ANALYSIS:Berlin's unspoken long-term goal is to urge consolidation of public and private banks, writes DEREK SCALLY

A QUIET revolution is under way in Germany’s banking sector, one that will change forever the financial landscape in Europe’s largest economy.

For years analysts who viewed Germany’s banking scene as too fragmented have called for consolidation. Now the change is coming, pushed through from an unlikely quarter: the federal government in Berlin.

After a slow start, this was the week when events began to pick up speed.

First, the German cabinet agreed on a radical “bad bank” plan to deep freeze banks’ toxic assets for 20 years.

Yesterday, following the state buy-in to Commerzbank, shareholders met in Frankfurt to vote three government representatives on to the board of Germany’s second-largest commercial bank.

This week also marked the disappearance, after 137 years, of the Dresdner Bank name following the Commerzbank take-over.

At the same time, the European Commission in Brussels gave its approval to plans to nationalise the troubled property leader Hypo Real Estate (HRE).

Now, after providing loans and guarantee infusions worth over €200 billion – €102 billion to HRE alone – Berlin now wants some bang for its euro.

The short-term goal of all of state efforts, Berlin officials claim, is to buy German banks time and free up liquidity. The unspoken long-term goal, however, is to encourage consolidation of banks – public and private.

Berlin’s “bad bank” proposal, expected to become law in July, would allow banks to move toxic assets at 90 per cent of their book value to off-balance sheet holding companies which, in turn, would swap them for state guaranteed bonds.

It’s a trade-off: not as much as banks were hoping for, but about as far politicians facing re-election in September are prepared to push taxpayers.

The banks aren’t freed of their burden for good – they will see the toxic waste again in 20 years and pay fees for state storage in the meantime. But it does tidy up their accounts for now and should free up money for actual banking.

But Berlin’s “bad bank” plan has several weaknesses. It is difficult at the present to determine the value of assets with a life of 20 to 99 years.

Secondly, the toxic waste will have to be hauled out of the freezer eventually, at unknown cost. In addition, the “bad bank” plan only tackles the most urgent problem, €190 billion in structured bonds, just a fraction of German banks’ total toxic asset problem, worth at least €800 billion.

However, the biggest weakness is that taxpayers would have to foot the bill for the toxic assets of any institution that goes bankrupt over the next 20 years.

Off-the-record, officials in Berlin agree the banking plan gives the state an unprecedented opportunity to reshape the industry.

The most interesting opportunity lies with Commerzbank. After an €18.2 billion government investment to date, analysts say the bank needs another €10 billion and may eventually have to be nationalised.

Chief executive Martin Blessing denied that claim yesterday and rejected suggestions that by buying a stake of 25 per cent, Berlin had bought influence over strategy. “As long as there are no further significant upheavals on financial markets, I expect that we won’t need additional funds,” said Blessing in Frankfurt . “The government doesn’t intend to actively influence our business policy.”

But Berlin’s arrival on board coincides with a radical upheaval in Commerzbank’s operations: it has shuttered its stock market business, mothballed foreign consulting operations, and will focus more in future on medium-sized companies in the domestic market.

The next big revolution surrounds Germany’s regional state banks, the nine Landesbanks.

One of the three pillars of German banking, their vain search in recent years for a worthwhile business model saw them sucked into the profitable but murky world of subprime loans and asset-backed commercial papers.

About two thirds of Germany’s estimated €800 billion in toxic assets are bunkered in these public banks, supervised by regional politicians with little understanding of banking other than the influence it brings.

In exchange for “bad bank” assistance, the Landesbanks will be pruned back to a fraction of their current size and merged into just two or three institutions, with a focus on financing German small and medium enterprises.

Commerzbank should, with gentle pressure from Berlin, concentrate on medium-sized businesses. Its Eurohypo subsidiary is likely to be hived off and merged with whatever remains of post-nationalisation Hypo Real Estate to finance German deals.

Finally, in this new German banking order, the big corporate business will be left to Deutsche Bank.