In Germany, it is not uncommon for primary-school children to have their own savings account. A reason for this is that on World Savings Day, savings-bank representatives visit schools all over Germany to educate pupils about the benefits of saving. Besides being clever marketing, this program is rooted in the savings banks’ legal pledge to foster economic welfare: German state law requires savings banks to support the local economy, to provide account access to people from all socio-economic backgrounds, to grant loans to local small-to-medium-sized enterprises, and to educate children about basic economic knowledge. In this, they are quite similar to development banks. In fact, they were founded – and are still owned – by local governments to fulfill this developmental purpose. For these reasons, German savings banks are subject to supervision by local politicians.
What sounds like an innocuous framework necessary to enact welfare-enhancing policy, may come with strings attached: Institutionalized political control via the savings bank’s board of directors creates an opportunity for incumbent county politicians to influence bank activities. Specifically, politicians may push for more lavish lending before an election to boost economic conditions, the mood of the electorate, and, ultimately, their re-election prospects.
To test whether politicians use their power over savings banks with respect to their lending activities, we analyzed a dataset that covers all German savings banks over a time span of more than twenty years. We contrast the changes in savings-bank lending to the lending changes of cooperative banks, which allows us to exclude any factors that might increase lending other than political manipulation, as cooperative banks have a very similar business model to savings banks, but no political linkages. We also compare the behavior of savings banks in states that held an election in any given year with those that did not. These two strategies ensure that we identify causal effects of elections on lending.
Our data confirms that there are strong side effects of political control over savings banks. In an election year, savings-bank lending increases by roughly 1.5% on average, which corresponds to approximately EUR 30 million per bank. We also find suggestive evidence that these extra-marginal loans depress bank profitability, and that they are more prone to default.
Intriguingly, the documented pattern is especially pronounced for counties in which politicians face a highly contested election, suggesting that the costly manipulation of bank activities is reserved for situations when the incumbent’s fate is in real jeopardy. Given the generally beneficial role of political competition for social efficiency, it is remarkable that it catalytically generates unintended consequences, in the form of intensified political rent-seeking, when combined with another principally welfare-enhancing institutional feature necessary to implement the developmental mission of savings banks.
Considering that savings banks constitute an important pillar of the German banking system, and that they are the main lender to private customers and small-to-medium-sized enterprises, it is worrisome to find their policies substantially distorted. Currently, savings banks are exempt from regulation and supervision through the European Central Bank due to their size. Germany lobbied for this arrangement, but our findings raise the question whether this decision is tenable.
Ultimately, whether the documented unintended consequences of government control cause more harm than good, or whether they are an inevitable – but tolerable – concession to adamant political incentives in the process of public-good provision remains a question for future research.
Featured image credit: Piggy Bank by pictures of money. CC-BY-2.0 via Flickr.