Corporate Governance and Current Regulation in the German Banking Sector: An Overview and Assessment

The recent financial crisis has put the German banking sector under enormous pressure. Besides the macroeconomic drivers like, for example, the expansionary monetary policy in major countries, insufficient risk management and weak corporate governance systems have been identified as the main reasons for the financial crisis. In Germany, corporate governance is weakened by the three-pillar structure of the German banking system that reduces the power of market for corporate control. Furthermore, the large ownership stake of the government in the German banking sector weakens corporate governance, since government officials may have other interests than private shareholders and may be less motivated to monitor the management. Politicians may also be less educated and experienced to fulfil their role as monitor of bank managers. This corresponds to the results of a recent OECD report on corporate governance in the financial sector (Kirkpatrick, 2009). The report identifies adverse incentives created by remuneration schemes together with insufficient monitoring by the supervisory board as one of the main reasons for the financial crisis. To improve corporate governance the German government has started several initiatives in the past two years. They mainly focus on improving the risk management of banks, on reducing the incentives for managers to increase short-term profits created by remuneration schemes and on further professionalizing the supervisory board. To reduce the incentives to take large risks, remuneration schemes for managers must, for example, in future be geared toward long-term performance and also reflect negative business trends, while the supervisory board must, henceforth, include at least one person that has the required knowledge, abilities and expert experience to properly fulfil his monitoring tasks. This should particularly improve corporate governance in the public sector where members of the supervisory boards are often based on their political affiliation and not based on their experience and skills. Problematic is that several laws that were enacted in the past years to improve corporate governance focus on listed firms. Furthermore, the recommendations and suggestions made by the German Corporate Governance Code are not legally binding even for stock corporations. In particular, most Landesbanken have so far abstained from applying the code and enacted their own corporate governance guidelines. This reduces the comparability and transparency of corporate governance standards in particular in those banks that have shown the biggest corporate governance problems during the recent financial crisis. Recent empirical evidence, moreover, suggests that shareholders pushed for greater risk-taking and not managers. This contrast with public view that the bank managers are pushed by aggressive remunerations schemes to increase risk-taking. This indicates that the recent legal and regulatory changes fail to remove all weaknesses of the German corporate governance system.

Köhler, Matthias (2010), Corporate Governance and Current Regulation in the German Banking Sector: An Overview and Assessment, ZEW Discussion Paper No. 10-002, Mannheim.