ABSTRACT. The financing of small and medium-sized firms
is important for the catching-up of the East German to the
West German economy since reunification. We explore
whether it is restricted by unfavorable bank loan terms, using
bank-survey data on lending decisions to small and medium-
sized firms. A comparison of the terms of lending between the
former East German and West German states yields a lending
gap given by higher loan prices and collateral requirements
in East Germany. This gap can be explained by differences
in credit risks and lending strategies of banks.
With German reunification in 1990, the East
German economy has been challenged to be trans-
formed from a centrally planned economy to a
competitive market economy with the same
standard of living as in West Germany. The
general intention has been to close the huge
economic gap between East German and West
German states as soon as possible with support
from federal state authorities, the corporate sector
and the banking sector. The banks have been asked
to finance the transformation of formerly state-
owned East German firms and the foundation and
growth of new firms.
Since many firms closed down, the financing
of new, small and medium-sized enterprises
(SMEs) plays a key role for the catching-up of the
East German economy.
Small companies are said
to have become the most important creators of
new jobs and the seedbeds for cutting edge tech-
nological innovation (Acs and Audretsch, 1990).
It is a stylized fact that in a market economy, a
large number of jobs arises from SMEs, while
simultaneously many jobs are destroyed by close-
downs of SMEs (Davis et al., 1996). In East
Germany, the difference between firm foundations
and firm exits was high shortly after reunification,
but converges towards zero at the end of the 1990s
(Ostdeutscher Bankenverband, 2000b, p. 10).
Credit restrictions have been one of the highest
impediments to firm foundations in East Germany
(Steil, 1998, p. 131). Many SMEs in East
Germany complained of severe financing restric-
tions because of lacking equity capital and a low
willingness of banks to grant loans (Hummel and
Ludwig, 1994). The equity gap between East and
West Germany could not be closed, despite large
public equity aid programs. The scarcity of equity
capital is most severe for SMEs which have no
access to the capital market and are not owned by
West German or foreign firms.
which are highly dependent on bank loans, criti-
cize banks for excessive collateral requirements
and loan prices (Carlin and Richthofen, 1995, p.
In the general public, too, German banks are
often claimed to be too risk averse, while on the
other hand, the banks allege that they help to build
up the small and medium-sized sector of the East
German economy. Because of high loan losses in
Lending to Small and
Medium-Sized Firms: Is There
an East-West Gap in Germany?
Small Business Economics 23: 23–39, 2004.
2004 Kluwer Academic Publishers. Printed in the Netherlands.
Final version accepted on 27 May 2002
Department of Economics
University of Konstanz
Doris Neuberger and Solvig Räthke
Department of Economics
University of Rostock