State-Owned Success From Stupidest to First

German development bank KfW has come a long way since 2008, when one newspaper dubbed it “Germany’s stupidest bank” for transferring over €300 million to Lehman Brothers after it went bust. Eight years on, the bank is highly profitable, unlike struggling private-sector rivals like Deutsche Bank.
The state-owned development bank is more profitable than many of Germany's private financial firms.

It took a single money transfer, at 08:37 in the morning of September 15, 2008, for German state development bank KfW to earn the title “Germany’s stupidest bank.”

The banner headline by Germany's tabloid Bild newspaper came after the bank’s IT system sent some €320 million, or $361 million, to none other than Lehman Brothers, even though by that time it was already clear that the U.S. bank was bust.

That is long since water under the bridge now. Business is booming for KfW, Germany's third-largest bank, which is 80-percent owned by the federal government and 20 percent by the 16 regional states.

While bigger private banking rivals Deutsche Bank and Commerzbank are still battling with the fallout of the financial crisis, and European banking stocks are struggling across the board, KfW has rebounded well. It's been aided by its access to fresh capital at record-low interest rates, thanks to the state guarantee that underpins its business.

Its net profit for 2015 will likely exceed €2 billion, up from €1.5 billion in 2014, management board member Günther Bräunig said last week. Compare that to Deutsche Bank, which lost a record €6.8 billion last year and has watched its share price plunge to record lows as a result.

“It was definitely a very pleasing business year, also as far as profits were concerned,” Mr. Bräunig said.

The key question now facing a state-owned bank like KfW: What should it do with the profits? The bank's political minders will be watching it closely.

While KfW has emerged well from the financial crisis, it hasn't been completely free of controversy.

Based in Frankfurt, KfW operates somewhere between a typical development bank and a normal, privately-owned financial firm. It was formed in 1948 as part of the U.S. Marshall Plan to help rebuild Europe after the Second World War.

While it finances a number of development projects in Germany and around the world, it also passes on money in the form of loans to private households and companies, funding everything from energy-efficient homes to solar plants in the Sahara.

The bank is in demand like never before. Its loan volume increased by 7 percent last year to €79.3 billion, the highest level since 2010.

The bank also acts as a kind of fire brigade for the government, most recently helping out in the refugee crisis by providing a total of €1.5 billion in interest-free credit to regional states and municipalities to fund the construction of accommodation for asylum seekers. The money is said to have funded housing for up to 150,000 people.

“I can’t remember when a KfW program was taken up as quickly as this one,” Mr. Bräunig said. The bank has also loaned out €1.7 billion in 2015 for about 70 projects across 20 countries related to the refugee crisis, including Syria, Jordan and Turkey.

The bank’s business volume will likely keep on growing this year, even though the bank has stressed that it wants to scale back its lending. Chief Executive Ulrich Schröder has said that before.

Being a state-owned bank also brings extra scrutiny, especially now that the bank is profitable. The bank's non-executive supervisory board, which has the power to hire and fire managers and set key strategic decisions, is made up of 37 members, many of them politicians. German Economy Minister Sigmar Gabriel is the bank's chairman, a position that rotates annually. Last year, it was German Finance Minister Wolfgang Schäuble.

For now, it looks like the bank will be able to keep all of its earnings rather than pay them out to German states or the federal government, as it has sometimes been forced to in the past. The bank hopes to use the money to shore up its capital reserves, and politicians on the bank's supervisory board have so far rejected another change in the rules.

"The ban on disbursing profits [to states] has proved itself, and changes are not up for debate," said Eckhardt Rehberg, a spokesperson for Chancellor Angela Merkel’s party on budgetary matters, who sits on KfW’s supervisory board.

That could change, however, if the mood turns against the bank. German politicians will be keeping a close eye on exactly what KfW does with its newfound profitability.

“It would be good if the KfW invested its profits into future projects, like social housing or strengthening cooperation in development,” said Gesine Lötzsch, a parliamentarian from the opposition Left Party who leads the German parliament’s budget committee, and also sits on KfW's supervisory board.

 

 

While KfW has emerged well from the financial crisis, it hasn't been completely free of controversy. Last year, environmental groups accused it of not living up to standards for its development projects. Today, the bank's solid business growth and role in helping refugees risks being overshadowed by controversy over loyalty bonus payments for two executives at the bank.

Two long-serving management board members, Mr. Bräunig und Norbert Kloppenburg, each received some €110,000 in 2014 to mark 25 years of service at the bank. That amounts to two-and-a-half monthly salary payments. KfW confirmed the payments, which were first reported by Bild newspaper. All employees on old contracts were entitled to such a bonus, the bank said, adding that the rules had been changed since.

Banking analysts said such loyalty bonuses are outmoded. “Payments for length of service at the management board level are quite unusual,” Florian Frank, an expert on remuneration at advisory firm Willis Towers Watson, told Handelsblatt. “The remuneration of a management board member should be linked to performance and success, there’s no room for anniversary bonuses.”

Some politicians also voiced criticism. “I think that’s inappropriate,” said Volker Wissing, a leading member of the pro-business Free Democratic Party. “I thought that after the excesses of the financial crisis, banks had become more modest.”

Others, however, were more forgiving. Kerstin Andreae, deputy parliamentary group leader of the opposition Greens party and another member of KfW’s supervisory board, defended the bonuses.

“If such a rule applies to all employees, I find it acceptable,” she said. KfW had been very successful in recent years, she said, adding that “even a state-owned bank must pay salaries in line with the market.”

The annual remuneration of KfW’s management board members in 2014 ranged from €571,000 to over €1 million paid to Chief Executive Ulrich Schröder.

Including his loyalty bonus, Mr. Bräunig, in charge of capital market operations, received €672,000. Mr. Kloppenburg, in charge of international finance, was paid €678,000. Those sums include the cost of a company car and driver and insurance for management errors.

But there are limits to the tolerance of German politicians. Management calls for a salary increase as stipulated by their wage contracts have been met with criticism from some supervisory board members.

 

Michael Brächer covers banks and financial markets for Handelsblatt in Frankfurt. Christopher Cermak of Handelsblatt Global Edition also contributed to this story. To contact the author: braecher@handelsblatt.com

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