Troubled Depfa is a case of political pass-the-parcel


Hypo Real Estate's Irish subsidiary's liquidity woes were known to German authorities, writes Derek Scallyin Berlin

THE INTERNATIONAL financial crisis has given a new spin to an old saying in Germany. When it comes to its banks, "success has many German fathers, but failure is an Irish orphan".

Since the near-collapse last year of the Irish subsidiary of Sachsen LB, Dublin's IFSC has earned the dubious reputation in Germany as the financial wild west of Europe, a frontier of gung-ho capitalism where normal rules don't apply.

In this narrative, the Irish financial regulator is the feckless bean an tí who earns money from strangers' sons and daughters but turns a blind eye when they run amok.

When they crash and burn, Ireland lets the foreign parents pay for the funeral.

So when German bank Hypo Real Estate (HRE) faced collapse last month, not once but twice in the space of a week, because of liquidity problems of its Irish subsidiary Depfa, it was tempting to point the finger at Dublin.

Documents seen by The Irish Times, however, suggest that concern about Depfa, and the consequences for the HRE group, were well known to German authorities. Last summer, government regulators delivered a "grave appraisal in particular in the risk management area" to HRE managers in Munich and passed on their concerns to Berlin.

Nearly all HRE managers in Munich have been fired, with at least two preliminary criminal investigations into the near-collapse. But the question of political and regulatory responsibility has yet to be addressed, in particular: might the need for a €50 billionplus bailout have been prevented if the information available earlier this year had been acted on?

Hypo Real Estate Holding is Germany's fourth-largest bank, managing assets worth €400 billion. It was created five years ago after Hypovereinsbank spun off parts of its real estate financing business.

The Munich-based HRE group focuses on three areas: commercial real estate, infrastructure and public finance, and capital markets-asset management. Last year it spent over €5 billion to acquire the Dublin-based Depfa group, which lends to governments for big infrastructure projects.

These projects are refinanced in turn by means of short-term loans.

In February, the Bundesbank contacted the Irish financial regulator to ask for permission to send over six auditors to examine Depfa's operations. All involved say this is regular practice, but the run-of-the-mill audit produced notable results.

The Bundesbank sent several preliminary reports back and, based on this information, Germany's financial regulator BaFin noted in its second-quarter report that Depfa's operations for 2008 were "burdened" and "below expectations". Standard Poor's Depfa downgrade from A+ to A would "burden even further the already fraught liquidity position of the group".

"Critical is, in particular, the considerable short-term unsecured refinancing of the Irish Depfa Bank," noted the report. "A further downgrading . . . would have severe consequences for the refinancing of Depfa."

Concerns about individual company sectors meant, the banking regulator said, that the organisation of HRE group business "could not be described as in line with" the relevant paragraphs of German credit laws.

A spokesman for HRE confirms that government auditors met board members including chief executive Georg Funke "sometime before May" to discuss their concerns about the Dublin operation.

The BaFin report was forwarded to the finance ministry in Berlin. The relevant section head was on holiday and, according to the ministry, his deputy passed the report on to another official who filed the report away, seeing no need to bring it to the attention of any superiors.

"The impression I have is that they had very good information, they knew about the liquidity problems with Depfa. The head of BaFin himself told us they had a very clear picture," said Volker Wissing, finance spokesman for the opposition Free Democrats (FDP) and a member of the parliamentary finance committee.

"I don't see a responsibility for this in Ireland, only with BaFin and the finance ministry . . . only the organisation supervising the holding company can understand what all the subsidiaries are doing."

With BaFin's Depfa report safely filed away in the finance ministry, what happened next is well known. Fears about Depfa's reliance on unsecured short-term capital were realised when short-term liquidity markets dried up after the collapse of Lehman Brothers on September 15th.

Berlin - convinced HRE was "too big to fail" - hurriedly agreed with German banks to underwrite a €35 billion guarantee. When, days later, HRE admitted it actually needed €50 billion, a furious finance minister Peer Steinbrück ponyed up the extra guarantee.

The price was the head of Funke, of other senior managers and of members of the HRE supervisory board. This week, Funke's successor said the bank will need further guarantees and had already applied to the general bank bailout fund agreed by Berlin last month.

Officially, HRE is restructuring its business, but there is speculation in official circles in Berlin that the business will be wound up.

As the financial story retreats, the political story remains unresolved, in particular the question of action - or inaction - by German authorities.

The Bundesbank points out that Depfa has an Irish licence and, as such, the Irish regulator has the initial responsibility for monitoring the company. But, as this year's audit and last month's bailout show, German authorities are well aware of their responsibility for the Munich- based group.

There appears some confusion over the limits of German auditors in Ireland. A 1993 agreement allows German authorities, with Irish permission, to visit German subsidiaries in Ireland and examine their operations.

But a finance ministry report to the parliamentary finance committee last week implied that the 1993 agreement does not allow German inspectors examine the liquidity position of foreign subsidiaries.

"The latter falls under the jurisdiction of national regulatory authorities, in this case, the Irish authorities," the report says.

Experienced officials with experience of such audits said that, as a core business indicator, liquidity is always closely examined in these cases. Regardless, the report says that Depfa sent weekly liquidity reports to the German regulator from February. In June, it was put on the regulator's "watch list" and was later required to file daily liquidity reports.

A spokesman for HRE confirms that Depfa's liquidity data would have been available to HRE bosses in Munich.

Although BaFin's second-quarter report describes Depfa's refinancing situation as "critical", the finance ministry report says there was no indication that Depfa would have payment difficulties, "neither at the time of the report, nor later".

The finance ministry report concludes that HRE is "supervised in only a very limited fashion" by BaFin and the Bundesbank because as a holding group, "it isn't a bank in the sense of the credit legislation".

Reading the documentation, it's hard not to be reminded of pass the parcel, first between BaFin and the Bundesbank, which share responsibility for bank regulation in Germany. Then, both insisting they did their job correctly, they passed the parcel to the finance ministry, which denies failing to recognise the report's implications.

"It's the typical blame game and it's opportune for politicians to blame other countries for not paying enough attention," said Hans Obermeier, spokesman for the HRE group in Munich.

As the Depfa dust settles, opposition parties smell a political rat. Behind the government's unwillingness to talk is, they believe, a simple explanation.

"The head of the department that received the Depfa report and didn't act on it is now a state secretary in the finance ministry, Peer Steinbrück's right hand," said Wissing of the FDP. "And who wants to cut off their right hand?"