Five Charts Show the Big Problems for German Banks

(Bloomberg) -- Deutsche Bank AG and Commerzbank AG’s struggles to achieve healthy profits are the norm rather than the exception in Germany’s troubled financial landscape.

Europe’s biggest economy boasts some of the world’s most successful industrial companies and has seen eight consecutive years of growth. Yet it’s financial sector isn’t keeping up. The country’s lenders have struggled for so long to eke out a decent profit that fixing the broken banking system has now emerged as a top concern for regulators and politicians.

One key issue is that German lenders have consistently failed to make enough profit to adequately compensate investors for their money -- known as the cost of capital. That’s part of the rationale behind the push for consolidation, including the recent failed attempt to create a German banking giant. Commerzbank CEO Martin Zielke -- who abandoned merger talks with Deutsche Bank last month -- said on Wednesday that the bank may need to “sharpen ” its strategy and that it’s unhappy with current profitability. Why, though, is decent banking income so hard to come by in one of Europe’s richest nations?

A look at the competitive landscape is one place to start. Germany is crammed with small banks surviving on razor-thin margins. Many are owned by municipalities, which may prioritize a steady supply of credit to the local economy rather than maximizing the bottom line. Consolidation could help -- but as the recent Deutsche Bank and Commerzbank talks show -- is unlikely to happen quickly or easily. The shape of the market in the future also looks increasingly uncertain. A foreign suitor could take over Commerzbank, or the country could see mergers from the Landesbanken, Germany’s large savings banks.

Another weak point has been cost control. In part, this has to do with the country’s tough labor costs and boosting expenditure on compliance and regulation to atone for past sins. The banks are also playing catch up on investment in IT. Deutsche Bank also knows it has to pay top investment bankers competitively if its to retain talent and keep its edge in traditional areas of strength. Still, Germany’s top banking regulator recently gave the country’s lenders a public ticking off for their failure to reduce costs over the past decade.

Negative interest rates are compounding the situation. German banks sit on large deposits and are more dependent on lending than their counterparts in many other European countries. Lending income has been further eroded by competition from foreign banks such as ING entering the market and keeping costs low through an online business model. Replacing the dependency on interest income with fee income is difficult in a market where clients are accustomed to free basic banking services such as checking accounts and ATMs.

As if all of this weren’t enough, Germany’s banks are also staggering under the weight of the regulatory burden. The ECB imposes higher capital requirements on the country’s largest banks than in other countries, limiting shareholder returns and the funds needed to grow their businesses. The screws could tighten further when regulators meet next month to discuss implementing a so-called countercylical capital buffer, or funds lenders are required to build up during good times to increase their resilience in a potential economic downturn.

“The currently weak revenue situation is a big challenge for the German banking sector,” the finance ministry said in a statement recently. “It’s important that banks review their business models and adapt them if necessary to support a positive economic development in Germany in the long run.”

To contact the reporters on this story: Steven Arons in Frankfurt at sarons@bloomberg.net;Nicholas Comfort in Frankfurt at ncomfort1@bloomberg.net

To contact the editors responsible for this story: Dale Crofts at dcrofts@bloomberg.net, Christian Baumgaertel

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