German Banks Are Not Such Alert Watchdogs After All

How could it happen? After being rocked by the bankruptcy of real estate developer Jurgen Schneider and by Metallgesellschaft's $1.5 billion oil-trading loss earlier this year, German banks are now facing the failure of

Balsam, an international manufacturer of artificial surfaces for sports facilities, with debts of $900 million.

The conventional view is that Germany's bank-based system of investment finance prevents such scandals, since banks not only take equity positions in companies they lend to but also sit on advisory boards. A recent study by economists Jeremy Edwards of Cambridge University and Klaus Fischer of London's Centre for Economic Policy Research, however, suggests that the banks' role is overstated.

German banks, they report, finance no more corporate investment than banks in the U.S. or Britain, and their equity stakes amount to only 3% of the value of bank loans to the nonfinancial sector. Moreover, German banks usually secure their loans with collateral, thereby lessening their incentive to monitor companies closely.

Thus, the view that close bank supervision helps ensure the sound performance of big corporations seems exaggerated. These days, a lot of German banks would probably agree.