Disruption of Financial Services in Germany

By Peter Walburg and Boris Liedtke

The crowdfunding industry in Germany is doing what many European banks are afraid to do — creating value by combining technology and banking. The authors explore the rise of Germany’s crowdfunding industry and how it has affected the way people obtain financial services.

Value creation and profitability at European Banks has languished behind their American counter parties ever since the industry was shaken up following the Global Financial Crises. Contrary to the advice from Winston Churchill, “Never let a good crisis go to waste”, senior management of large continental money banks have done exactly that. They appear to have missed the opportunity to adapt and reinvigorate their business models according to technological changes after the crisis. In an upcoming study by Professor David Young and Dr Boris Liedtke, both from INSEAD, the two argue that the new direction, which European Banks took between 2006 and 2016 was not focused on value creation but instead was driven towards risk reduction and enhanced social accountability while largely maintaining their business model and systems. In fact many have struggled for decades to update the very core IT system that drives their behemothian operations. The share price, price-to-book valuations and the lack of improvement in earnings reflect this missed opportunity. The German market is a case in point.

Deutsche Bank, once the largest private financial institution in the world by assets and among the top ten by valuation, is down to a market capitalisation of less than USD19bn with an alarming price to book ratio of below 25 cents in the dollar. In terms of market value, the largest bank of the largest European economy now ranks far behind American financial institutions – JP Morgan Chase (USD365bn) – and Chinese – ICBC (USD308bn) but is also worth a fraction of once much smaller local players such as Royal Bank of Canada (USD110bn), Commonwealth Bank of Australia (USD92bn) or OCBC in Singapore (USD36bn). The balance sheet of the prime German lender remains full of near-impossible to value tier 3 illiquid assets and billions of partly failed IT project “investments” which are slowly amortising over years. These are leading to its abysmal price-to-book value. The financial outlook of the number two German lender, Commerzbank, which itself is a creation of a merger with Dresdner Bank, does not show a much brighter future. So the two do what prey usually do in such situations: they huddle together fearful about what the future might bring.

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The competition is smelling blood for an opportunity to crack into this economy and have been circling their helpless prey for years. DiBa, a German subsidiary of the Dutch Bank ING has ventured in for the kill. Its business volume and market share in Germany is up in every segment from 2012. It is now serving almost 10 million customers in a country of 80 million people and has grown from a virtual standstill in 2002, when ING acquired DiBa, to a top 10 German Bank by balance sheet assets. DiBa has embraced a new method of delivering financial services, which has totally escaped the traditional private banks’ senior management. Instead of operating with hundreds of retail banks across the country, DiBa maintains only three substantial offices in Frankfurt, Hannover and Nuremberg. Mortgages, current and saving accounts and consumer loans are delivered online backed up with call and data centres to facilitate client contact. As a result, its parent, ING Group, has not only recovered its pre-2008 financial crisis value but even more impressively is now worth three times Deutsche Bank’s entire global operations.

However, worse is to come for the well-remunerated bank managers in Frankfurt as they discussed their failed potential merger of equal “sequel”. A new business disruption is already well under way in revolutionising the industry at a time when they have barely come to grips with the last technology revolution. Some borrowers are becoming sceptical of traditional banks and are flocking towards online portals to raise their funding requirements. The recently published market report by crowdfunding.de illustrates the speed of this disruption. Since 2011, the compounded annual growth rate of the crowdfunding industry in Germany exceeded 110%. To put it differently, over the last 7 years, the industry has on average doubled every year and does not appear to slow down soon.

Initially, the industry was almost purely focused on providing funding to corporations typically in their start-up phase. In 2015, this segment still made up over two-thirds of the entire German crowdfunding market. A year later, investors and borrows alike gained confidence and trust in funding property investments via online portals. Mortgage type lending via crowdfunding exploded and nowadays this segment makes up over 70% of the entire industry. 

In Germany, crowdfunding can roughly be divided into providing for real estate, corporations and energy projects. As is frequent in early developments in a disrupted market, each segment has small but very focused service providers who aim to dominate their segment before branching out into a broader business model. In the largest segment, real estate, a 2014 start-up from Hamburg, Exporo is establishing a comfortable lead. However, the business opportunity and margin pressure on traditional rental and real estate brokers such as Engel & Völkers Capital have broadened the market and will give the listed start-up Exporo literally “a run for their money”.

In the market segment for corporate start-up funding, Kapilendo and Funding Circle lead a highly fragmented field for credit, mezzanine and equity funding. The newest segment, energy project lending is still in its infancies but given the political decision and pressure in Germany on the traditional energy firms such as RWE and E.ON, one can expect a virtual explosion of new energy projects funded via the crowd.

What is most notable in the league tables is the complete absence of any of the traditional banks or even of their more technology savvy recent competitors such as DiBa. The growth field is left almost entirely to new start-ups. This is surprising given the growth of the industry as well as the recurring positive data on minimal defaults of loans extended via online platforms. Since 2011, when data was started to be tracked more closely, crowdfunding in the German real estate sector has had no noticeable defaults and already successfully returned the full principle plus interest on 30% of all loans granted. A recent study by the Federal Government shows that even including financial defaults in the traditionally high-risk start-up corporate funding segment, the entire non-performing loans of crowdfunding since inception remains below 4%.

For the market participants, it is crucial to continuously offer an easy to use platform, which will allow investors to have access to a number of projects at attractive returns with little risk of default. In a low interest rate environment, such as the EURO-zone presently, this is becoming quickly an opportunity for retail investors to shift some of their more liquid savings from a zero-interest paying savings account to a crowdfunding platform with a positive track record. Greenvesting.com is such a firm in the segment of energy lending. It is carving out a niche for specifically green projects in energy and real estate opportunities via its online portal where new projects are constantly offered after in-house financial and ethical scrutiny. Depending on the specific projects, financial annual returns can exceed 6.5%, run from a few months to over a couple of years and have not seen a single default. Slowly, its investor base is expanding while maintaining repeat clients with after-loan services.

As the barriers of first-mover fear are slowly removed and the attractive returns via crowdfunding become the after dinner and pub conversations in Germany, retail clients will increasingly shift towards this industry and drag their friends with them. As a result, traditional banks will undoubtedly see their saving volumes come under pressure as well as feel margin competition in lending products such as mortgages. So far, it would appear that the established financial industry is ignoring this rising threat, while the start-up participants are quite happy to stress the argument that there is presently room for both – traditional banks and crowdfunding; an argument that once was put forward by the combustion engine challenging the horse-and-cart industry over a century ago.

It is impossible to estimate with certainty when this part of the industry becomes a dominant segment of financial services. What can be stated with certainty is that the growth of the crowdfunding industry will not be without risks. A major default, a corruption scandal or another black swan event might cast doubt over the entire industry. Nevertheless, it is certain that the online funding platforms will eventually disrupt the traditional financial services. When this occurs it is to be expected that managers from the established banks will wake up and weigh in heavily with their political cloud to stifle the competition via new regulations and public scaremongering. How well the participants stand up to this future challenge will determine the course of the industry and with that, the service that the broad public will obtain from its banks and their disruptors. 

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About the Authors

Peter Walburg is the CEO and Founder of GreenVesting. He has more than 30 years of investment banking and asset management experience. The economist has worked as an analyst and portfolio manager for leading international financial institutions in Frankfurt and Toronto, and most recently, at DWS, the asset management subsidiary of Deutsche Bank.Peter Walburg lives in the Rhine-Main area and is a member of the German Association for Financial Analysis and Asset Management e.V. (DVFA). As a portfolio manager, he was a member of the Euro Debt Market Association (AMTE) and the International Commission of Standardisation of Corporate Bonds.

Dr Boris N. Liedtke is the Distinguished Executive Fellow at INSEAD Emerging Markets Institute and has over twenty years experience in the financial sector. He was the CEO of the largest bank by assets in Luxembourg and board member for Operations at the largest German fund manager. He is author of numerous articles on finance and trade as well as having received his PhD from the London School of Economics for the publication of Embracing a Dictatorship by MacMillan.