Banking on German lenders becomes risky

Costly bail outs suggest incompetent management at state banks, writes Derek Scallyin Berlin

Anyone considering a career at the Dublin subsidiary of Sachsen LB can learn more on the German bank's website. Dublin has, it says, become a popular location for foreign companies seeking a "stable, profitable English-speaking (sic) base".

Dublin restaurants are expensive, it adds, though pubs have the "occasional animated barman". As for public transport, "it is reliable, though one must have a sense of humour".

In Germany's normally reliable banking sector, a sense of humour was a requirement to make it through this annus horribilis. When the US subprime market hit the skids, several German banks were caught fumbling big bundles of debt.

One of the first victims of the credit squeeze in Europe was Germany's Industrial Credit Bank (IKB), which specialises in business loans to one in 10 of Germany's largest companies. It nearly collapsed in July after its "Rhinebridge" subsidiary faced huge losses on investments in bad risk US home loans. A rescue fund was hurriedly put together by Germany's state-owned financing bank KfW, along with Deutsche Bank and Commerzbank.

German prosecutors have since launched an investigation into IKB's near collapse, suspecting breach of trust and violation of securities laws. The total cost of the bail-out, meanwhile, has already topped €6 billion and continues to rise.

"If we'd known then what we know now about the market problems, we wouldn't have put together this rescue effort," admitted Ingrid Matthäus-Maier, head of the KfW, in an interview earlier this month.

But IKB was only the warm-up act for an even more spectacular collapse, when German state bank Sachsen LB faced bankruptcy in August as a result of exposure to subprime credit through risky Dublin-based financial vehicles.

The German Savings Bank Association (DSGV) stepped in to provide a €17 billion rescue and another state bank, LBBW, eventually bought the company this month. The total exposure remains unclear, but could top €40 billion, prompting a well-known financial analyst to describe Sachsen LB's Dublin subsidiary as "a sloppily-run pigsty".

Sachsen LB's near meltdown livened up the German business press. The Handelsblatt financial newspaper sent a journalist to the IFSC on a fruitless hunt for bogeymen. After turning up nothing of note, he contented himself with repeating the infamous New York Times remark from 2005 that Dublin was the "wild west of the European finance sector". Back in Germany, the credit squeeze revived talk of consolidation of the 11 state banks. "What happened in Dublin is a sign of incompetent asset management from inefficient state banks," said German banking expert Prof Wolfgang Gerke. He favours merging all banks into one financial institution to reduce inefficiency and increase its standing.

Similar consolidation talk has followed the many state bank crises in the last decades. Each time, the suggestion was shelved by regional politicians anxious to maintain the financial muscle afforded by a state bank, even if the institutions are dwarves on the international market.

Prof Gerke doubts that any lessons will be learned from the Sachsen LB episode and, apart from the sale of the bank itself, he predicts no change to the German banking landscape. "The same mistakes are always being made here and will always continue to be made," he said.

Experts are still debating whether the bank bail outs will have economic consequences for Germany. For the banks, the appearance on their books of risky off-balance sheet investment could pose a challenge when they go to refinance loans of a total financial risk that is not yet known.

"We don't know if all these loans are as rotten as everyone claims," says Dr Manfred Jäger, finance expert at the German Business Institute (IWK) in Cologne. "But it will depend on whether bank balances are elastic enough to be able to even out these loans. But Citibank and UBS are managing their refinancing and I think German banks will succeed too."

The IWK is optimistic that the banking crises won't cause a serious credit squeeze that would adversely effect the German economy or businesses.

"If anything, this is coming at the best possible time when companies are in a good financial position and not as dependent on external credit," said Dr Jäger.

Growth was robust in Germany in 2007 despite the bank crisis as well as other shocks - a VAT hike, the oil-price hike and the strong euro.

But after expected GDP growth of 2.6 per cent in 2007, leading economic institutes predict a cooling off to 1.9 per cent in 2008.