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Black box German bank


Slowly, public awareness is growing in Germany that bank riskiness is not only a problem in Southern Europe. On July 1, for example, Sü had a long article about the lack of transparency of financial institutions focussing on the latest financial statement of Deutsche Bank, and on July 9, Handelsblatt mused about the risks hidden in German bad banks in an article titled “Gefährliche Altlasten” (dangerous legacy). This legacy is probably one of the reasons why, as Reuters put is, it is “unlikely that Berlin would accept the creation of a new agency in Brussels or elsewhere with powers to overrule its own national authorities on the sensitive issue of whether to save or close an ailing bank” .

In recent years, both German financial institutions and their regulators have developed a high level of bad-bank sophistication. In May 2009, a German  „bad-bank law“ (Gesetz zur Fortentwicklung der Finanzmarktstabilisierung) has been established which allows banks to “clean” their balance sheets by transferring non-performing loans and other loss-generating assets to special institutions.

There are two variants: In the beginning, solutions were part of public rescue operations and the resulting bad banks are external public law entities operating under the umbrella of the Financial Market Stabilisation Authority (Bundesanstalt für Finanzmarktstabilisierung – FMSA): In December 2009, Erste Abwicklungsanstalt (EAA) was established in order to take over, and unwind, assets and risk exposures of WestLB (now Portigon). In 2010, FMS Wertmanagement (FMSW) was founded in order to take over risk positions and non-strategic operations from the nationalised Hypo Real Estate (HRE) Group. More recently,  banks developed in-house solutions without public involvement. (A detailed general discussion of variants of private and official bad-bank solutions can be found in this McKinsey study on Bad Banks: Finding The Right Exit From The Financial Crisis.)

The following table illustrates the unwinding progress of major bad banks.

GermanBadBanksSource: Handelsblatt, FMSW, EAA

Compared to experiences elsewhere, the numbers appear encouraging. However, they also illustrate, that the banks still have a long way to go. Several aspects must be kept in mind:

(1) No one can say whether these amounts are realistic or only the tip of an iceberg. There are no general rules or standards to determine which assets are to be transferred to a bad bank, and banks make these decisions depending on circumstances.

(2) Exposures to European crisis countries such as Greece, Ireland, Italy, Portugal and Spain are still high. This was one reason for Moody’s downgrading of German banks in February last year stating:

“While Moody’s recognises that German banks have taken actions in recent years to address asset quality challenges, the rating agency believes that banks have only partially incorporated the downside risks posed by the ongoing euro area debt crisis and evolving global economic trends. As such, they may record further significant losses, if such downside risks materialize.”

(3) A smaller portfolio is not necessarily a less risky one. The Handelsblatt authors rightly hint to the fact that assets of comparably high-quality will probably be sold first so that the remaining bad bank portfolio may be even riskier than the initial one.

Let us hope that the EBA Asset Quality Review next year, and the following overall stress test to be conducted by EBA in cooperation with the ECB, will not uncover new unpleasant surprises.

From → Markets

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