5. Germany’s Integration into International and European Financial Markets

Germany abolished all controls on international capital flows in 1981 and, in the course of the 1980s, the country’s international financial integration increased steadily, but from a low base. Between the late 1990s and 2008, when Germany generated a large current account surplus, international financial integration increased strongly, with a marked growth of both portfolio investment and bank lending from Germany to other countries. The bank lending was predominantly to other European countries, with the largest part going to Euro area countries. German banks also extended their lending in the US during this period and, in addition to funds from Germany, German banks drew extensively on funds raised in the US itself. As a result, German banks were strongly exposed to the financial crisis when it broke in the US in 2007. Following the dramatic deepening of the crisis in September 2008, German international financial integration was partly scaled back and German banks reduced their lending abroad at the same time that there was an outflow of foreign funds held in German banks. However, as a result of increased international financial uncertainty following the outbreak of the financial crisis, there was a large inflow of funds from other countries into German government bonds, which consequently registered unprecedentedly low interest rates.