Germany: Policy Lessons from Financial Market Turbulence
| Author | Jurgen Odenius |
| Position | IMF European Department |
| Pages | 77-78 |
Page 77
Reverberations from the U.S. sub-prime mortgage crisis that first hit Germany in mid-2007 have started to change the country's financial sector.
The near-collapse last July of IKB, the first midsize German bank in three decades to face serious problems, indicates low profitability and excessive risk taking among some German banks.
IKB's problems heralded the arrival in Europe of the financial crisis that was unleashed in the U.S. subprime market. Although the IMF's most recent annual assessment of Germany's economy covered a broad range of issues, it specifically highlighted the lessons from the ongoing financial market turbulence.
The ensuing rescue of IKB, a private bank, was shouldered in large part by the KFW, a public sector bank that owned 38 percent of IKB at the onset of the crisis. Sachsen LB, a public sector bank, faced similar difficulties in August 2007 and was rescued by Germany's largest public sector bank.
West LB, another prominent public sector bank, also faced severe difficulties that necessitated a rescue package in early 2008. In addition, many other private and public banks reported larger-than-expected write-downs, including Bayern LB and Deutsche Bank more recently.
What do these events have in common? First, all three rescue efforts were swift but appreciably burdensome to the public purse. Notably, the KFW is widely expected to more than double its shareholdings of IKB as a result of the latest recapitalization, although efforts to divest its stake are already under way.
Risky business
[ SEE THE GRAPHIC AT THE ATTACHED ]
As a result of deep-rooted fragmentation, interest margins remain low by international standards, and Germany's banking sector has made only modest progress in generating income from nontraditional services (see Chart 1). Sectorwide profitability remains low, and banks may therefore be inclined to take on excessive risks.
A case in point is the combination of high leverage ratios and the large scale of the conduits that were operated by the rescued institutions. More broadly, the recent turbulence has raised questions as to whether many banks-especially the Landesbanken-have viable business models. The latest report maps out policy options for effective banking sector...
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