Why German banks should merge

Purpose - The paper aims to investigate whether the wave of mergers observed in other European countries is suitable for the German banking industry. Design/methodology/approach - This question is approached by studying the relationship between market structure and profit (the so‐called profit‐structure relationship) in the German banking industry using the model suggested by Berger. By extending his econometric model to include portfolio and capital risk and using German banks' financial data, the authors are able to test simultaneously for three competing theories of the profit‐structure relationship. Findings - It is found that including portfolio risk significantly improves the fit of the estimated profit‐structure relationship. In addition, it is found that scale economies are present in German banking and that the so‐called structural conduct – performance hypothesis is accepted. Owing to the acceptance of this hypothesis, conclude it is that mergers are likely to boost German banks' profitability but possibly at the expense of lower consumer welfare. Research limitations/implications - The research methodology employed is unable to weigh the potential benefits of higher financial sector profitability and stability against the possible detrimental impact on consumer Originality/value - The value of the paper is to provide a robust estimate of scale economies and a reliable test of the profit‐structure relationship in German banking based on recent data. It should be of particular value to bank managers, seeking to increase their institution's profitability by way of merger and to the regulator of the financial industry.