German Banks Cash in on the Crisis

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Nevertheless, the economic crisis threatens to get even worse, because the credit system is still not working the way many politicians specializing in financial issues believe it needs to, if greater damage is to be prevented.

Ilse Aigner has asked officials in her ministry to carefully examine and document the behavior of financial institutions. She plans to release the results of the study to the public. In her view, banks that do not pass on interest rate reductions to their borrowers are operating in legally shaky territory. Her position is based on an April ruling by the German Federal Court of Justice, according to which banks cannot set variable interest rates and fees at their own discretion.

Even Axel Weber, the chairman of Germany's central bank, the Bundesbank, is relying on public pressure. He knows that banks have steadily tightened their requirements for the creditworthiness of borrowers in recent weeks and months. And he also knows that much of the money the banks have borrowed from the ECB is not reaching businesses and bank customers.

In a startling move, Weber called upon the banks to pass on interest rate reductions. Otherwise, he said, "central banks will be forced to circumvent the banks and take direct measures to support the economy."

That's something they will in fact probably have to do, should politicians fail in their attempts to stabilize the financial sector. Despite the current profits and rising share prices, the banking crisis is far from over.

Toxic Assets and Hidden Losses

Banks still have unimaginable amounts of toxic securities on their balance sheets. The International Monetary Fund (IMF) estimates that potential global write-downs resulting from the financial crisis could be over $4 trillion (€2.85 trillion). Crisis-related write-downs to date amount to only about $1.5 trillion (€1.1 trillion).

Although new, more generous write-down rules have eased the problem, they have not solved it. And the real solution, the establishment of functioning bad banks, is something the German government has been struggling with for months.

So-called "bad" banks are companies into which banks can deposit their toxic securities. This removal of troubled assets from balance sheets frees up equity capital otherwise needed as a buffer against risk. It also prevents banks from being further downgraded by the rating agencies, which would mean that they would have to establish even larger buffers.

In return for relieving the banks of their toxic assets, Germany's center-left Social Democrats, and some members of the center-right Christian Democrats, have pushed through strict rules that would hamper the banks for years should they participate in the bad bank program. Under one of these rules, the banks are required to immediately pay the federal government 10 percent of the book value of the transferred securities. Exceptions are only permitted if such a payment would reduce a bank's capital base to such an extent as to sharply curtail its ability to compete.

All other potential losses are estimated and must be paid in installments over a 20-year period. A bank is only permitted to pay a dividend if its profits exceed the payment it owes the federal government. But a bank that is restricted in this way would be unable to raise money on the capital markets—and therefore would have no capital to invest. In the worst case scenario, the bank would exist in a comatose state for decades.

More generous rules were not feasible, for political reasons. Bank bailouts are unpopular—especially at the moment, when parties are campaigning in the run-up to Germany's Sept. 27 national election. It is difficult to convince voters that such aid averts far more serious consequences, especially when banks are reporting profits and their share prices are rising sharply.

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