Jürgen Stark: German financial markets - meeting the challenge
Speech by Dr Jürgen Stark, Deputy Governor of the Deutsche Bundesbank, at the Euromoney
Conference, held in Frankfurt, on 19 September 2000.
* * *
It was the Greek philosopher Heraclitus who said panta rhei - that everything is in flux, like a river.
No one steps into the same river twice. All things are subject to change and in constant flow. But it
makes a very big difference which river you step into - the gently flowing Main-river, for example, or
the headwaters of the Rhine-river. As far as the financial markets are concerned, there is much to
indicate that we are caught up in a raging mountain river which is digging a new bed after heavy
thundery rain.
During the past few years, individuals, enterprises, markets, institutions and governments have been
up against a raging current of change in the conditions under which they operate. Remaining passive
in the face of such a development is fatal. It is imperative to take an active role in shaping those
conditions or, at least, to look ahead and adapt to the given circumstances.
In this situation, it is the primary task of the legislature to set the underlying statutory and regulatory
conditions which enable legal certainty, equal opportunity and competition to prevail on the markets
not just nationally, but internationally too. Examples of this to be cited for Germany are the
implementation of EC directives on capital market liberalisation, the construction of an efficient
securities trading supervision, the planned extensive reform of legislation governing stock exchange
transactions and - probably of greatest significance at the moment - the recent tax reform.
It is up to market organisers and market players to create efficient market structures and offer products
that hold out the promise of sustained profits within the given statutory framework in line with the
pursuit of their individual business. Instances of this are the emergence of new stock markets and
stock market segments, and the creation of a large number of derivative instruments.
Following the establishment of the European Central Bank (ECB), the Bundesbank is now an integral
part of the European System of Central Banks (ESCB). The Bundesbank participates in the
performance of the ESCB's tasks with the primary objective of maintaining price stability, and
arranges for the execution of domestic and international payments. Price stability and a functionally
viable financial market structure are the preconditions which permanently have to be ensured so that
there can be efficiency in financial transactions. In turn, efficient financial markets are the
indispensable medium for a predictable and rapid transmission of monetary policy measures. Seen in
that light, monetary policy and efficient financial markets are in a symbiotic relationship.
Although the Bundesbank cannot, on regulatory grounds, take on the role of moderator - or even
promoter - for the financial centre that some market players would like, it is, in fact, always ready to
give active support as an advisor and initiator. The modernisation of German debt management or the
customer-friendly ECB minimum reserve arrangements are illustrations of that. The fact that monetary
policy has been transferred to the European Central Bank allows the Bundesbank to attend more than
before to the continued strengthening of the competitiveness of the financial markets in Germany.
A radical transformation is taking place in the financial sector, driven by the "mega trends" of
globalisation, deregulation, innovation and the use of new technologies. In this connection, the trend
has been strengthened by the introduction of the single currency in Europe. Securitisation was already
one of the dominant trends in the early and mid-nineties. The adoption of the euro has now brought
about a further surge in securitisation and given an additional boost to disintermediation. For the
German credit institutions, the euro means that they no longer have the competitive advantage of the
D-Mark, whereas for others it means that they no longer face the "D-Mark home currency" barrier to
entering the market. Competition is becoming more and more intense within Europe and globally.
Increasingly, credit institutions not only have to withstand growing competition from other banks but
are also competing to a greater extent with insurance enterprises, investment and pension funds as well
as online brokers - in some cases even from within their own groups.
The response to such developments can basically be either consolidation or specialisation.
Consolidation - even if only at the national level - is not an easy undertaking. The past failed attempts
of the big German banks to merge in a range of combinations illustrate how difficult it is to bring
together different corporate cultures and strategies. It may be that the favourable tax treatment of
capital gains from the sale of domestic participating interests from 2002 will provide new impetus for
mergers. Another possibility is cross-border consolidation in Europe with the involvement of German
institutions. However, irrespective of the Common Market and EMU national interests have often
stood in the way of cross-border activities. It is also often argued in this context that, because of the
comparatively strong competition as a result of the density of banks' branches, the majority of German
credit institutions are generally - but especially in retail banking - not profitable enough. To counter
such criticism and create the conditions for cross-border consolidation, further streamlining of the
branch network and the increased use of new technologies therefore seem inevitable.
The introduction of the euro created the essential precondition for the development of a large
supranational euro capital market. The fragmentation into national capital markets - particularly bond
markets - which was essentially due to the existence of different currencies and the resulting
interestrate differentials, can admittedly still be felt. But, under the influence of competition, the previously
national markets are increasingly merging and gradually losing their special features. The immediate
conversion of government issues into euro and the large degree of harmonisation in market
conventions have played a major part in the market becoming more homogeneous.
For a variety of reasons, the emergence of a completely uniform European bond market will scarcely
be possible. Despite a greater degree of coordination, the fiscal, economic and social policies of the
participating countries will, for the present, remain a national responsibility.
That is likewise true of government debt management with its significant repercussions for the capital
markets. Differences in financial standing, liquidity and issuing procedures, and the varying efficiency
with which the cash, futures and repo markets interact in the individual countries will ensure yield
differentials in the case of issuers and issues in the medium term as well.
In that respect, the Federal Government is in a favourable position. Even after losing the competitive
advantage of the D-Mark, it has remained the benchmark issuer and is able to borrow at the
comparatively lowest cost. For that reason, the Federal Government - quite apart from the fundamental
legal reservations against a communitisation of debt management - should hardly be interested in
communitised borrowing under the umbrella of a European debt agency. As experience of the German
Länderjumbos
shows, its financing costs might tend to rise. What should also not be overlooked is the
fact that competition among the individual countries for the lowest possible financing costs has a
healthy influence on budgetary policy and the efficiency of issuing policy.
If the debt agency that is planned by the Federal Minister of Finance does come about - despite many
reservations, not least on part of the Bundesbank - I hope it will be able to maintain or even build on
the present strong position of the Federal Government as an issuer. The Bundesbank is ready to work
together with the debt agency, to bring its expertise to bear and, in particular, to provide all the
operational banking services for it. This would also signal to the markets that setting up the debt
agency does not imply any abrupt paradigm change in debt management. That applies especially to
any apparently politically motivated stronger short-term orientation in borrowing.
Non-government issuers, too, have successfully adapted to the new underlying conditions. Mortgage
banks regularly put "jumbo mortgage bonds" on the market, and place them successfully with foreign
investors as well. The issuers are thereby making use of the fact that institutional investors in Europe
are gearing their portfolios more and more to euro-area-wide investment. "Exporting" mortgage bonds
means that the idea of long-term fixed-rate real estate financing is also being exported. I believe this to
be a good thing since it promotes the stability of the financial system in Europe.
Despite several signs of becoming more popular, domestically issued corporate bonds continue to lead
a somewhat neglected existence in Germany. Above all, because one-half of paid interest on
permanent debts is included in trade earnings, German enterprises are prompted to issue bonds
through foreign financing vehicles. Abolishing that regulation would be desirable but would probably
be realistic only in connection with the abolition or reorganisation of trade tax as such.
Overall, the "corporate bonds" sector is growing sharply in Germany - as it is throughout the euro
area. Lower government deficits - which are made possible by higher tax revenues, the auctioning of
mobile telecommunications licences, privatisations as well as a consistent course of limiting
expenditure, are creating scope for corporate financing through the bond market. Institutional investors
appreciate the enhanced opportunities of portfolio diversification, which bring with them not only
higher yields but also greater risks.
There has been a clear improvement in the "share culture" in Germany over the past few years. Large,
broadly spread issues, such as those of Telekom or of t-online, have played a part in that in the same
way as the extremely successful development of the "Neuer Markt" as a new stock market segment for
young high-growth enterprises. The frequent claim that German investors are risk-shy and prefer
fixed-yield paper has been emphatically refuted over the past few years. The - in some cases
meteoric price increases on the "Neuer Markt" have, if anything, given rise to the fear of widespread
euphoria leading to a lack of discernment. The more reflective mood that has now set in is only to be
welcomed in the interests of a favourable market development in the longer term.
The number and market capitalisation of listed German public limited companies have made great
advances in the past few years:
• At the end of 1995, 527 enterprises achieved a market value equivalent to 
• At the end of 1999, the figure was already 933 enterprises with a market value of
 billion.
• Measured in terms of GDP, market capitalisation is now at 68% compared with 24% at the
end of 1995. This means that Germany is still in a lower mid-table position among the
industrial countries. There exists potential for further growth.
The European stock market landscape is still distinctly fragmented with a large number of market
models, trading and settlement systems. Mergers and close cooperation are inevitable if one wishes to
approach the ideal of the perfect market by means of pooling liquidity and lowering transaction costs.
The Deutsche Börse AG recognised that fact at an early stage and took the lead in that development. In
the "contest of the systems" between "open outcry" and electronic trading in the futures market, it was
consistent in opting for the electronic alternative and thus decided the competition for the Bund Future
- the capital market contract which currently has the highest turnover - in its own favour.
Generally, it seems that the triumphant progress of electronic trading systems - whether it be stock
exchange or OTC trading - is irresistible. Not being bound to a single location, transparency and low
transaction costs are major advantages.
Not all Deutsche Börse AG's plans and projects have been realised. Who ventures much will also lose
sometimes. But who ventures nothing will never gain. As someone said in a recent discussion with
German banks: "There are no failed experiments. There are only experiments with unexpected
outcomes."
It is not just for monetary policy reasons that the Bundesbank is interested in efficient financial
markets and therefore also in efficient trading and settlement systems. As the fiscal agent for the
Federal Government, the Bundesbank is also a major market player in on-the-floor bond trading in the
stock market and in Xetra bonds. The Federal Government and the Bundesbank have been following
Deutsche Börse AG's plans for Eurex bonds as a successor system for Xetra bonds from the outset
and, a few weeks ago, decided on active participation. The Federal Government and the Bundesbank
have declared their expectation that the system will be open to a wide range of participants. In this
connection, I hope that Deutsche Börse AG soon succeeds in the intended linking of the cash, futures
and repo markets and that it can successfully hold its own in competition with other electronic bond
trading systems.
Germany sometimes has difficulties with reforms. In a federally structured state with numerous strong
interest groups, that comes as no surprise. It is therefore all the more gratifying to state that - despite
all the criticism of specific points - a tax reform has been initiated which deserves the name. The tax
reform will bring about a crucial improvement in the conditions for economic activity in Germany. It
will mean a considerable easing of the burden on enterprises and households and create planning
certainty for the medium term. The fact that capital gains from sales of domestic participating interests
are to be exempt from tax in the case of incorporated enterprises will make the - in some cases
overdue restructuring of German groups much easier. With the lowering of corporate tax rates,
Germany will in future occupy a competitive mid-table position in international terms.
What is a problem, however, is that the reform will create further competitive distortions owing to
retained profits being given preferential treatment over the distribution of dividends by incorporated
enterprises, and other sources of taxable income. This will weaken the steering function of the capital
markets. What will prove to be a particular drawback for the financial centre Frankfurt is the planned
tax prohibition on offsetting losses arising from share derivatives against profits from the underlying
shares. Here, a better solution should be found. Another justifiable point of criticism is the continued
failure even to make a start on simplifying the highly complex German tax system. Tax consultancy is
still going to be a growth industry in Germany.
Despite all the satisfaction about tax relief measures, we should not overlook the fact that the tax
burden will still be quite high in Germany, which means that Germany has to maintain a consistent
course of fiscal consolidation. Excluding the receipts from the mobile telecommunications licences,
the fiscal balance in 2000 will show only a slight improvement despite much higher tax revenues. In
the coming year, the structural deficit will increase significantly. In other words: further reductions in
expenditure are required in order to create scope for lower taxes.
Maintaining and enhancing Germany's overall competitiveness - and certainly not just the
competitiveness of its financial markets - is an ongoing task. International investors are looking to how
Germany, as Europe's largest economy, copes with changed underlying conditions. Much has already
occurred or been set in motion in Germany, such as the privatisation of former public enterprises
together with market liberalisation and deregulation in such important areas as telecommunications
and the post services, or price liberalisation in electricity.
What still has to be done is the reorganisation of our social systems in line with foreseeable
demographic developments. The basic features of the statutory pension scheme reform presented by
the Federal Government would contribute to distributing the demographically induced burdens more
equally between the present and future generations of pensioners, but consideration should continue to
be given to raising the actual retirement age. The envisaged capital-backed supplementary pension
would also place the funding of old-age provision on a broader foundation.
What is also needed is to make our labour markets more flexible with the aim of reducing
unemployment, which is still very high. That would also be an essential condition for bringing down
non-wage labour costs - which are extremely high by international standards - in a systemically
appropriate manner.
Regrettably, the reforms that have already been implemented or are planned in Germany as well as in
other European countries have received scant attention up to now outside of Europe. The markets
obviously lean towards an asymmetrical view of things, with matching consequences for the external
value of the euro.
In conclusion, I would like to say a few words on our own behalf. The establishment of the ECB has
created a new level of decision-making in the monetary policy of the countries in the euro area. The
Bundesbank is now part of the European System of Central Banks (ESCB). This means that the
Central Bank Council no longer has the power to decide monetary policy.
What is necessary under the new conditions is to have a uniform management body located in
Frankfurt. This would mean that the provision of Bundesbank services to the regions is not
jeopardised.
The independence of the ECB and of the national central banks within the ESCB is a key feature of
European monetary policy. The "denationalisation" which this achieved was desired by all of member
states and explicitly recognised by the signing of the Maastricht Treaty, which was unanimously
approved by the second chamber of the German parliament representing the Länder or regions, the
Bundesrat. Monetary policy can only be "denationalised", however, if national aspects no longer play
a role in the assessment of monetary policy. That applies all the more to specific regional aspects.
The Bundesbank is ready to adjust. During the past few weeks and months, the President of the
Bundesbank has repeatedly pushed for the necessary measures of reform. As a member of the ECB
Governing Council, he is aware of what kind of reforms are needed. That is not so in the case of
proposals that have recently been put forward elsewhere, which, by contrast, appear to be short of the
basic information about how the ESCB operates. Tackling the reform of the Bundesbank now with all
speed and setting a clear course is something that undoubtedly requires political courage. The
Bundesbank's ability to reform - something which the Bundesbank itself desires - is, however,
indicative of the "reform-ability" of Germany as a whole. This, in turn, lies in the hands of the
politicians. We are waiting for good and forward looking political decisions.