The titanic struggles of German banking

Dominic O’Neill
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The decline of Deutsche Bank may be grabbing the headlines, but the woes of German banking run far deeper. Low interest rates and tighter regulation are hurting all the private-sector banks. That simply adds to concerns that Germany’s banks cannot, or perhaps in politicians’ eyes should not, be profit-hungry institutions. But are the statebacked banks that still dominate German banking reaching a limit on their ability to fund themselves? And does that mean that the famed three-pillar system is heading for disaster?




Germany’s banks go down with the ship

Rates put Germany’s financial ecosystem at risk


When fears over the size of a  Deutsche Bank fine coincided in late September with news of a drastic business restructuring at Commerzbank, it seemed like the crisis in European banking had suddenly shifted north. 

The problems facing Germany’s two biggest private-sector banks are of course different. But they are both symptomatic of the lack of profitability afflicting the three pillars of German banking. 

Low interest rates are a pan-eurozone problem, but German banks are more vulnerable than most because of their reliance on net interest margin and because their return on equity is already only in the low single digits; higher only than Greece and Portugal, according to the European Banking Authority. 

While headline-grabbing jumps in spreads of five-year senior and subordinated credit default swaps are not a direct driver of bank borrowing costs, it is hard to see how the big German private banks can drive their funding costs lower amid regular bouts of panic about solvency.

At Deutsche Bank, the latest worry is a potentially crippling fine in the US. This could have systemic implications for Germany. But what Deutsche has historically lacked is a home cushion to fall back on. UBS and even Barclays have that advantage. Twice this year the bank has come close to the point where a declining share price threatened to spill over into a broader sell off in its subordinated and senior debt. 

Analysts point out that although a manageable settlement with the US Department of Justice may be well received by investors in the short term, concerns about core profitability and shareholder dilution will persist as the bank struggles to define its core business. 

After a triumphant return to dividend payments in 2015, Commerzbank has had to suspend payouts again to fund restructuring costs as it retreats further in investment banking and cuts 9,600 jobs. 

This is a bank, moreover, that has already embarked on what Neil Smith, banks analyst at Bankhaus Lampe, calls a "steady and clear" restructuring process over the past five years. That restructuring just about pulled the bank through the aftermath of the financial crisis and the ensuing bad-loan problems that required state support and repeated capital raisings that have tested the patience of shareholders to the limit. 

Now the realization is dawning that while those efforts may have assured the bank’s survival, they have not remotely prepared it for the new business landscape.

Commerzbank’s new direction is a sharp reflection of Germany’s challenges, as interest rates stay low, regulation tightens and online banks add still more competition.

"We’re assuming rates will stay negative for at least four years," says Michael Reuther, Commerzbank board member for a newly merged corporate clients division, explaining the new strategy.

Commerzbank hopes goodwill write-offs against parts of its trading businesses will allow it to re-orientate more rapidly than others as it focuses more on the clients and the businesses that promise better returns. Tellingly, neither German mortgages nor larger corporates are flagged for growth. 

German industry has benefited from the willingness and ability of public-sector banks, not answerable to private shareholders, to supply adequate funding, even after many of those banks suffered bad losses in the financial crisis. But lower rates will hit Germany’s public-sector banks and cooperatives hardest due to their particularly high reliance on interest income and businesses easily disrupted by digital competitors. 

And of course many in the private sector blame Germany’s profitability lag precisely on this large part of the domestic market (more than 50%, across products) that is less motivated by financial returns. 

Savings banks and Landesbanks are often seen in Germany as something akin to a public service. This might sound like exactly the kind of utility system that regulators want, but their fragmentation means their ability to finance themselves may now be reaching a limit, signalling perhaps the beginning of a different kind of banking in Germany. 

If that happens, it may prove to be a good outcome for the private-sector banks, which have previously suffered a relatively high cost of equity. The transition process in the public-sector system, however, has already proven slow, painful and full of risks. In a worst-case scenario, the Landesbanks’ shipping dramas might just be a preview of the real crisis to come.