A Major Defect in the German Banking System Is That Bankers Stopped Being Bankers in the Classical Sense of the Term

The events of the last few weeks have made obvious to everyone the defects in the German and Austrian banking systems, which previously were recognized by only a few.

At least until very recently, English and American banks have acted, in principle, purely as bankers in the classical sense of the term. That is, they have viewed their primary business to be the lending of money. The development of German banking activity made them not merely banks but also put them in the business of being industrial holding companies and investment trusts. This development did not occur through any logical process. In the beginning, German banks also limited themselves to the granting of credit. They ended up becoming partners in the businesses to which they had granted credit because they lent too much to these enterprises in proportion to their own capital. These banks were plunged into difficulties when there were attempts for immediate conversion of those enterprises’ stocks and debentures into cash.

Gradually, banks were pushed out of the role of creditor into the role of the chief interested party. As a result, these banks no longer faced those enterprises with the critical eye of a banker who carefully judges the businesses’ prospects as debtors, and who constantly evaluates the borrower’s creditworthiness in order to limit or withdraw lines of credit if changing circumstances warrant it. These banks no longer looked at businesses’ activities from the standpoint of a lender but from the viewpoint of the borrower. When the monitoring function that the lending institution normally exercises over businesses fell by the wayside, an essential regulator of the money market disappeared in fact if not in name.

The news media would appropriately offer strong criticisms of any combination of the banking business with production and trading activities, when individual enterprises and business firms made attempts to publicly raise investment money. But it was overlooked that at many respected banks that had readily put money into risky ventures (including three major banks in Vienna and Berlin that have recently failed) conditions were no better. The independence of these banks from industrial enterprises was in many cases purely formal in the legal sense.

The representatives of the banks who had to decide on the granting of credit were, unfortunately, in many instances, identical with the representatives of the debtors who appealed for loans and credit expansion. When writers on the economy spoke out against this combining of banking and industry, those in banking labeled them ivory-tower theoreticians. Modern conditions, it was said, absolutely demand the amalgamation of banking and industry. The failure of this system clearly proves who was right. The more cautious the bank was in the establishment of its associations, the better off it is today.

The most pressing reform that must be pushed for is the elimination of the existing close ties between the banks and industrial combinations. Everyone agrees with this. Of course, this goal can be only slowly achieved. It will be years before it will be possible to transfer the large debts of many enterprises from the banks to the public through the issuing of stocks and bonds. Recent experience has caused severe mistrust of stocks and bonds issued by industry, and this mistrust will not be quickly overcome. But the distrust is even stronger against stocks issued by banks, due to the serious doubts about their connections with industry.

—Ludwig von Mises, “The Economic Crisis and Lessons for Banking Policy,” in Selected Writings of Ludwig von Mises, vol. 1, Monetary and Economic Policy Problems Before, During, and After the Great War, ed. Richard M. Ebeling (Indianapolis: Liberty Fund, 2012), 296-298.