With an already fragmented banking sector and state-owned banks reluctant to change, Germany will remain behind its European peers.

Compared to their European peers the estimated returns of German banks – at 11.8% in 2003 – lag far behind others such as the Spanish (24.6%) and the Austrians (33.9%). Cost income ratios are also very weak at 75% compared to the Spanish (53.1%) and the UK (48.8%). Analysts suggest that the high fragmentation in the German banking market – the five largest credit institutions account for only 20% of total assets – is one of the factors behind the relative inefficiency.

Consolidation has been urged for years but owners seem unwilling to change the banking structure that may have done well in the post-World War II period but seems unsuited to the 21st century. In April the state-owned Frankfurter Sparkasse rejected a possible sale to a commercial bank, the second savings bank in the last two months to reject privatisation efforts. Hostility from local politicians is seen as the key reason why sales have been rejected. And so Germany continues with 519 different savings bank institutions which continue to perform below European averages and continue to paralyse the emergence of an efficient German banking sector.

While many may think that solving the problems of Deutsche, Commerzbank and HVB is the answer, and no doubt this would help, the big banks are not the core problem or the solution. The inability to consolidate the hugely over-banked market because of local political considerations and localised interests, such as in the case of Frankfurter Sparkasse, is the critical issue.

A strong and efficient banking sector usually goes hand in hand with a vibrant economy. Germany’s fragmented banking sector needs massive structural change if it is to be the engine behind future economic growth as it was in previous decades.

The localised focus of German institutions, except for Deutsche and some others, and the reluctance of state-owned banks to consolidate is undermining the sector. As EU accession becomes a reality it is surprising how the banks of Europe’s largest economy have such little direct representation in central Europe. While HVB does own Bank Austria, which has a strong presence in central Europe, the German banks are relatively under-represented compared to the country’s trading links with the region. If Germany and its financial sector are to prosper, local politicians need to see the big picture and stop obstructing the consolidation process.

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