German Bank Consolidation Reveals Conservative Business

UNCLAS SECTION 01 OF 02 FRANKFURT 002857 DEPARTMENT FOR EUR/AGS SIPDIS E.O. 12958: N/A TAGS: EFIN ECON EU GM SUBJECT: German Bank Consolidation Reveals Conservative Business Models ENTIRE TEXT IS SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET DISTRIBUTION REF: Frankfurt 2735 ¶1. SUMMARY. In a recent wave of acquisitions in the German banking sector, private German banks have taken over partners with large retail businesses to shore up capital and acquire steady, reliable sources of income. These moves reflect a changing business model designed to help banks adjust to a new reality where previous sources of funding such as investment banking are more limited and capital is scarce. In a series of conversations with a Treasury delegation, private bank risk officers discussed the new reality, forecasting that banks would be following more conservative strategies in the coming years. END SUMMARY. Takeovers Reflect New Business Models -------------- ¶2. On September 11, Treasury Deputy Assistant Secretary for International Monetary and Financial Policy Mark Sobel, Office of International Banking and Securities Markets Director William Murden, US Treasury Representative for Europe Mathew Haarsager and ConGen Econ Off met with risk officers at Dresdner Bank, Deutsche Bank and Commerzbank to discuss ongoing trends in the European financial sector (Note: These meetings took place a few days before Lehman Brothers declared bankruptcy and Merril Lynch was acquired. End Note.). Deutsche Bank's chief risk officer (CRO) confirmed media reports to the group that the bank was in final stages of buying a 30% stake in Postbank (which is 50% owned by Deutsche Post) with an option to increase its share to a majority at a later date, a move which will greatly expand Deutsche's retail presence. The move follows Commerzbank's acquisition of Dresdner Bank one week before (see reftel). ¶3. The Deutsche Bank executive welcomed the deal saying that it offered stable, profitable business on Deutsche's "own turf." Although retail banking is a crowded market in Germany, he expressed confidence that his bank offers better service and products than the many savings banks. Commerzbank's chief risk officer expressed similar optimism about his bank's acquisition of Dresdner, saying the new bank would be a leader in lending to small and medium-sized businesses in Central and Eastern Europe and would follow a very traditional and conservative business model avoiding the pitfalls of some banks during financial market turmoil. By expanding their retail business, both banks will gain access to capital, whose availability from other sources, such as equity markets, has diminished in the last year. Lessons Learned on Risk Management -------------- ¶4. Dresdner Bank's chief risk officer agreed with his colleagues at Deutsche and Commerz that the main lesson from the credit crisis was that none of the banks anticipated the rapid drying up of liquidity in August 2007. When the crisis hit, Dresdner found that it was unable to unload asset-backed securities which it usually held on a six-month basis. The assets have now become illiquid, forcing Dresdner to write down their values. Dresdner, which has suffered negative earnings since the beginning of the turmoil, will be forced to keep the assets for the foreseeable future. ¶5. At all three banks, the CROs pointed to challenges ahead in staving off future crises and maintaining vigilance in risk assessment. All sides agreed that the term "procyclicality" (the idea that market and regulatory conditions can amplify a crisis) remains vague and there is no wide-spread agreement on what it is or how to prevent it. While Basel II may be a step in the right direction, the Deutsche Bank executive pointed out that it also operates as a "double whammy" on banks by raising capital requirements in already difficult times. Moreover, raising capital requirements fails to differentiate among banks by ignoring the underlying quality of assets on balance sheets. All of the interlocutors saw accounting standards as a vexing problem, as current mark-to-market rules fail to account for a dysfunctional market. But there is seemingly no better way. ¶6. The three executives agreed that the role of the CROs in banks needs to be strengthened. While Deutsche Bank cautioned against "going back to the Stone Age" in risk management, the Commerzbank executive argued that CROs need to define risk policy, think more about liquidity and be independent and strong. The Dresdner executive expressed more fatalism saying that management would continue not to listen to CROs in high times, making the next crisis inevitable. He argued that while a CRO can disapprove individual transactions, he or she can not change the whole business model, and can at times be either complicit in or not able to see the FRANKFURT 00002857 002 OF 002 problems. ¶7. COMMENT. The takeovers among German banks reflect a change in the business model to more traditional banking as well as an attempt to access fresh capital. This strategy of risk aversion as well as diversification may also mean that German banks are positioned conservatively if and when market conditions improve. Many of the debates about the way forward remain unresolved, leaving risk officers and senior management little choice but to pursue a more cautious strategy in the coming years. END COMMENT. ¶8. This cable was coordinated with Embassy Berlin and cleared with Wilbur Monroe at the Treasury Department.