Margaret Doyle

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Germany yet to learn the lessons of IKB

August 24, 2009

IKB Deutsche Industriebank, the Mittelstand bank that almost collapsed two years ago due to its huge exposure to American sub-prime mortgages, is on the road to recovery.

The bank — now owned by Lone Star, an American private equity firm — on Monday reported first-quarter (April to June) profits of 19.4 million euros against a 517 million euro loss last time.

It is about time: after two privately-led bail-outs in 2007, the German government had to step in early in 2008. After the European Commission last month approved 7 billion euros in government guarantees for new bonds, IKB now enjoys total guarantees of 12 billion euros.

That may look like small beer compared to a total package of  500 billion euros of banking support organised by Berlin. However, the more worrying fact is that all this money seems to be being thrown at the banks without any underlying reform.

In contrast to its world-beating industrial export machine, Germany’s banking sector is sclerotic. With more than 2,000 banks, there is little money to be made from the domestic market, which is what prompted supposedly conservative banks like IKB to seek profits abroad in areas they did not fully understand.

Even though Germany avoided a domestic debt binge, these ill-fated ventures have left its banks dangerously undercapitalised: Gunter Verheugen, the Commission’s German vice-president, describes the country’s financial companies as “world champions in risky banking transactions”.

Moreover, despite the Commission’s success in 2005 in banning state support to the landesbanken (regional banks), both federal and regional governments still own swathes of the industry. This means lending decisions tend to be made on political, not commercial, grounds.

The crisis in German banking is particularly acute because the country’s industry traditionally relies on bank loans rather than bonds or the equity markets for financing.

Berlin has so far resisted American-style stress-tests that might identify where the biggest problems lie. Instead, it is putting its faith in a bad bank. However, with federal elections looming in September, the government has opted for a structure that minimises losses to the taxpayer. Unfortunately, this means there is little incentive for any bank to take part.

Without cleaning up their balance sheets properly, the banks will not resume lending to a shrinking German industrial base. And without fundamental restructuring, the banks have little hope of generating the profits they need to put their business on a sounder footing.

The risk is the spectre of a Japanese-style “lost decade” of deflation. That would cost Germany far more than radical reform of its banks, whatever the short-term pain.

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  • About Margaret

    "Margaret Doyle is a Reuters Breakingviews columnist, based in London. She writes about investment banking. She has been a journalist for over 14 years. She has written for The Daily Telegraph and The Economist and presented various radio programmes for the BBC. She began her career as a consultant at McKinsey & Co. She has an economics degree from Trinity College, Dublin and an MBA from Harvard Business School, which she attended as a Fulbright scholar. She is a Conservative Member of Westminster City Council."
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