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What are German banks for?

04 April 2017
Richard Kemmish

A small German bank that I follow closely recently released its results. The first sentence of the accompanying press release said that 2016 was a very successful year for them because they significantly expanded their corporate loan book. That was it. Details about profitability and credit were in the second paragraph of the press release. The return on equity wasn’t mentioned at all.

Only in Germany.

The symbiotic relationship between corporates and ‘their’ banks is frequently cited as a cause of the German economic success story. What if it is, as I hypothesise, an effect? Vast deposits, historically low interest rates and low risk loan books – all results of German industrial growth - allow the banking sector to be a service provider to the real economy and disregard RoEs so low that, in other countries the banks would have been embarrassed into a wave of consolidation.
None of which would really matter to the average German corporate treasurer enjoying the current set-up if it were not for the fundamental changes to the European banking system that are afoot and the disruption that they threaten.

To take just a few of those changes.

It is no wonder that Capital Markets Union is the biggest financial project of this parliament. The real economy in many member states remains in the doldrums and the banking system is not fit for purpose. I don’t think I am exaggerating to say that the suffering that this is causing is an existential threat to the Union. The fact that Germany does not have these problems and does have a banking system that is ‘fit for purpose’ is irrelevant. Capital Markets Union is inevitable, many of the work streams will have profound, often unpalatable consequences for the German banking system.

Then there is the new approach to risk weighted assets. Readers of my covered bond commentary will know that this is something of an obsession of mine, but I make no apologies: It is important. The leverage ratio and/or the floor under risk weights in internal capital models are inevitable, fundamental and, no doubt about it, they punish the prudent. The biggest losers will be the banks with the lowest risk balance sheets, particularly residential mortgages and corporate loan books. Guess who I’m talking about here.

Finally, interest rates. The ECB’s deposit rate has been negligible for about 6 years now. We may be starting to see the first awakening of Eurozone consumer inflation, and therefore of justification to start the rate hike cycle. But this monetary policy has already caused vast asset price inflation. Anyone else see the parallels to the relationship between the Fed Funds rate and US inflation (CPI and financial assets) from 2000 to 2005? Anyone remember what happened next?

Corporate treasuers of Germany have enjoyed incredible funding from the banking system for decades. Time to think of plan B?
I’m looking forward to discussing plan B at the Euromoney German Forum in Berlin later this month. For more information about the event and to view the agenda, please visit the conference webpage, here.

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