge proportion of their total pay from the bank; for the top 
managers, incentive pay was more than 80 percent of total 
compensation. This payment system raises all the questions we 
associate with the stock-options scandals of the 1990s and early 
twenty-first century in the United States. One could ask how much 
these payments were really the fruit of high-powered incentives 
needed to propel managers to hard work, and how much reflected cozy 
relations with the entities responsible for setting their pay.

The dissertation and later articles mark an important step in our 
better understanding of the German Kreditbanken and their role in the 
German economy. The combination of careful empirical work, sensible 
use of economic and financial theory, and broader understanding of 
the German economy are just what is needed in research on these and 
other financial institutions.

A Bigger Picture

Much of the recent literature on the German Kreditbanken has 
maintained an almost claustrophobic focus on these banks alone, to 
the exclusion of the rest of the German banking system. There are 
good and bad reasons for doing so. Burhop (and Fohlin, and others) 
are certainly justified in arguing, explicitly or implicitly, that 
the Kreditbanken were the only part of the system that were 
individually large institutions, that they were the only banks that 
usually had a country-wide presence, and that they were the primary 
source of finance for industry especially. And while they might not 
have been entirely unique (in the strict sense of that word) the 
German Kreditbanken's methods were sufficiently different from banks 
in other major economies in the nineteenth century that it is 
understandable that scholars such as Alexander Gerschenkron assigned 
to the Kreditbanken a major role in Germany's industrialization and 
development. As such they are worthy of detailed study. In any case, 
we all have to specialize, and there is no sense in which a scholar 
of these banks should be criticized for not studying something else.

But we should not accept the implication (by omission, at least) that 
the other parts of the banking system are not worth close study. In 
addition to a number of specialized banks for mortgages and other 
purposes, the German banking system had two other classes of 
institutions largely unfamiliar in the Anglo-Saxon world: credit 
cooperatives (Kreditgenossenschaften, but also called by several 
other names) and savings banks (Sparkassen). For the cooperatives the 
reader can refer to my own work (see, for example, Guinnane 2001 and 
2003). One would be hard-pressed to assign to these individually very 
small institutions any major role in German economic development; 
their importance (at least to me) rests on the intellectual issues 
they raise, although they clearly mattered to their owners, 
borrowers, and depositors.

The more important current lacuna in the literature concerns the 
Sparkassen. The Sparkassen were, collectively, larger than the 
Kreditbanken, taken together (see Guinnane 2002, Table 1). The 
Sparkassen and their regional affiliates, the Landesbanken, were 
owned and controlled by local authorities, either a city or a 
regional government. As such their depositors enjoyed an iron-clad 
deposit guarantee (unless the government itself went bankrupt, which 
was not a realistic fear until after World War I). The Sparkassen 
were intended to provide a safe place for working-class deposits, but 
contemporaries were aware that most Sparkassen deposits actually came 
from middle-class and professional households who lacked good 
alternatives at other banks. Here we see the first question one might 
pose about the relationship among the various classes of German 
banks: as Burhop notes, the Kreditbanken did not begin to take 
deposits in the modern sense until the 1870s, and as late as World 
War I, retail deposits were not a significant part of their 
liabilities. Instead, most large German banks had very low leverage 
ratios; they were, in effect, lending mostly their own money. This 
meant the banks had to worry less about the liquidity of their loan 
portfolios (owners cannot as easily "run" on the bank as can 
depositors) and reduced the information problems associated with 
lending someone else's money.

Burhop and others have noted the importance of this fact for the 
lending practices of these banks, but none, to my knowledge, ask what 
it had to do with the strength of the Sparkassen (and to a less 
extent, the credit cooperatives). I can think of two hypotheses to 
explore. First, how much of the Kreditbanken's policies were in 
effect forced on them by the difficulty of raising deposits in the 
face of these competitors? One might think that Kreditbanken would 
not only have to pay higher interest rates to pry depositors away 
from the Sparkassen; such depositors might also be more likely to 
"run," given the safe haven of the Sparkasse, often literally down 
the street. Second, as in most countries, the German banks were 
periodically the objects of political fears about their size and 
power. In the United States, the development and persistence of the 
unit banking system owes much to two specific concerns. One was the 
generalized fear of large financial institutions. A second was the 
more specific fear that regional banks would "siphon" capital out of 
an area to invest at higher rates elsewhere; that is, local savings 
would not be available to fund local investments. Scholars familiar 
with the history of banking in the United States will wonder whether 
the credit cooperatives and the Sparkassen reduced the fear of large, 
centralized banking institutions in part by giving any locality in 
Germany a simple way to create its own banking institution that would 
provide services even if Berlin bankers were not interested.

Another important outstanding question concerns Sparkassen loan 
portfolios. Most scholars simply repeat the assertion that the 
Sparkassen lent most of their funds to governments and put the rest 
in very safe mortgages. Most accounts claim these banks almost never 
lent to industry. A few accounts, on the other hand, claim just as 
baldly that they routinely did. I know of no study what would justify 
either opinion. We can probably safely assume that prior to World War 
I, when the Sparkassen were empowered to take on many of the roles of 
a universal bank, their involvement with industrial lending was 
minimal. But there are two possible objections here. First, we need 
to know more about what the Sparkassen actually did on the lending 
side. Assertions, no matter how confident or time-worn, are not a 
good substitute for research. Second, we need to ask what indirect 
roles the other parts of the system played in industrial lending. 
Here the questions become more speculative. One could imagine, for 
example, that a well-functioning system for mortgage lending made it 
easier for firms and cities to finance the large-scale infrastructure 
projects (such as electrification) that were so important to the 
Kreditbanken's customers. In any case, even if the Sparkassen did 
little direct lending to industrial firms, it strains credulity to 
believe that institutions of this size had no indirect impact on 
German industrialization.

Burhop (and Fohlin, and the others who have built this reassessment 
of the Kreditbanken) are to be commended for setting the operation 
and characteristics of these banks on much firmer empirical and 
theoretical foundations than had ever before been the case. Burhop in 
particular has, in my judgment, made a major advance in the research 
reported here and elsewhere. But we need someone else, probably 
several scholars, to follow up on the Sparkassen. When I began my 
research on the credit cooperatives, a number of German economic 
historians were overtly contemptuous of the idea of spending any time 
on what they viewed as quaint, irrelevant institutions. I can only 
hope that those embarking on a career in banking history today will 
not be put off by the similar attitude toward the Sparkassen. If we 
are going to understand how banks contributed to the development of 
the German economy, we need close study of all its banks.

References and further reading:

Burhop, Carsten, 2004. "Executive Remuneration and Firm Performance: 
The Case of Large German Banks, 1854-1910." _Business History_, 46 
(4), October 2004, 525-43

Burhop, Carsten, 2006. "Did Banks Cause the German 
Industrialization?" _Explorations in Economic History_, 43 (1), 
January 2006, 39-63

Edwards, Jeremy and Sheilagh Ogilvie, 1996. "Universal Banks and 
German Industrialization: A Reappraisal." _Economic History Review_ 
49 (3): 427-446.

Fohlin, Caroline, 2007. _Finance Capitalism and Germany's Rise to 
Industrial Power_. New York: Cambridge University Press.

Gerschenkron, Alexander, 1962. "Economic Backwardness in Historical 
Perspective," in _Economic Backwardness in Historical Perspective: A 
Book of Essays_. Cambridge, MA: Harvard University Press.

Guinnane, Timothy W., 2001. "Cooperatives as Information Machines: 
German Rural Credit Cooperatives, 1883-1914." _Journal of Economic 
History_ 61(2): 366-389.

Guinnane, Timothy W., 2002. "Delegated Monitors, Large and Small: 
Germany's Banking System, 1800-1914." _Journal of Economic 
Literature_ 40: 73-124.

Guinnane, Timothy W., 2003. "A 'Friend and Advisor': External 
Auditing and Confidence in Germany's Credit Cooperatives, 1889-1914." 
_Business History Review_ 77: 235-264.

Hakenes, Hendrik, and Isabel Schnabel, 2006. "The Threat of Capital 
Drain: A Rational for Public Banks?" Preprints of the Max Planck 
Institute for Research on Collective Goods.

Tilly, Richard, 1966. _Financial Institutions and Industrialization 
in the Rhineland, 1815-1870_. Madison: University of Wisconsin Press. 
			 Tilly, Richard, 1986. "German Banking, 
1850-1914: Development Assistance for the Strong." _Journal of 
European Economic History_ 15 (1): 113-152.

Wixforth, Harald and Dieter Ziegler, 1994. "The Niche in the 
Universal Banking System: The Role and Significance of Private 
Bankers within Germany Industry, 1900-1933." _Financial History 
Review_ 1(2): 99-120


Timothy W. Guinnane is the Philipp Golden Bartlett Professor of 
Economic History in the Department of Economics at Yale University. 
Current projects include a comparative history of company law, with 
Ron Harris, Naomi Lamoreaux and Jean-Laurent Rosenthal, focusing on 
France, Germany, the United Kingdom and the United States in the 
period 1800-2000 (see "Droit et capital à l'épreuve de l'histoire: 
l'essor des sociétés á responsibilité limitée" forthcoming in 
_Annales E.S.C._, and available in English as SSRN paper #1071007); 
and continuing work on German cooperatives and their role in the 
banking system.

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