At the annual reception of the Bundesverband Deutscher Banken – the association of private banks in Germany – held in Berlin in mid-April, its president Jürgen Fitschen told the gathering that it was “a time of big challenges for banks”, with low-interest income, regulatory burdens and the risk aversion of German retail investors impacting upon revenues.
In spite of this gloomy picture, Mr Fitschen would hardly have believed that less than two months later he and co-CEO of Deutsche Bank Anshu Jain would be tendering their resignations. Mr Jain’s leaving date was set for June 30, with Mr Fitschen staying on in an interim capacity to help John Cryan prepare to take over as sole CEO early next year.
Deutsche Bank occupies a unique place in German banking, as the country's only global bank with a heavyweight investment banking presence, and many of its problems have come from legal problems surrounding its investment banking division.
Nonetheless, some of the same underlying domestic profitability issues that have afflicted Deutsche Bank (and its Deutsche Postbank subsidiary) are seen right across the three pillars of the German banking system.
An overbanked market
The sparkassen (savings banks) and their associated landesbanken, the co-operative banks, and the private sector commercial banks, all find themselves in a familiar situation of weak earnings in an overbanked country, with their problems now exacerbated by the low-interest-rate environment, which has compressed net interest margin. In addition, low non-interest income is testimony to the conservative approach of German retail bank customers, who are reluctant to buy additional products.
The picture looks similar to the early 2000s, when weak earnings convinced many German banks to look overseas to boost returns. That strategy resulted in disastrous losses in commercial real estate in markets such as Spain. Global shipping was another area of vast expansion, and excessive lending in segments such as container ships (including risky bridge loans to so-called Kommanditgesellschaft ship funds which were themselves helping create industry overcapacity) contributed to the need for government rescues at institutions such as Commerzbank and HSH Nordbank.
Following that debacle, a strong domestic focus and risk aversion are back in vogue – even though there are currently some concerns about softening loan conditions. But returns are low.
Limited opportunities
Within Germany, there is fierce competition for mortgage business, and a large number of banks are also sharpening their focus on small and medium-sized enterprise (SME) borrowers or the Mittelstand as they are called in German-speaking countries.
The Mittelstand is targeted by big private banks such as Deutsche, Commerzbank and HypoVereinsbank, as well as by the landesbanken and the sparkassen; HSBC subsidiary HSBC Trinkaus has notably been ramping up its Mittelstand business, using the global presence of its parent to offer services such as trade finance to exporters; and there is also competition from Société Générale.
Opportunities in household credit remain limited, with Germany still having a rental culture and low levels of home ownership, while Germans are largely avoiding running credit card balances – if they have a credit card at all.
In consumer credit, the car culture generates a high volume of business. But this is dominated by captives such as BMW Bank and Volkswagen Bank, while a foreign bank – Santander – has managed to claim third place in the auto loan market. In retail banking, ING Diba has been growing rapidly with its low-cost online banking model, and now has 8 million customers.
Safety first
However, in spite of all these challenges, the slow-moving but stable groups of banks in Germany's co-operative sector (with DZ Bank at the top of the structure) and the savings banks (the sparkassen with their links to the landesbanken) remain a profitable cog in the functioning of the real economy.
There is little appetite to change the model, in which Mittelstand company owners, high-net-worth individuals and mass retail customers are mostly happy to stick with their local relationship bank.
Since the financial crisis, the sparkassen have been stressing this theme of safety, and the central role of banks in supporting the real economy, in an expensive TV and print advertising campaign. They have hit back at what is often viewed in Germany as an obsession with targets such as return on equity (ROE) that comes from Wall Street and the City of London.
The branding campaign is backed by a business strategy, which stresses that, even in the digital communication era, the human contact with customer relationship managers and service staff who know the customer should make a difference, particularly compared with pure online banks.
“This logic is completely different from the 2002 business strategy which was focused on ROE,” said German Savings Bank Association (DSGV) president Georg Fahrenschon at the association's annual press conference on March 12.
“Our principle is that we will not take excessive risks for the sake of higher returns – we will continue to pursue our cautious and economically sustainable business policy,” said Mr Fahrenschon. “I am amazed at some competitors who currently do credit business at nearly any price, or who dispense with liability commitments by the managing directors of limited liability companies.
“In my view, these competitors will have to pay dearly in the not too distant future for such a business policy that ignores risks.”
Under threat?
However, the question remains whether the challenges posed by the EU's quantitative easing (QE) and near-zero interest rates, coupled with the increasing regulatory burden, might gradually eat away at the safety and stability of this highly conservative banking model, if the revenue side continues to be challenged in the medium term, as it will take some time for the EU to stimulate economic growth and extract itself from its low-interest-rate/QE policies. And if revenues cannot be boosted it means that the expenses side will need to be tackled.
“To some extent, the German banking system is back to square one after its expansion abroad led to huge losses when the financial crisis came along,” says Carola Schuler, managing director of banking in Europe, the Middle East and Africa at Moody’s Investor’s Service in Frankfurt. “They are now facing the same problems of weak earnings in an overbanked market as they were in the early 2000s, but in addition they have the problems of low margins in a very low interest rate environment, higher capital and liquidity requirements, and regulatory changes such as MiFID II and consumer protection laws, which impact the way they run their business, and add to the cost structure of many products.”
However, Ms Schuler adds that in spite of low margins, asset quality had been excellent so provisions were very low. “So now would be a good time to make operational changes, such as looking at mid-office and back-office staffing levels and developing online products, and there is a growing realisation that more needs to be done in terms of the industrialisation of product ranges and greater [automation],” she says.
Loan softening
Certainly the way in which so many banks have been targeting the Mittelstand suggests that loan conditions may soften further, which could bring problems if an economic downturn comes along.
“Under current conditions, SME lending may be a loss leader for the private sector banks, and may only be worthwhile if accompanied by the sale of capital markets products and services such as trade finance and cash management,” says Michael Dawson-Kropf, senior director, financial institutions, at Fitch Ratings in Frankfurt. “The landesbanken are also active in this segment, and though their loan books currently look good because of the very low levels of loan impairments in the Mittelstand, this picture could clearly change in a downturn.”
Nonetheless, on the positive side Mr Dawson-Kropf notes that although returns in Germany may be structurally weak, both the savings banks and co-operative bank segments are profitable, while deleveraging has proceeded at a rapid pace since the financial crisis at the landesbanken as well as private sector banks such as Commerzbank.
Large non-core asset (NCA) portfolio sales have rapidly reduced commercial real estate assets, although the rundown of the mostly US dollar-denominated shipping loan book has been impacted by the rapid rise of the dollar, which is boosting loan volumes expressed in euros. Exposure at default for NCA at Commerzbank was reduced by €32bn in 2014 (though this included a €12bn internal transfer of high-quality assets from NCA to treasury), to reach €84bn at the end of the year.
In 2014, Commerzbank saw good growth in lending volumes in its Mittelstandsbank, which has been expanding in Austria and Switzerland as well as Germany. Commerzbank’s operating profit increased by more than 40% to hit €1bn for 2014.
But having been bailed out in the financial crisis, Commerzbank still has a 15% stake held by the German Federal Republic and the government flexed its voting power at the annual general meeting in April, helping to block a move to pay senior executives, including chairman Martin Blessing, up to double their fixed salaries as a bonus. EU rules cap bank bonuses at 100% of salary, with a maximum of 200% requiring shareholder approval.
At the smaller end
The deleveraging process has also been proceeding well at the landesbanken. The DSGV, the umbrella organisation which includes 416 sparkassen, seven landesbank groups plus DekaBank (the German Savings Bank Finance Group's provider of asset management and capital market solutions), estimates that between the end of 2008 and June 2014 the landesbanken reduced their risk exposure by more than half. Most of them are now profitable in operational terms.
The sparkassen had a total balance sheet of €1130bn as of December 2014, and generated €4.9bn-worth of earnings before taxes. The sector ran ahead of its own expectations for the year in terms of both loan and deposit growth, and net commission income. For example, DekaBank has been stepping up its sales of investment fund products.
Within the landesbank sector, one large outstanding issue remains the future of HSH Nordbank, which had to be rescued after the financial crisis, in part because of its excessive lending into riskier parts of the shipping business.
HSH Nordbank is 85% owned by the City State of Hamburg and the State of Schleswig Holstein, with 5.3% owned by the Sparkassen Association of Schleswig Holstein. It also has loan portfolio loss guarantees in place, for which it pays an annual insurance premium. HSH hopes over the coming months to reach agreement with the European Commission on the structure of continued state support, and is pointing to the good progress that it has made with deleveraging and getting back to an operating profit.
The co-operative banks and savings banks segments remain profitable – even if their profits do not show up in the headline numbers posted by listed banks, as is the case in a market such as the UK.
One factor that could increase the pressure for change is the EU banking union, though some analysts see this as a supervisory process rather than one that will actually promote the emergence of pan-European banking groups.
A European example
One sizeable pan-European model that already exists is UniCredit, which has a large presence in Italy, Germany and Austria, as well as in central and eastern Europe. In the German market, a modernisation of UniCredit's retail banking activities was initiated in August 2014, which will see all 341 branches remodelled and equipped with state-of-the-art systems by the end of 2015, and mobile and internet-based advisory expanded.
But individual banks within the UniCredit Group operate very much within national borders. For example, UniCredit Group subsidiary HypoVereinsbank (HVB), which still uses the HVB brand across Germany, is extremely well capitalised. As of March 2015 it had a common equity Tier 1 figure of 21.8%.
It is not, however, possible to move resources around within the UniCredit group in a way that could benefit the Italian parent company’s capital ratios at the expense of the German subsidiary. HVB posted a consolidated profit after tax of €958m for 2014. ING Diba, meanwhile, has excess liquidity from its German online bank, but faces many hurdles in utilising this liquidity for the benefit of ING in the Netherlands.
Conservatism reigns
On the regulatory front, the determination of German politicians to avoid any more use of taxpayers' money to bail out errant banks is illustrated by the pending amendment to the bail-in waterfall, which will make German bank senior unsecured bonds more likely to be bailed in than other jurisdictions. Most countries have not yet put bail-in structures in place, but the bail-in law came into force in Germany in January 2015.
In any case, German banks are not very reliant upon benchmark-sized senior bond offerings for their funding, but rely mostly on deposits. For this reason, there is little impact on banks from rating agency initiatives such as the review of support assumptions for the landesbanken recently completed by Fitch. This led to downgrades, mostly into A- ratings territory. With their close links to the savings banks, and limited use of the bond markets, downgrades make little difference to fund raising.
“Household and corporate debt in Germany has historically been very low, and there has been little need for private sector deleveraging since the financial crisis,” says Nick Anderson, senior analyst, banks, at Berenberg in London. “The focus is more on SME finance than consumer lending, and the Mittelstand continues to do well in export markets, and loan impairments are very low."
“The revenue issue is more a matter of weakness in generating fee income rather than low interest margins. So far the banking union is focused on the single supervisory mechanism rather than changes to the way in which banks operate, but if the banking union does eventually encourage new challengers to move across borders they would still have to contend with conservative and relationship-driven customers in Germany.”
So, with the sparkassen openly playing down ROE targets as an important goal, and continued slow but steady profitability, Germany looks unlikely to change its model anytime soon, but will modernise at a steady pace and gradually introduce more internet and smartphone-based apps.
Critics may point to the banking union as a danger on the horizon, but foreign banks looking to expand may well not choose an overbanked country with a long track record of low returns.
