[A-List] Germany: banking crisis?

["Michael Keaney" <michael.keaney@xxxxxx>]

Are Germany's banks about to go the same way as their Japanese rivals?
The major players cannot find enough profit growth to counter rising bad
debts
By Katherine Griffiths, Banking Correspondent
The Independent, 30 October 2002

Disappointing results and a recent surge of profit warnings has heightened
speculation about the collapse of one of Germany's big four banks, sparking
fears of a banking crisis in Europe's largest economy.

Until recently, analysts worrying about a brewing banking crisis after
two-and-half-years of economic downturn have focused on Wall Street, where
high-profile corporate scandals have left banks under intense scrutiny from
regulators and lawmakers alike.

But the slew of warnings from Germany's largest banks has shifted attention
to Europe, with commentators warning of disturbing echoes of the banking
crisis in Japan. The speculation has become so intense that leading German
bankers have spent the past few days trying to assuage the markets' fears.

Ernst Welteke, the president of the Bundesbank, said it was "dishonest" to
talk of a banking crisis. Mr Welteke acknowledged that Germany's banks are
having a rough time, due to the stagnant state of its economy and the
sickliness of some of its largest companies. But he said Germany's banks
would emerge "strengthened rather than weakened" from this latest bout of
economic downturn.

Mr Welteke's comments echoed senior banking executives'. Commerzbank's
chairman Klaus-Peter Müller insisted that despite the bank's warning on
Monday it might suffer a loss this year, it was not in the middle of a
full-blown banking crisis.

Neither statement bolstered confidence in the market. The German banks,
which have already seen their shares hammered this year, yesterday suffered
a further sell-off. One German banks analyst said: "Their shares are
currently valued at about half of their book value. From the point of view
of their equity, the German banks are already in crisis."

Senior banking executives argue their underlying businesses are not in quite
as bad a shape as the dramatic slump in their shares would suggest. But
indications are more worrying. The spread on German banks' borrowing has
more than tripled in the space of a month, indicating serious doubts in the
market about the institutions' credit worthiness (See table).

Some commentators have warned the recent pattern at the country's top four
banks is looking worryingly similar to that of Japanese banks in the late
1990s, which were swamped by a mass of bad corporate debts following the
spectacular bursting of its asset-price bubble.

Germany may also be tottering on the edge of a deflationary spiral similar
to the one Japan is now stuck in, increasing the risk of bad debts and
making it more difficult for banks to offset the problem with new business
from individuals and companies.

HVB, Germany's second-largest bank, last week shocked the market by posting
a deeper-than-expected third-quarter pre-tax loss, which included a doubling
of provisions against loan losses.

Commerzbank, the number three bank, has suffered a crisis of confidence
among investors over rumours it has heavy derivative losses. Meanwhile,
Germany's largest bank Deutsche has raised capital by selling off
cross-holdings in other companies while Dresdner, owned by the insurance
giant Allianz, is considering selling the most unprofitable bits of its
business and slashing its headcount to preserve capital.

But German banks' record on bad debts is actually quite respectable. One
analyst said: "As a percentage of the loan book we expect German banks to
take a charge of 0.8 to 1 per cent for the full year. A charge of that
nature for UK banks would hardly make them sneeze."

The trouble is German banks are either pocketing a negligible profit or have
plunged into the red, making the effect of bad debts more serious than in
the UK, where banks have still produced impressive returns for shareholders
this year.

Observers say that if there is a German banking crisis, it is in why this
sector is so unprofitable compared with UK or US banks ­ a situation which
has made it particularly ill-prepared to deal with the economic downturn.

John Rushton, a consultant at analysts PA Consulting, found earlier this
year that UK banks' return on capital is on average five-times higher than
of the German big four, and the British banks' cost income ratios are
between 20 and 40 per cent better than those in Germany.

This lack of productivity and profitability in Germany have meant that
Deutsche, despite being the third largest bank in the world, has a market
capitalisation of less than Halifax in the UK.

The reasons for the stodginess of Germany's banks lies in the political and
economic role they have had in the last 50 years and, critics say, still
have now.

Dr Bob Hancke, a lecturer in political economy at the London School of
Economics, said: "After the Second World War, a highly regimented financing
system was needed as a way to create growth with very little capital."

Just as in post-war Japan, in Germany banks to provided far more of the
capital to drive industrial growth than the capital markets. This led to
banks such as Deutsche taking large stakes in "national champions" such as
the car maker Daimler Benz, to stop them from going under.

In Germany's case, the government also underwrote a range of regional saving
and corporate banks, which continue to compete with commercial banks for the
business of individuals and companies. The savings banks, known as
Sparkassen, and the regional development banks, known as Landesbanken , are
in effect state-owned and have remained very powerful. Despite their high
international profile, Germany's private banks only have a 20 per cent
market share at home.

This has meant even Germany's premier private banks are not competing on a
level playing field, because their costs of lending remain much higher than
these rivals, which are underwritten by the government.

Those who are optimistic about Germany's banking sector say that the current
economic crisis is acting as the nasty dose of medicine politicians need to
finally renounce the post-war economic model, known as "Germany
Incorporated".

Last year the German government changed the capital gains tax rules. This
allowed banks and insurers to start to unwind some of the massive
cross-holdings they have in each other and in industry ­a change some senior
executives have wanted to do since the mid-1990s to boost shareholders
returns.

Allianz has been praised for its decision to sell its holding in HVB, while
taking control of Dresdner, which it is now subjecting to radical surgery to
try to boost its profitability.

At the same time banks and politicians are proving increasingly willing to
let struggling companies fail rather than be propped up by the banking
establishment. Kirch, the media empire, was the most high profile casualty
of this new tougher line this summer. The final step is consolidation, which
analysts say is urgently needed to strip out some of the over-capacity in
banking market.

There have been some attempts at this ­ HVB is the product of major mergers,
while Deutsche has signalled it is scouting around for a deal outside
Germany, possibly with Lloyds TSB. The stumbling block remains the public
banks. Despite encouragement fromEuropean competition authorities, German
politicians have made it clear they will not allow private banks to take
over the state-sponsored banks.

Yet the consensus is that Germany is not another Japan, and that if there is
to be a high-profile failure from this downturn, it is still more likely to
be in largest banking market in the world ­ the US.