German banks hold firm in difficult times

Germany’s banking sector performed well in 2021, helped by the phasing out of the Covid-19 lockdowns and the subsequent economic bounce back. This positive trend continued at the start of this year, but then things took a turn for the worse because of macroeconomic and geopolitical events.

Pandemic-related bottlenecks started to build up in Germany’s supply chains, labour shortages began to bite, energy prices soared as a result of Russia’s invasion of Ukraine, inflation in Europe began to climb, and economic growth faltered — all of which will have a detrimental effect on banks’ bottom lines. All types of German banks — private banks, co-operative banks and public sector-held savings banks — face the same challenges.

Deutsche Bank, the country’s largest lender by Tier 1 capital, continues to overcome the problems it has seen in recent years and provides a good example of how the private banking sector hopes to ride out this year’s challenges. It achieved an 18% increase in post-tax profit in the first quarter of 2022. “Together with strong results in 2021, this shows clearly that our transformation strategy, launched in 2019 under CEO Christian Sewing, is paying off,” says Fabrizio Campelli, Deutsche Bank’s head of corporate and investment banking.

“We took the decision to refocus the bank around four core businesses, so that we could concentrate on areas where we are most competitive and where clients need us most,” he continues. “As part of this, we created a dedicated corporate bank to better service our multinational and corporate clients. We also sharpened the focus of our investment bank on our core strengths of fixed income, financing and advisory. Both of these businesses — as well as the other two businesses: asset management and private bank — grew profits year-on-year in the first quarter [of 2022].”

A key target for the entire group is to finish the year with a post-tax return on tangible equity of at least 8%, despite the burden of the 2022 bank levy paid into the EU’s Single Resolution Fund, and it achieved 8.1% in the first quarter. Rising interest rates will help boost both net interest income and margin. Deutsche Bank research expects the European Central Bank to raise rates by 1 percentage point to 0.5 percentage points this year and US rates to rise by 1.75 percentage points.

“We have seen a change in the interest rate cycle which has turned a headwind for the corporate bank into a tailwind, so that’s positive,” says Mr Campelli. “We calculate that the revenue tailwind from rising interest rates will be closer to €500m this year and nearer €2bn cumulatively in 2025.”

Deutsche Bank began reducing its exposure to Russia in 2014 after the annexation of Crimea and, following a further reduction in the first quarter of this year, its net loan exposure was just €500m at the end of March.

“In March we announced that we were in the process of winding down our remaining business in Russia, to help our non-Russian multinational clients in reducing their operations, and that there would not be any new business in Russia,” says Mr Campelli.

Strong start

Commerzbank, the country’s second-biggest lender by Tier 1 capital, posted a healthy net profit in the first quarter of 2022 of €298m, 125% higher than the €133m achieved in the first quarter of last year. “We had a very good start to 2022,” says Bettina Orlopp, deputy CEO and chief financial officer. “In particular, underlying net interest income was up 21%. The biggest contributor has been mBank, our Polish subsidiary, which is benefiting from the increase in interest rates in Poland. Net commission income was also very strong in the first quarter.

“The good start to the year has confirmed our expectation that we will generate a net result of more than €1bn in 2022,” she adds. “These expectations are based on the assumptions that there will be no extraordinary provisions from Swiss franc loans at mBank in 2022 and that effects from Russia will remain contained.”

Commerzbank is taking on no new business in Russia, and between mid-February and the end of April it reduced its net exposure to the country by 37%, down to €1.2bn, with further reductions planned. However, it will continue to support its German and international clients operating there, in compliance with all sanctions.

In common with other banks, sustainability has become an integral part of Commerzbank’s strategy. “We are channelling more capital into sustainable economic activities to mitigate the consequences of climate change,” says Ms Orlopp. “We are also supporting our corporate customers in their transition to become sustainable companies.” Commerzbank aims for its operations to be net zero by 2040, and its customers’ operations to attain the goal by 2050.

Moderate exposure to Russia

DZ Bank, the third-largest German bank by Tier 1 capital, posted a pre-tax profit of €465m — nearly double that of the previous year. The sharp rise was driven primarily by a good level of customer business across the board and a relatively benign risk environment. DZ Bank acts as the central institution for the Volksbanken Raiffeisenbanken Cooperative Financial Network of 772 co-operative banks (which between them have 30 million customers), and also serves companies and institutions.

“German banks have deliberately kept their Russian activities at a moderate level in recent years,” says a DZ Bank spokesperson. “At DZ Bank, we have a manageable exposure in Russia, Belarus and Ukraine, amounting to around €200m net. First-round effects in credit risk are therefore less of a concern for us, though possible second- and third-round effects are still difficult to assess.

“More significant for us in the short term are the stock market declines and the sharp rise in interest rates. In principle, the turnaround in interest rates is positive for us because it will increase net interest income.”

DZ Bank is continuing to digitalise its operations, and to integrate products and services more closely into the value chains of the real economy. This includes for example upgrading its homes and housebuilding digital ecosystem at Bausparkasse Schwäbisch Hall (a provider of home savings products) and acquiring the FinCompare sales platform to provide finance to small and medium-sized enterprises (SMEs). As for sustainable finance, the volume of transactions supported by the bank in that respect doubled to €53bn last year, up from €27bn the year before.

Increased profits

The umbrella organisation for the Volksbanken Raiffeisenbanken Cooperative Financial Network is the Bundesverband der Deutschen Volksbanken und Raiffeisenbanken (BVR), which translates as the National Association of German Co-operative Banks. The network turned in a pre-tax profit of €7.7bn in 2021, up 20% on the previous year.

“The major factors in our network’s success are the broad base among Germany’s SMEs and our regional presence,” says BVR’s president and CEO, Marija Kolak. “Net interest income is the biggest profit driver, making up 73% of total income in 2021. It rose by 3% to €16.5bn, despite the low level of interest rates. Net fee and commission income climbed by 5.7% to €6bn.”

Given their co-operative values, the banks are naturally committed to sustainable finance. Ms Kolak therefore believes that many of the environmental regulations being imposed on banks by the European Commission are excessive. “It is doubtful whether customers can actually take in all the product information that has to be provided under the Sustainable Finance Disclosure Regulation, the EU Taxonomy and Markets in Financial Instruments Directive, yet it requires banks to work through a vast amount of complex information,” she says.

In common with other German banks, the BVR is opposed to the creation of a European Deposit Insurance Scheme (EDIS), the so-called “missing third pillar” of the European Banking Union (the other pillars being the Single Supervisory Mechanism and the Single Resolution Mechanism). EU member states already have national deposit guarantee schemes, where each country’s banking sector compensates customers up to €100,000 if their bank goes bust. Under EDIS, the compensation payments would be financed jointly by all member state banking sectors, not just by the banking sector of the country where the failed bank was based.

“The existing system for compensating depositors in the EU runs smoothly, so the discussions about strengthening the banking union should no longer focus on the mutualisation of the national deposit guarantee schemes,” says Ms Kolak.

Sustainability efforts

DekaBank, the 12th biggest bank in Germany by Tier 1 capital, made a pre-tax profit of €791m last year, doubling its 2020 figures. Despite the pandemic, it was a year that saw stock markets hit record highs, which benefited DekaBank — a wholly owned subsidiary of, and the central asset manager and securities services provider for, the Sparkassen-Finanzgruppe (the German Savings Banks Finance Group). There are 370 savings banks in the group with 50 million customers, plus a large number of leasing, mortgage, insurance and other companies, bringing the total number of entities in the group to 520.

Sustainable finance is one of DekaBank’s areas of focus. Christoph Kehr-von Plettenberg, executive director of sustainability management, and his team have identified five “fields of action” for managing sustainability-related issues. The first of these is “sustainable banking operations”, whereby every effort is made to reduce consumption of energy and natural resources. The second is “sustainable products”, which covers capital investment and loans.

“Deka has defined sustainable investment areas in which it intends to be increasingly active — the positive list — and various types of financing which are to be excluded as a matter of principle — the negative list,” says Mr Kehr-von Plettenberg.

The positive list includes renewable energy and projects to reduce carbon emissions from manufacturing facilities. The negative list includes companies that violate human rights or are involved in businesses such as gambling and certain types of mining. “Lending to businesses on the negative list is regarded as undesirable or high risk, and can only be carried out with the exceptional approval of the board of management,” he says.

Expanding loans portfolio

The coordinating organisation for the German Savings Banks Finance Group is the Deutscher Sparkassen-und Giroverband (DSGV) — the German Savings Banks Association. The group put in in a solid performance in 2021, providing a record €197.3bn in new loans to corporate and retail clients, €5.6bn more than in 2020. “Throughout the two pandemic years, the savings banks proved to be stable and dependable partners to their customers,” says Karl-Peter Schackmann-Fallis, an executive member of the DSGV board.

“We also saw a record number of our customers investing in equities, exchange-traded funds and other securities, which led to a client investment turnover of €166.9bn, up 14.4% from 2020. This is an important development, as many customers in Germany have in the past been hesitant to invest in capital markets,” he says.

“On a related note, our group was, for the first time, able to counter the declining interest income (minus €314m) with an increase in our commission income (plus €560m) by becoming less dependent on interest-earning business.”

But there is no doubt that difficult times lie ahead. “Russia’s war in Ukraine is a turning point in history and nothing less than the biggest threat to peace in Europe since the end of the Cold War,” Mr Schackmann-Fallis says. “Our group emphatically supports the sanctions that have been imposed, and while the exposure of the Savings Banks Finance Group to Russia is very limited, we are closely monitoring the economic fallout of the current crisis including all potential second- and third-round effects.

He adds: “Above all, Germany and other European countries must diversify their energy sources better. This transition needs to be at the top of the political and economic agenda. Anyone still unconvinced of the overarching importance of combating climate change should by now at least share the objective to achieve greater energy independence.”

Regional landesbanks’ success

Helaba, the eighth-biggest bank in Germany by Tier 1 capital, achieved post-tax profits of €501m in 2021, 183% higher than the €177m achieved in 2020. It is one of several landesbanks, regional state-owned banks that are members of the German Savings Banks Finance Group.

“The figures prove that our strategic agenda is paying off,” says Thomas Gross, chief executive of Helaba. “Our operating activities saw growth across almost all segments. The further increase in net fee and commission income is an especially positive development. We coped well with the Covid-19 pandemic. It accelerated digitalisation and the move towards more flexible and mobile working at our company.”

As for the coming year, rising inflation, lower economic growth and the war in Ukraine will present problems. On this last point, Mr Gross says that Helaba has been managing its exposure to Ukraine, Russia and Belarus for many years, and its net exposure is “in the low double-digit millions”, most of which is export credit agency-guaranteed trade finance.

Another reason to be positive is that the bank has expanded its range of environmental, social and corporate governance (ESG)-related products and sustainable finance advisory service. “ESG criteria have become an integral part of any large transaction and client demand for sustainable finance has reached unprecedented levels,” adds Mr Gross.

Good progress is being made on the bank’s digitalisation strategy. “In 2021, we launched what is arguably the most comprehensive IT programme in our bank in decades,” he says. “With an investment in the triple-digit-million range, we will make our IT infrastructure fit for the future over the next five years.”

There is no doubt that Germany’s banks face a difficult year ahead. However, they are well capitalised and this, combined with their digitalisation programmes, focus on sustainable lending and the prospect of higher interest income, bodes well for the future.