For the past few months, the clouds gathering over Italy’s banks have overshadowed the pressures on Germany’s lenders. But the last week has given a stark reminder that the outlook north of the Alps is also bleak.
In Europe’s latest set of stress tests, released last Friday, German lenders posted four of the 10 biggest falls in capital strength in the adverse scenario modelled as part of the exercise.
Commerzbank’s results cover just one quarter, which included the UK’s decision to leave the EU. But, despite such caveats, the struggles of Germany’s second-biggest lender encapsulate problems facing the banking sector in Europe’s largest economy as negative interest rates start to bite.
Unlike in Italy, the big issue for German banks is not bad loans. Some, such as the Landesbanken, HSH Nordbank and NordLB, are battling with exposure to the shipping industry.
But for the sector as a whole, the ratio of non-performing loans to total loans was just 3.1 per cent in March, below the EU average of 5.7 per cent, and a far cry from Italy’s ratio of 16.6 per cent, according to the European Banking Authority.
Instead, the problem is a chronic lack of profitability. The German banking sector’s return on equity was just 2.6 per cent in the first three months of the year, according to the EBA. That made it the third-worst performer in the EU, ahead of only Greece and Portugal.
“This is the root of the trouble for German banks, and it was a problem long before the financial crisis,” says Martin Hellmich, a professor at the Frankfurt School of Finance and Management. “As long as their profitability remains so low, they are going find it hard to strengthen their capital buffers.”
The origins of the low profitability of Germany’s banks lie in the sector’s structure. The profusion of local savings and co-operative banks means that Germany has the most fragmented banking system in the eurozone. In 2014, the share of assets held by its five biggest banks was just 32 per cent.
The upshot is a toxic combination of a brutal battle for market share, which has squeezed margins on retail and corporate lending; and high costs stemming from duplication of banking capacity. In the eurozone, there was one bank employee for every 166 people in 2014, according to the ECB. In Germany there was one for every 127.
Negative rates have only made the situation worse for a banking system that is awash with deposits, and in which most lenders traditionally derived a sizeable chunk of their earnings from net interest income.
Commerzbank said on Tuesday that the phenomenon had cut its net interest income in two key divisions by €161m in the first half of the year. If rates stay where they are, the bank expects an additional €100m hit each year from 2017, as loans to customers run out and are replaced with ones with lower interest rates, although the bank hopes to be able to mitigate this effect.
For the German banking sector as a whole, the ECB’s 0.4 per cent levy on excess deposits will cost about €787m this year, according to analysts at Deutsche Bank. “When rates are negative, it puts the German model under a lot of pressure,” says Mr Hellmich.
Gunter Dunkel, head of the Association of German Public Sector Banks, and chief executive of NordLB, takes a similar line. “Almost every large German bank has to reinvent its business model to reflect the new regulatory and interest rate environment. These have changed dramatically and we have to react to this with a fundamental review of what we do,” he says.
Most lenders have made a start. Several, including Commerzbank and Deutsche, have passed on negative interest rates to institutional and big corporate clients.
Commerzbank has increased lending volumes in its retail bank, and some banks have begun increasing the interest they charge on loans in an effort to protect their margins. Others are introducing charges for previously free services, such as paper account statements.
The problem is that the cut-throat competition in Germany’s corporate and retail banking markets means that there is limited scope to bolster revenues. That means that banks will have to do much more to cut costs.
Such schemes often incur big upfront costs before the benefits begin to emerge. But given the severity of the pressure on their income streams, banks have little choice but to push on, says Rüdiger Filbry from Boston Consulting Group.
“If banks can’t afford to take these costs in one go, then they should do it in steps,” he says. “Doing nothing is not an option.”
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