TAILIEUCHUNG - CHANGES IN GERMANY’S BANK-BASED FINANCIAL SYSTEM: IMPLICATIONS FOR CORPORATE GOVERNANCE

One important principle of the 1936 legislation was mandatory specialization. The law distinguished between commercial banks (specializing in short-term business, ., shorter than 18 months) and special credit institutions (operating in medium- and long-term busi- ness and specializing in one particular sector – agriculture, building, public works, indus- try, or the Mezzogiorno). Moreover, since 1973, banks had been subject to a “portfolio re- quirement” and a credit ceiling for loans to the private sector. The former required banks to hold a minimum amount of medium- and long-term government or government-guaran- teed bonds, while the latter was an explicit quantitative ceiling on the amount of loans to the private. | CHANGES IN GERMANY S BANK-BASED FINANCIAL SYSTEM IMPLICATIONS FOR CORPORATE GOVERNANCE Sigurt Vitols Forthcoming in G. Jackson and A. Moerkes guest editors Corporate Governance An International Review. Special Issue on Germany and Japan Vol. 13 Issue 2 May 2005. 1. Introduction One of the most basic concepts in comparative political economy is the distinction between bank-based and market-based national financial systems Deeg 1999 World Bank 2001 Zysman 1983 .1 Although financial systems as a rule include both banks and markets bank-based systems are distinguished from market-based systems by a number of characteristics a greater proportion of household assets are held as bank deposits stock markets tend to be smaller and less liquid and bank loans account for a greater proportion of company liabilities. This difference has implications for company finance and corporate governance. Bank financing is understood to be more suited to low-risk investment in capital-intensive incrementally innovating manufacturing companies. Market based finance and in particular equity finance in contrast is better able to support higher-risk companies such as start-ups. Furthermore banks play a much more significant role in corporate governance in bank-based systems than in market-based systems Hall and Soskice 2001 . Germany has long been known as having one of the most bank-based financial systems in comparative context see section 2 for an overview . With regard to corporate governance German banks have played a particularly significant role in monitoring the behavior and influencing the strategies of large companies. This role has been supported by multiple relationships between banks and companies banks are not only the major providers of external finance in the form of loans but also are the most influential shareholder in many companies through a combination of direct shareholdings and of the control of voting rights on shares deposited with them by customers. Furthermore banks

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