Germany not immune to bank fiasco

“A toxic mix of corruption and incompetence, not to mention a multibillion bill for the taxpayer.” Ireland’s financial sector? No. Germany’s banking system

IN IRELAND’S economic collapse many view the massive lending of German banks as a key ingredient – alongside weak Irish financial regulation, lopsided budgets and lax individual responsibility – that inflated Ireland’s property bubble to bursting point.

But long before the financial crisis turned Irish economic gold to lead, German banks – particularly the landesbanken owned by German federal states – were notorious in international financial circles.

Since the financial crisis broke in 2008, with attention focusing first on EU bailout candidate states Greece, Ireland and Portugal, then Italy and Spain, all has been quiet on the “German bank” front. Even recent German bank downgrades have been presented as rating agency jitters at the prospect of pooled European debt rather than weakness in German banks.

But, in Frankfurt financial and analysts’ circles, there is a growing certainty that not all is well on German banks’ balance sheets. After shrugging off the developing European crisis for several years, the clouds are gathering for 2013. With the euro zone still roiled by crisis, German banks could be poised to write a new, notorious chapter.

“In Germany we have a problem with the bigger banks, but no one is talking about it,” said Dr Mechthild Schrooten, professor of economics at Bremen’s University of Applied Sciences . “It is not clear how big a banking problem there is, I wouldn’t even want to begin to guess, but it has a lot of zeroes.”

Some people are concerned about Commerzbank, Germany’s second largest lender, but most concern and attention is focused on the landesbanken.

Originally set up to supply money (as local central banks) to smaller banks and loans to small and medium business, the banks thrived in recent decades by being able to borrow and lend at bargain basement sovereign rates, by virtue of being owned by the states.

They began to look beyond their core business to play in the big international leagues until the European Commission stepped in and ruled their sovereign interest rate discount gave them an unfair competitive advantage over their private banking rivals.

But, before Brussels forced an end to low rates in July 2005, many landesbanken went on spending sprees, loading up their balance sheets in the US and elsewhere with credit default swaps and products that others refused to touch, earning them a notoriety on Wall Street and leaving them extremely exposed in the cold post-Lehman light of day.

First up was Saxony’s SachsenLB, which almost collapsed because of speculative positions taken by its Dublin-based subsidiary before being swallowed by the LBBW Landesbank, based in Stuttgart.

The crisis has changed the leverage in the power struggle over these banks in Germany. Previously, demands by Brussels or the federal government in Berlin for landesbank reform or mergers were blocked by regional politicians. They were anxious to have a “house” bank at their disposal even if, since losing their state guarantee rate bonus, those banks had no discernible business model.

While the landesbanken were distracted by the lure of the “big league” on Wall Street and elsewhere, Germany’s regional Sparkasse savings banks took over their one-time bread-and-butter business – secure but unsexy SME financing.

Now the chickens are coming home to roost for the landesbanken. Last week WestLB in Düsseldorf was broken up – a condition imposed by the European Commission in return for emergency state aid of €3 billion it received at the height of the financial crisis.