When LTU International Airways hovered on the brink of insolvency in November, Wolfgang Clement was quick to act. Within hours of hearing the news, the Prime Minister of North Rhine-Westphalia, Germany's most populous state, summoned the company's top executives to an emergency meeting with board members of Westdeutsche Landesbank.
Over Kaffee and Kuchen in his spacious office, Clement brokered the beginnings of a rescue plan. WestLB, in which his state has a 43.2% stake, and Stadtsparkasse Dusseldorf, a savings bank controlled by the city of Dusseldorf, would provide LTU with $110 million in fresh loans. If the banks had any initial reluctance, Clement overcame it when he promised the state would guarantee the lion's share of the new credits. LTU remained airborne, and 2,300 jobs in and around Dusseldorf, the capital of North Rhine-Westphalia, were saved.
LTU's irked competitors--including national flag carrier Lufthansa--lost no time in alleging unfair treatment. The banks were lending the money for political rather than economic reasons, they charged. And they were doubtless right. Yet in Germany, there's nothing unusual about what happened in Dusseldorf that blustery Saturday--although it is increasingly controversial. So close are the ties between Germany's powerful regional governments and the 12 Landesbanken--or state banks--that it's commonplace for ministers to influence their lending decisions. In fact, the Landesbanken serve as house banks for the federal states, doing everything from funding government-run development projects to issuing bonds on the states' behalf.
Now these cozy arrangements are under heavy attack again. The trigger was the looming bankruptcy of the Kirch Group. Last year, Bayerische Landesbank granted a $1 billion loan to the media company at the behest of Bavarian Prime Minister Edmund Stoiber, who is the conservative candidate for chancellor in this fall's election. The bank, which is 50%-owned by Bavaria, is the financial institution that's most heavily exposed to Kirch, and it stands to lose up to $1.9 billion if the company collapses.
Critics of the Landesbanken point out that such deals are usually a characteristic of developing countries, and that they seriously distort Europe's biggest economy. Indeed, the very existence of the Landesbanken discourages foreign banks from making acquisitions in Germany, analysts say, which in turn holds back the creation of pan-European banks. Along with Germany's savings banks, which are usually owned by municipalities, the Landesbanken now account for 37% of all banking business in Germany. Landesbanken loans are guaranteed by the states and therefore enjoy top-notch credit ratings, which means they can raise money at up to 50 basis points cheaper than commercial banks.
Under pressure from the European Commission, Germany will phase out new government guarantees for the Landesbanken by 2005. That means their credit ratings will slip, the cost of their funds will increase, and they will be forced to compete on equal terms with private banks. It's another blow against the state corporatism that has long dominated Europe, and another step in the unraveling of Germany Inc. However, although the Landesbanken are expected to restructure and merge in anticipation of tougher times, they will continue to be influenced by the politicians. "Many people may want to see them privatized," says Michael Zlotnik, who follows the banks for credit-ratings agency Standard & Poor's Corp. in Frankfurt. "But the states will remain part owners."
The bad loans made under pressure from politicians could hasten the restructuring of the Landesbanken. Bankgesellschaft Berlin, 81%-owned by the city-state of Berlin, is just the most dramatic example of how bad things can get when lending goes wrong. Urged on by the city government, it lent billions to property developers rebuilding Eastern Germany, only to discover that they couldn't repay their loans. Bankgesellschaft lost $1.4 billion in 2000 and had to be recapitalized with $1.5 billion from city coffers last year. "The influence of the politicians is felt throughout these institutions," says Chris Huhne, a member of the European Parliament's economic & monetary affairs committee.
No wonder. Ministers have seats on the banks' supervisory boards and ministerial appointees usually dominate their guarantor committees, which oversee many of their business activities. Take Landesbank Schleswig-Holstein, which may soon be mobilized to tackle the mounting financial problems of MobilCom, a money-losing local mobile-phone operator. The bank is 25.05%-owned by the state, and Prime Minister Heide Simonis chairs its 34-member supervisory board. If she decides the bank should help MobilCom, odds are she will get her way.
State ministers and Landesbankers insist that their relationship isn't incestuous. A spokesman for Bavarian Economics Minister Otto Wiesheu says BayernLB makes its own lending decisions; officials at the bank say they loaned money to Kirch because it made commercial sense. But BayernLB decided to support Kirch just days after private-sector Hypovereinsbank turned it down. And WestLB and Stadtsparkasse Dusseldorf agreed to help LTU after the private Dresdner Bank decided not to get involved.
Of course, not all politically inspired loan decisions are bad ones. In the late 1990s, Clement encouraged WestLB to back the restructuring of Preussag, a failing steel company that has successfully transformed itself into a major tour operator. And the Landesbanken aren't the only banks encouraged to make politically motivated loans. In 1999, Chancellor Gerhard Schroder pulled out all stops to persuade a consortium of mainly private banks to bail out troubled construction company Philipp Holzmann. The outfit is now once again in trouble.
Government jaw-boning to support local companies means that the Landesbanken tend to have more loans on their books than private banks. Lending accounts for more than 60% of their business, compared with less than 50% for banks overall in Germany. That's one reason Landesbanken profits are miserable. Their average return on equity over the past five years was just 6%, vs. around 10% at the private banks.
Officials such as Huhne say that once the European Union-inspired reforms take hold, it will be harder for politicians to influence the Landesbanken. But don't bet on it. The pols will still have seats on Landesbank boards and close ties to their senior staffers. And state governments will continue using them as their house banks. It will take full-scale privatization, which is not likely in the near term, to change all that. Meanwhile, German politicians probably will go on as they have for decades--using the Landesbanken for their own ends. By David Fairlamb with Susanna Scherer in Frankfurt