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Germany's Banking Titans Are in Trouble


Less than 10 years ago, Frankfurt-based Deutsche Bank (DB) was the biggest bank in the world outside Japan in terms of market capitalization. It had the financial muscle to acquire any bank in Britain or on the Continent, and had grand plans for global expansion. Now, Deutsche doesn't make the global top 20 in market cap. One measure of how far it has sunk is outgoing Chief Executive Rolf Breuer's statement to journalists on Apr. 29 that it's "not inconceivable" that Deutsche Bank itself might be acquired. Indeed, in February, Citigroup (C) approached Deutsche to sound out the possibility but was rebuffed.

Deutsche Bank and its fellow German giants--Frankfurt-based Dresdner Bank and Commerzbank and Munich-based HypoVereinsbank--were once counted among the undisputed masters of Continental banking. No more. Sky-high costs, reckless lending, mounting bad debts, and ill-conceived forays outside their core markets have taken a heavy toll on their profits and stock prices.

Now, under growing investor pressure, the banks are belatedly trying to right themselves, turning 2002 into the year of restructuring. One after another in recent months has rolled out cost-cutting and reorganization schemes. Most important, the banks have finally faced reality on staffing. Dresdner, which was acquired by insurance giant Allianz last July, is eliminating 7,800 jobs as part of a streamlining that CEO Bernd Fahrholz says should give it a "storm-proof cost structure." All told, the four big banks plan to lop off 30,000 staff--some 10% of the total--over the next two years, 17,000 of them in Germany. At the same time, they are trimming their expensive branch networks. Commerz, for example, is midway through a program that will shut 200 of its 925 branches.

The banks have to do something to reverse their decline. Most German banks report costs that equal up to 80% of their income, way above the 60% that is typical of their European competitors. Deutsche, Dresdner, and Commerzbank scarcely managed to make any money at all last year. And in November, 170-year-old, privately owned SchmidtBank had to be rescued by a consortium of the biggest players after running up $1.2 billion in bad loans.

No surprise, then, that when consulting firm Accenture Ltd. recently compared banks across Europe in terms of efficiency and the esteem in which they are held in the capital markets, it put the Germans at the bottom of the pile. "They have systematically eroded value," concludes Accenture partner Norbert Linn.

The big banks have traditionally blamed Germany's inhospitable financial-services market for their poor showing. Competition, they say, is distorted and margins are squeezed because state-controlled banks, which account for more than half of all deposits in the country, unfairly benefit from guarantees and close links to municipal and state governments. "The protectorate of the public-sector banks has prevented reforms and consolidation," says Commerzbank CEO Klaus-Peter M?ller. Bankers also say the country's tough labor laws make it complicated and costly to shed surplus staff.

All this is also true in Spain, however, and yet Spain boasts some of Europe's most efficient, dynamic, and profitable banks. The fact is, the big German banks precipitated many of their own problems by not cutting costs and addressing weaknesses in their strategies soon enough. "They've repeatedly failed to take capacity out of the system. They've never been willing to bite the bullet," says Mark Hoge, an analyst at Banc of America in London.

The special status of the state-controlled banks will be phased out by 2005. But the four big banks need to institute radical reforms long before then, and some progress is being made. On Apr. 9 Commerz unveiled plans to restructure its German asset-management activities by bundling them into a new company, cominvest. It will sell Jupiter Asset Management, its British fund subsidiary, and could sell Montgomery Asset Management, its North American operation, as well as its Italian venture. Dresdner, for its part, announced on Apr. 24 that it would merge the debt and equity operations of Dresdner Kleinwort Wasserstein, its investment-banking subsidiary, in a bid to cut costs and increase revenue per employee.

Deutsche Bank, still the world's second-largest bank in terms of assets, behind Citigroup, isn't sitting still, either. On Apr. 30, Chief Financial Officer Clemens B?rsig announced that the bank would speed up the sale of its industrial holdings, which include stakes in carmaker DaimlerChrysler, reinsurer Munich Re, and Allianz. Frankfurt is also alight with rumors that Deutsche may soon ditch several subsidiaries, including money-losing Banque Worms of France and Deutsche Banc Alex. Brown Inc., the U.S. money manager and investment bank. New CEO Josef Ackermann, who takes over on May 22, is said to be worried that Deutsche may indeed be vulnerable to a takeover unless it shapes up quickly. Deutsche's share price has plunged 30% in a year.

The German banks' troubles will probably get worse before they get better. The recent collapse of construction firm Philipp Holzmann, the Kirch Group media conglomerate, and aircraft manufacturer Fairchild Dornier could cost the banks billions of dollars. And there are many more bankruptcies on the way. Creditreform, which collects data on corporate insolvency, predicts 40,000 companies in Germany will go belly-up this year, a rise of 24% over 2001.

The rising tide of bad debts won't be offset by an increase in demand for banking services by other companies; the German economy is recovering too slowly from last year's recession for that. When sales of its industrial stakes are excluded, pretax profits at Deutsche Bank fell 70% in the first quarter. To make things worse, competition from foreign banks is heating up as they move deeper into the crowded German market--witness BNP Paribas' Apr. 29 acquisition of a controlling stake in Consors, SchmidtBank's online broking subsidiary.

Bold as they are, the plans announced in recent weeks don't go far enough. Deutsche Bank Chief Economist Norbert Walter says the banks need to shed not 10% but 30% of their staff and close half their branches in the medium term. That means they must merge--just as their competitors in Britain, Spain, Scandinavia, and the Netherlands have done. The past five years have seen only one major banking merger--two Munich banks joined to create HypoVereinsbank. Other marriage proposals faltered after bitter squabbles over such issues as which executives would be in control and which bank would be the senior partner. Until they can rise above such petty issues, the big German banks will remain in trouble--and tempting bait for more efficient competitors interested in penetrating the big German market. By David Fairlamb in Frankfurt


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