What lessons can the UK learn from Germany’s co-operative banking sector?

Co-operative banks make up about two thirds of all German retail banks, and have a broad customer base made up of individuals and small businesses. But their small size means they only account for about 11% of total bank assets.

The largest banks by assets are private banks, which account for about 36% of total banking sector assets, while publicly owned banks (Sparkassen and Landesbanken) together account for a further 30%.

But co-operative banks are a very important part of the German economy. They are significant lenders to the “Mittelstand” of small and medium-size enterprises, many of them also co-ops, which are the bedrock of the German economy.

Volksbanken and Raiffeisenbanken are owned by their members, who broadly are their customers – depositors and borrowers – although most of the banks accept non-member customers as well. Each member has one vote, regardless of their contribution to the co-op.

Many of the co-operative members are business clients – typically owners or managers of small or medium-sized enterprises: business lending makes up about 28% of all co-operative bank assets. Employees may opt to become members, but as only about 160,000 people in total are employed by Volksbanken and Raiffeisenbanken, their influence tends to be limited. The co-operative financial sector in Germany has about 18 million members.

Shared network

Volksbanken and Raiffeisenbanken are part of a single co-operative network, Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (BVR), giving them access to common clearing, liquidity and risk-sharing facilities through their co-operative “central banks” WGZ BANK and DZ Bank.

Despite this, people familiar with the extensive branch networks of UK banks are surprised to find that they may be charged fees to obtain money from a Volksbank in a different town from their own.

The co-operative banking network operates its own deposit protection scheme, for which each bank pays a risk-related levy. It uses rating methods and individual audits to make sure banks don’t take too much risk, and can take preventive measures, such as requiring a bank to restructure.

In effect, network members guarantee each other’s lending.

Co-operative principles apply not only within individual banks but across the sector as a whole, with stronger banks supporting weaker ones. Risk is also shared to some extent via the central banks (for instance, through securitisation).

This meant co-operative banks could stay small and local, and prevented them from taking excessive risks. Because of this, the German co-op banking sector required no public funds in the recent financial crisis: the few bank failures were handled within the sector itself.

Co-operative banks continued to provide finance throughout the crisis period – in fact increasing lending in 2008-9. The speedy recovery and subsequent robust performance of the German economy is, to a considerable extent, due to the stability and resilience of the co-operative banking sector.

It is also worth noting that countries with smaller co-operative banking sectors generally fared worse in the financial crisis and subsequent recession. Because of this, there has been renewed interest in co-operative banking as a more robust and stable form of banking.

Challenging times

But German co-op banks are facing another challenge in the form of falling interest rates, the result of low inflation and the policies of the European Central Bank.

This is an issue for the co-op banks, which are funded almost entirely by customer deposits, with their capital base growing slowly through retaining earnings and increasing membership.

The current climate forces them to offer lower interest rates on lending in order to be competitive with other lenders – but they are unable to cut deposit rates into negative territory. As a result, income is squeezed.

As non-profit organisations with an overall strong capital base, this is not an immediate problem – but it will over time reduce co-operative banks’ ability to develop services for their customers and provide dividends to their members.

It may also force consolidation in the sector, with weaker institutions merging with stronger to cut costs and gain economies of scale. This would be at the cost of the distinctive offering of the co-operative pillar and dilution of the principles of decentralisation and mutual support that are such a feature of the German co-operative banking sector.

Germany’s co-operative banks are also at risk from the EU’s principle of free movement of capital that encourages savers to seek better returns elsewhere.

Germany perhaps should learn from the UK’s experience: the savings banks were eventually forced out of business by interest rate distortions that benefited commercial banks.

It is to be hoped that German savers will continue to appreciate the stability and local economic support that Volksbanken and Raiffeisenbanken offer, and resist being lured away by higher interest rates in other places.

Message for Britain

Those who argue that the UK should develop a small bank network similar to Germany’s need to be careful what they ask for. The UK’s history and culture are very different from Germany’s: there is no real equivalent of the Mittelstand, and small banks have historically invested mainly in safe assets, either property (building societies) or government debt (savings banks). The one savings bank remaining in the UK, Airdrie Savings Bank, does lend to businesses, but it is only able to do so because of the legal changes in 1975 that forced savings banks to compete directly with commercial banks – and thereby destroyed the rest.

The disaster that has overtaken UK SMEs in the wake of the financial crisis is not fundamentally due to the lack of small banks: business lending in the UK has historically come from larger commercial banks and investment banks (particularly for trade finance), rather than small retail banks.

Rather, the crisis is due to the failure of big commercial banks, and in particular, the lack of medium-sized lending banks following the consolidation of the building societies and their absorption into larger institutions.

There is clearly an opportunity here for UK challenger banks, including mutuals and co-ops, but, as Dr Hans-Detlef Wülker said in 1995: “No country’s co-operative system can be duplicated by another country. Social, economic, historical and ethnic factors in individual countries require a corresponding adaptation.”

As they develop to fill the gap left by the shrinking commercial banks, the UK’s renascent mutual and credit unions can learn from the principles of mutual support and co-operation that have enabled the German Volksbanken and Raiffeisenbanken to develop their extraordinary resilience.

But they should put them into practice in their own way. The UK has its own rich tradition of mutual and co-operative banking. It is time to rediscover it.

Sector’s history rooted in self-help

Co-operative banks in Germany have a long history – they first appeared in the mid-19th century, pioneered by Hermann Schulze-Delitzsch and Friedrich Raiffeisen.

Like many financial co-operative movements, they were originally associated with particular locations or industries. Schulze developed co-operatives in Prussia, while Raiffeisen focused on supporting farmers. From these grew Germany’s extensive network of Volksbanken (“people’s banks”) and Raiffeisenbanken, named after their founder and operating according to the principles he established – self-help, self-administration and self-responsibility.

Other industries, too, developed co-op banks, principally to support their employees. Sparda banks were created by employees of the railway industry and still have a strong relationship with Deutsche Bahn, while PSD banks originated in the German postal service.