Journal of Comparative Economics29, 195–197 (2001)doi:10.1006/jcec.2000.1673, available online at http://www.idealibrary.com on

Hans-Werner Sinn,The German State Banks: Global Players in the InternationalFinancial Markets.Northampton, MA: Edward Elgar, 1999. x+ 144 pp., index,$70.00.

In this brief book, Sinn examines the role of public banks in the German bankingsector. Since the beginning of the 1990s, Germany’s public banks, especially thelandesbanks, have been confronted with steady demands for privatization. They arealso being scrutinized by the European Commission, which is concerned that theseinstitutions may be receiving hidden subsidies that are not allowed under EuropeanUnion rules. Sinn sets out to examine whether such a large public banking systemcan be justified on grounds of economic efficiency. His fundamental conclusionis that the German public banking system is far larger than is appropriate for amarket economy and, given the rapid integration of financial markets in Europe, itshould eventually be privatized, because this would yield net economic gains forthe German economy.

In Chapter 2, Sinn provides a brief overview of the structure of the Germanbanking system beginning with the widely recognized fact that the German stockmarket has long been comparatively underdeveloped and that bank loans representa large share of external company finance. Even by European standards, Germany,along with Switzerland and Austria, has a very large public banking sector amount-ing to about half of all banking business. The author provides background on thelandesbanks, which are the regional clearing banks for savings banks and, in mostcases, are co-owned by land (state) governments and their regional savings bankassociations. The landesbanks are the main focus of this book, because these pub-lic banks are the largest and most actively engaged in direct competition withGermany’s large private banks.

In the third chapter, Sinn reviews the competitive advantages of public banks,which face few, if any, restrictions on their activities and thus engage privateand cooperative banks across the board. He argues that public banks have twodistinct advantages that arise out of the fact that their liabilities are guaranteedby governments. The first is that they are able to make riskier loans than privatebanks. The second is that they can refinance more cheaply because internationalrating agencies take into account this government guarantee. Thus virtually allof Germany’s landesbanks receive the top credit rating. Without this governmentguarantee, these ratings would drop dramatically. Landesbanks derive a furtheradvantage from the relatively low rates of return on equity, coupled with high

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profit retention rates, that their owners (i.e., governments and savings banks) arewilling to accept. Sinn argues that this enables the banks to expand more readilythan private banks that must return more profits to their shareholders.

In Chapter 4, Sinn reviews economic arguments that have been, or could be,used to justify such a large presence for public banks. He starts from the positionthat only market failures and externalities, large-scale economies, or monopolisticmarket structures could provide an economic justification for state banking. Theauthor finds none of these present in sufficient amounts to justify the currentsize of the public banking sector in Germany. He also examines the argumentsadvanced by the public banks themselves to justify their existence, e.g., they enablegeographically comprehensive provision of bank services and encourage savingsamong the population. The argument, widely used in Germany, that public banksprovide a counterweight to the power of the private banks and thus maintaincompetition in banking is considered. However, Sinn finds neither compellingtheoretical argument nor empirical evidence that, in the absence of public banks,there would be insufficient competition or inadequate provision of bank services.

In Chapter 5, Sinn turns to an analysis of the ability of different kinds of financialinstitutions and systems to absorb and consolidate risks. Given Germany’s heavyreliance on bank financing, due to a shallow and relatively illiquid equity market,and the dominance of limited liability firms, the nature of public banks placesthem in a better position to absorb and consolidate the risks of lending than privatebanks because the former share the risk over all taxpayers while the latter canshare the risk only over a small number of shareholders. Thus, given the particularstructure and limitations of the German financial system, an economic argumentfor a large public banking sector could be constructed. However, this is a second-best solution. Sinn views public bankers as more susceptible to moral hazardproblems because of government guarantees and insufficient external monitoring.Customers of public banks receive favored treatment over customers of nonpublicbanks; hence allocative inefficiency results.

In the final, brief chapter, Sinn takes the position that Germany’s financial systemis generally less efficient than a stock market-dominated system. Thus Germanyshould liberalize and develop its equity markets. This would pave the way for theprivatization of public banks with minimal short-term disruptions and maximumlong-term efficiency gains.

Sinn’s book is modest in scope and ambition. It was written originally in Germanand clearly intended to inform an ongoing public policy debate within Germanyregarding the future (read privatization) of public banks. However, within thesemodest aims, Sinn is successful in presenting a theoretically and empirically soundanalysis of public banks and their advantages. While it is clear that his inherentbias is against public banks, he gives equal and serious consideration to argumentsin favor of public banks and does not completely disavow them. Moreover, hisanalysis is useful for analyzing the role and future of public banks throughout theEuropean Union. As the integration and transformation of financial markets in

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Europe accelerates, the fairly large public banking sectors in most European statesare, or will be, confronted with issues similar to those of the German public banks.

Yet even within these modest aims, Sinn could have gone further. First, the bookdoes not tie in explicitly to the recent literature on the role of banks in Germanycorporate governance (e.g. Jeremy Edwards and Klaus Fischer,Banks, Finance,and Investment in Germany, Cambridge: Cambridge Univ. Press, 1994) or to thedebates on the relative merits of bank- versus equity-based financial systems. Sinnprobably overestimates the competitive threat of landesbanks, especially when hesuggests they could become the dominant financial institutions in an integratedEuropean market. He does this because he does not balance his examination ofthe advantages of the landesbanks with an examination of their shortcomings andstructural constraints as market actors. On balance Sinn’s analysis should proveuseful to any debate on public banking.

Richard DeegTemple UniversityPhiladelphia, Pennsylvania 19122