The
German Banking Industry -Structure, Ownership and Challenges
Robert W. Becker, Vice President, Helaba New York Branch
The
banking industry in Germany is in a state of rapid change
influenced by intense global competition, new regulatory
approaches and advances in technology. The current structure
of the banking system follows the so-called universal bank
scheme, that distinguishes private and public sector banks
from specialized lending institutions. While universal banking
has historically added stability to the banking system,
this concept currently experiences major adjustments in
light of global market shifts. The current merger activity
and restructuring of existing banking conglomerates and/or
banking groups shows that the German banking industry is
in the middle of such a critical adjustment process. This
article reviews the current state of the banking system
and the implications of global trends on the industry.
Universal
Banking and Group Banking
Because banking in Germany is quite different from the US,
it is helpful to set out the fundamental principles of universal
banking and group banking. The universal banking concept
permits banks to provide commercial bank services, as well
as investment bank services at the same time. Unlike in
the US, banks in Germany provide all types of private and
corporate lending activities, asset management and investment
banking services through one banking institution, affiliates
or related banking organizations.
As
a result, the German banking system can be divided into
three major banking groups, namely private sector commercial
banks, public sector commercial banks and the cooperative
banking group. The bank institutions in each sector target
full-range service activities in the areas of retail and
wholesale banking through a bank conglomerate or independent
banks that co-operate among them and other financial institutions.
This will also include specialized financial institutions,
such as mortgage lenders, leasing finance entities and investment
fund companies. The banking associations maintain emergency
funds for the security of depositors and represent the political
interests of the bank group vis-à-vis public authorities
and the government.
Private
Sector Commercial Banks
The commercial banks in the private sector are the 3 super
regional "big" banks (Deutsche Bank AG, Dresdner
Bank AG and Commerzbank AG), regional private banks, branches
of foreign banks and private bankers. While super-regional
and regional private banks are incorporated as public or
private limited liability companies (AG, GmbH), private
bankers are usually run by a partnership or a sole proprietor.
The larger banks, including the 3 "big" banks
are typically organized as public stock corporations with
a management board and supervisory board elected by the
shareholders.
The
"big" banks are engaged in virtually all areas
of retail and wholesale banking, i.e., commercial and investment
banking. They are supported by domestic and international
branches, as well as specialized affiliates for mortgage
lending, leasing, venture capital, internet brokerage, asset
management or investment funds. The "big" banks
have recently joined forces and merged their real estate
finance and public finance activities into Eurohypo AG.
The
private banks have also historically had close business
ties to the major industrial conglomerates, in which they
own or safeguard substantial ownership interests. This is
typically coupled with the granting of corporate oversight
rights in the supervisory boards of the respective industrial
companies. As domestic investment banking is still considered
underdeveloped compared to the US, the "big" German
banks have taken some effort to acquire international investment
banks and asset management companies in the 1990s.
The
four largest banks in Germany are now the three super regional
"big" banks and together with HypoVereinsbank
AG hold a market share of approximately 16 percent of the
entire banking market. Although originally a regional bank,
HypoVereinsbank has gained national influence through the
past merger with Bayerische Vereinsbank and subsequent acquisitions
(Bank Austria, Wien etc). HypoVereinsbank has recently merged
three mortgage bank affiliates into HVB Real Estate Bank.
Dresdner Bank was recently taken over by Allianz Versicherung
AG that also has a stake in HypoVereinsbank. Private banks
are often specialized on less capital intense niche operations
(i.e., private banking, asset management and long-term lending).
The private bankers do not contribute significant market
share and larger bank conglomerates have acquired most of
them.
Public
Sector Banking Group
The commercial banks in the public sector consist of the
local savings banks and the regional Landesbanks. The group
structure is that of a "Two-Tier-Approach" within
statutory defined geographic areas. The Landesbanks are
generally less restricted in their powers and activities
than the local savings banks and perform largely wholesale
activities. The local savings banks and the Landesbanks
are backed by statutory guaranty and maintenance obligations
of the respective municipalities or the regional states.
However, the public guaranty obligations will be phased-out
over time due to a ruling by the Commission of the European
Union (EU) in 2001 . The combined market share of the Landesbanks
and the savings banks was together approximately 36 percent
at year end 2001.
The
approximately 700 local savings banks are incorporated by
local authorities (municipalities or associations of several
municipalities) based on the law of each regional state.
This law permits each savings bank to pursue an individual
management function, subject to legal review by the regional
state and ownership control through the municipalities.
The business of the local savings banks is comprised of
retail banking activities with small and medium-sized customers
in their geographical area. This included traditionally
the taking of savings deposits and real estate lending,
but the banks have outgrown these activities and offer full
retail banking services.
At
this time, 12 Landesbanks in 15 regional states exist, with
WestLB, BayLB, LBBW, NordLB and Helaba being the largest
institutions; this number does not yet consider the recently
announced merger between Hamburg LB and LB Kiel. DEKA-Bank
coordinates after the merger with DGZ Bank the joint investment
fund activities of the group. The Landesbanks act as central
banks, clearinghouses and service providers for all savings
banks within a regional state. This includes the assistance
for local savings banks when the loan size, complexity,
other financial services, or marketing activities exceed
the resources or powers of the local banks. In addition,
the Landesbanks are full-service wholesale banks with specific
emphasis on real estate finance and public finance, as well
as financing of infrastructure and essential service projects.
The
Landesbanks are formed by one or more regional states and
owned through a combination of local savings banks, the
regional savings bank associations, the respective regional
state(s), in addition to that in some instances by another
Landesbank. The banks are incorporated based on acts of
the respective parliaments in the regional state; these
acts address all organizational, ownership and control issues.
Cooperative
Banking Group
The cooperative banking sector followed historically a "Three-Tier-Approach"
consisting of approximately 1,500 local credit unions and
farm credit banks (Volksbanken, Raiffeisen-banken, Spar-
und Darlehnskassen), the central banks and DZ Bank AG (formerly:
DG Bank) as the lead bank. However, in 2001 DZ Bank has
virtually taken over all cooperative central bank activities
after its merger with GZB Bank, Frankfurt. This leaves WGZ
Bank, Düsseldorf, as the only remaining central bank
in the cooperative sector with regional business responsibility
for the State of Northrhein-Westfalia. Both, DZ Bank and
WGZ Bank act domestically as commercial banks in the wholesale
banking markets. DZ Bank also maintains the international
infrastructure of the cooperative banking sector. The combined
market share of the entire bank group, including the credit
unions, farm credit banks, WGZ Bank and DZ Bank, together
was approximately 12 percent at year-end 2001.
In
comparison to the local savings banks, the credit unions
and farm credit banks exist in a larger number, but are
of a smaller business size. This creates the specific need
for assistance by the central banks when the financial resources
or powers of the local entities are exceeded. The development
of new products and marketing programs, as well as the audit
function lies with the regional cooperative bank associations.
The
local credit unions are private law companies incorporated
in a specific legal format (e.g.), which grants each stockholder
a limited number of stocks and votes. The ownership is geared
towards small businesses, certain commercial client groups,
which usually bank with the local credit unions, as well
as local farmers and agricultural cooperatives. The legal
concept is to treat each shareholder more or less equally
to avoid majority control by one or more shareholders.
DZ
Bank was a government-sponsored entity until 1998 when it
was transformed into a private share company (AG). The shares
of the bank are not traded publicly and can only be acquired
subject to approval by the supervisory board and the shareholders,
i.e., local savings banks through regional holding companies
and WGZ Bank. The bank is currently in the process of re-packaging
their business activities in various affiliates following
a "center of competence" approach. DZ Bank still
has substantial stock holdings in related bank organizations
(2 domestic mortgage banks, several leasing companies and
investment funds, R+V Insurance Company, etc.) that provide
full-range services to its customers and the customers of
the local credit unions and farm credit banks.
Specialized
Lending Institution
Unlike universal banks, the business activities of specialized
lending institutions are focused on particular financial
services only. Such specialized banks are typically mortgage
banks, building and loan associations and securities clearing
houses, investment fund companies and government-sponsored
banks. The mortgage banks are with only few exceptions (for
instance Depfa Bank/Aareal Bank which has recently separated
its mortgage finance from the public finance business) not
independent and operate typically as part of a larger bank
conglomerates or bank groups. This is also true for the
building societies (i.e., Bausparkassen), which combine
annuity saving plans with public subsidies and the ability
to convert them into home mortgage loans. The government-sponsored
banks (Kreditanstalt für Wiederaufbau, Deutsche Aufbaubank,
etc.) were formed in the public interest to provide loans
and export finance for certain industries, as well as development
projects.
Due
to a modification of the German Mortgage Banking Act, which
became effective in July 2002, mortgage banks are now authorized
to do mortgage lending in the US at similar conditions as
already in EU countries; this includes the statutory right
to issue mortgage backed bonds or municipal bonds; this
funding base is less rating-sensitive given the quality
of the bond collateral which needs to meet relatively strict
requirements, such as senior mortgages at a max. 60 percent
loan-to-value ratio based on conservative appraisal techniques.
Due to similar laws for the Landesbanks (Öffentliches
Pfandbrief-Gesetz), DZ Bank AG and Deutsche Postbank AG
etc., these institutions are also benefiting from the issuance
of statutory mortgage bonds and municipal bonds in the German
capital market.
German
Banking Industry and Global Market Shifts
During the past few years, the German banking industry experienced
a number of fundamental market and regulatory pressures,
as well as economical and financial shocks. The recent regulatory
and economic shifts can be summarized as follows:
- A
drastically changed operating environment for banks as
a result of new regulatory and legal requirements, including
the Basel II Capital Accord, minimum requirements ("MAK")
for the various business lines and IAS-Accounting.
- The
intensifying competition of foreign commercial and investment
banks, fund companies and other financial services participants
from inside and outside the EU.
-
The current decline in the overall credit quality of medium-size
and large-size borrowers as a result of the sharp economic
downturn and lack of consumer confidence.
- The
relatively low profitability of German banks by international
standards based on relatively high cost structures, increased
loan loss reserves, over-banked domestic markets and high
volatility of investment banking.
-
The trends of continued disinter- mediation caused by
the rapid growth of securitization conduits and other
off-balance sheet financing techniques.
-
The enhanced abilities of structured capital market products
to undercut traditional relationship banking approaches
and low-margin corporate lending.
-
The use of major technical improvements in global transmission
and communication, as well as processing and warehousing
of computerized information.
Changes
in the Regulatory and Legal Environment
The EU indicated that the rules of the Basel II Capital
Accord would be imposed on all banks in member countries,
effective in 2006 . The reform concept requires more efficient
evaluation and disclosure of bank risks based on mathematical-statistical
modeling and data warehousing. The new standards alter the
methods of risk evaluation and management in banks and will
significantly affect the underwriting, legal structure and
pricing of loan transactions.
Given
the magnitude of the reform project, the German banking
industry has already commenced preparations with significant
investments into development of more advanced risk measurement
techniques and data technology. The member countries accepted
the new regulatory approach because national options were
granted for the capital treatment of small and medium-sized
companies and long-term lending activities. These exemptions
also take care of German regulatory concerns.
Another
critical issue for publicly listed limited liability companies
is the introduction of IAS-Accounting in the EU by 2005.
The new rules will affect the banking industry because the
accounting rules in Germany were traditionally lender-friendly.
They introduce the fair market concept for the evaluation
of most assets similarly to U.S. GAAP and require the full
disclosure of hidden reserves in financial accounting. Under
current law, those reserves are widely used in the industry
to make up for temporary profitability shortfalls.
Capital
Structure and Ownership
The banking industry is currently reviewing the options
for a more efficient use of their group-wide capital resources.
This coincides with the need to redesign the strategy, organization
and structure between various entities within a bank group
to achieve a favorable bank rating. The participation of
third party investors in bank affiliates or holding companies
and pursuit of strategic alliances without sacrificing group
control is one of the issues. To provide further capital
relief, the banks will continue to push forward to securitization
of entire loan portfolios.
The
phasing-out of statutory guaranty obligations has initiated
a structural debate about the most suitable business model
for the public banks. The models range from partial privatization
over strategic alliances and bank mergers (horizontally
among Landesbanks, and vertically with local savings banks
or even across traditional bank sectors) to cross-liability
pools. Other issues are related to the massive stockholdings
that the major banks still own in industrial conglomerates.
The sell-down of large stockholdings is considered crucial
under the aspects of capital intensity and corporate governance.
Trends
in German Banking
The stability of the German banking system is historically
based on the universal banking approach. Doing business
through diversified banking institutions and/or bank groups
has historically allowed for risk mitigation over various
business lines. However, the driving forces behind the structural
changes are increasingly proving universal banking as too
cumbersome and cost-intensive. The banking industry is currently
in the process of making adjustments to the organizational
structure and strategic positioning of bank conglomerates,
bank groups and strategic alliances with more significant
measures to follow. The banks make strong efforts to focus
on core bank activities, to use existing capital resources
more efficiently, to close down retail branches, and to
bundle or outsource back-office functions. The future regulatory
and legal environment will also contribute to a more internationally
and capital markets oriented business behavior. It can be
assumed that the adjustment process will result in a leaner,
cost-efficient understanding of universal banking in Germany.
Dr. Robert W. Becker heads Loan Syndication and Risk
Management within the Real Estate Finance area of Landesbank
Hessen-Thüringen - Girozentrale, New York (Helaba)
since 1994. Prior to that he was responsible for a group
of account managers for German industrial conglomerates
with DG Bank, Frankfurt and a lawyer for property foreclosures
with DG Hyp, Hamburg.
