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Lessons from history V: Banking separation (3/3) Why Europe did not copy the Glass-Steagall Act?

The separation of investment and commercial banks was adopted by US Congress in 1933. Today, EU banks oppose separation. They invoke a cultural difference with America, and a strong tradition in favour of universal banking in Europe. But what they don’t tell you is that back in 1933, separation had many advocates in Europe, and the model of universal banking was deeply questioned.

The crisis of 1929 started in the United States. But, like the 2008 financial crisis, it rapidly spread to the rest of the world. In 1931, the largest Austrian bank, Creditanstalt, went bankrupt. In Germany, Darmstädter bank also had to be liquidated. The economic crisis that followed in the 1930s struck Europe as badly as it struck the United States.

It took a few years for policymakers to react. In 1933, under the newly-elected President Roosevelt, US Congress adopted the Banking Act, which is known as the Glass-Steagall Act, to separate investment and commercial banks (see previous article). On the other side of the Atlantic, European policymakers were perfectly aware that a reform of the banking structure was necessary. Yet, Europe did not follow the path of the United States. Should this be interpreted as evidence that there is a culture of universal banking in Europe, as banks now argue? Or does Europe’s continuation with universal banking have another explanation?

The German model

Then, as now, London was the financial capital of the world but its banking culture was radically different from that of continental Europe. Until 1945, the United States constantly tried to emulate the British model of banking. There were thus two different models of banking in the 20th century: the Anglo-Saxon system and the continental European system. And the key to understanding continental banking was Germany.

Within continental Europe, French banks used to be the leaders of the financial industry. But when Germany was unified in 1870, politicians believed that the construction of a strong German banking industry was an important element of the economic unification of the new nation. At an astonishing pace, four international banks developed. They were called the “D-Banks” because they all started with D (Deutsche Bank, Disconto-Gesellschaft, Dresdner Bank, and Darmstädter-und-Nationalbank). In 1874, after just four years of existence, the thriving Deutsche Bank managed to open offices in London, New York, Paris, Shanghai and Yokohama.

German banks perfected the French tradition and developed in close proximity with industrial companies. For example, one of the first managers of Deutsche Bank was Goerg Siemens, a relative of the founder of the electrical firm Siemens. This proximity was and still is the distinctive feature of German banking, even if some German banks also imitated their American counterparts by developing large trading activities during the 1990s and 2000s.

Back to the interwar period, it was clear that Germany, and not France, was the alternative to the English model. Some European countries did separate industrial and commercial banks. For example, in 1933-34, Belgium adopted something very similar to the Glass-Steagall Act. Belgian “banques de dépôts” were only allowed to grant short-term credits (with a less than two-year maturity). But the fate of universal banking in Europe was to be determined in Germany.

The Nazis’ ambiguity toward banks

The big year for post-1929 reform of the banking structure was 1933, the same year Hitler gained power. So the Nazis were immediately confronted with financial issues. Ideologically, Nazi background tended to be strongly anti-capitalist. Large international banks were associated with Nazi fantasies of capitalist/Jewish domination over the German nation. However, the Nazis made industrial planning a top priority. Rearmament of the country required huge amounts of capital. So banks were to play a key role in the economic policy of the Third Reich. But they were still recovering from the hyperinflation of the interwar, followed by the 1929 crash. The financial industry was in poor shape.

Instead of splitting large yet fragile banks, which was the initial plan, Nazi authorities decided to use them to place government bonds and finance the state. Several times in the 1930s, when banks were unable to find buyers for bonds because of the growing isolation of the German financial market from the rest of the world, major banks were forced to buy the bonds themselves. The Nazis rapidly realized that they could use the banks to their own advantage.

In the late 1990s, revelations about the involvement of German banks in the Nazi regime prompted Deutsche Bank to designate independent historians with full access to archives (see also Deutsche Bank’s Historical Institute). Among those historians was Professor Harold James. In 2004, he published “The Nazi Dictatorship and the Deutsche Bank”. The book demonstrated that major banks had also preserved their political power by participating in the expropriation of the Jews. The process was called the “aryanization of the economy”. It started with the dismissal of Jewish directors, and it went as far in details as reducing the pensions of retired Jewish employees. This was followed by the systematic expropriation of Jewish assets, what Harold James called the “Nazi economic war against the Jews”.

A culture of universal banking?

Banks are very powerful political actors. Major reforms can only be enacted in specific periods, when political momentum provides windows of opportunity. In the 1930s, Europe could not use the momentum of the 1929 crisis, because it was entangled in much more dramatic political issues. What history is telling us here is that bank structures are not determined by some never-changing European “banking culture” but are the result of pragmatic choices made by governments in response to the political needs of the day.

In 1933, continental Europe might well have imitated the American Glass-Steagall Act had it not been for the rise of totalitarianism and the events that led to the Second World War.

Fabien Hassan

For more on Finance Watch’s views on bank separation today, click here.

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