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CommentNovember 26 2012

Germany’s ghost of crises past

Despite being hugely unprofitable, the German government is reluctant to get rid of the country's regional wholesale banks, the Landesbanken.
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There have been many prominent exits from the banking sector during 2012, but one significant departure attracted very little attention. On June 30, just in time to meet a EU-imposed deadline of July 1, WestLB was broken up. For many years before the 2008 crisis, WestLB had been the accident-prone whipping boy for those who questioned the business model of Germany’s regional wholesale banks, the landesbanken.

In its final decade of existence, WestLB generated annual profits just four times, with an average return on capital of -10.9%. Significantly, its final decade coincided with the period after the German government agreed with the European Commission in 2001 to end government guarantees on landesbanken liabilities, increasing their wholesale funding costs.

A decade later, there are still five other landesbanken, all among Germany’s top 15 largest banks, and all but one of which needed government assistance after the collapse of Lehman Brothers in 2008. The exception, Helaba, ultimately received €1.92bn ($2.46bn) in silent participation capital from the German state of Hesse in the second half of 2011 to meet the European Banking Authority’s (EBA) new 9% capital adequacy requirement following stress-testing.

The Helaba episode demonstrated how deeply ingrained the landesbanken are in German politics. Helaba was the sole EU bank that initially refused to participate in the EBA stress-tests, questioning the methodology used. In July 2011, the German federal government accepted this anomalous situation. The position changed only after national regulators agreed later in 2011, under pressure from the eurozone sovereign crisis, that the stress-tests would be used as the basis for determining capital requirements.

Given the scale of state assistance received, all the remaining five entities are likely to face growing demands from the EU competition commissioner to shrink to a much narrower base, with their future business models deeply uncertain. But there seems little willingness in Germany to force other landesbanken to follow WestLB into history. This could become especially thorny in 2013, since eurozone leaders and the European Commission aim to transfer supervisory powers from a
national level to the European Central Bank. Unhealthy and anachronistic they may be, but the landesbanken could still prove a significant obstacle to the eurozone’s efforts to enter a brave new financial world.

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