Teutonic trouble Why European rivals outperform German banks

Too many branches and an unfavorable environment are making life tough for German banks. They're even being bested by rivals in economically weaker countries like Spain and Italy.
Spain's BBVA knows the drill better than Commerzbank.

It's a tale of two banks. In 2016, Deutsche Bank plunged into a crisis owing to legal risks amounting to billions of euros, which caused the bank's share price to drop to an all-time low. Italy's UniCredit was in a similar situation, faced with a mountain of bad loans. Germany's largest bank needed a capital increase of €8 billion ($9.8 billion) to win back the trust of investors, while UniCredit required €13 billion in fresh funds.

A year and a half later, and the Italian bank has just posted a net profit of €5.5 billion, while Deutsche Bank suffered a loss of €500 million, its third consecutive annual loss. UniCredit's shareholders can look forward to a dividend again; Deutsche Bank investors will probably have to content themselves with a mini-dividend. This disparity is reflected in the banks' shares. While UniCredit shares have gained 44 percent over the last 12 months, shares in Deutsche Bank have plummeted by almost 20 percent.

The second-biggest German bank, Commerzbank, is not much better off. Although it reported a small profit of €156 million for 2017, net income was only about half that of the previous year, resulting in a paltry return on equity of just 0.5 percent. The bank is making faster progress than Deutsche with its restructuring and plans to pay a dividend after a two-year pause, but that can't hide the fact that it still has a long way to go. Commerzbank shares have nevertheless climbed more than 60 percent over the last 12 months.

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So why is it that Germany's two largest private-sector banks are still sorting themselves out 10 years after the financial crisis, while banks in other European countries have long since returned to profits of billions? Particularly when competitors' domestic markets have often been hit hard by the euro crisis, while the German economy has gone from strength to strength? "In Germany, competition on the banking market is a lot more intense than in other European countries. There's no other economy where so many institutions are battling for market share," said Achim Kaucic, a banking expert at the consultancy AT Kearney.

Germany still has around 1,700 independent banks vying for business, owing to the large numbers of small savings banks and cooperative banks. The number of banks has fallen by between 25 percent and 30 percent in recent years, but the equivalent figure for Spain is 45 percent, with 50 percent fewer in France, Christian Sewing, deputy head of Deutsche Bank, recently calculated. "Germany is still overbanked," he said.

The European Central Bank wants consolidation and Commerzbank is a perennial target of speculation, with UniCredit, BNP Paribas and Crédit Agricole all said to be interested. However, Commerzbank made it clear during its earnings press conference this week that it won’t agree to an offer any time soon. Chief financial officer Stephan Engels said regulators would increase capital requirements for a merged bank, and said that consolidation "will happen, but a lot more slowly than everyone currently expects."

The tough competition on the German market puts pressure on profitability. "There are very few other European markets where the margins for construction financing are as low as they are in Germany. It's a similar situation in business with small and medium-sized companies," said Mr. Kaucic. It's not much better when it comes to business with larger companies. The economy is booming, companies are investing, but commercial banking activity is stagnating. Chronically low interest rates and fierce competition are preventing banks from taking advantage of companies' growing demand for credit. The volume of credit reached a new record of almost €1.1 trillion in the first half of 2017, but the credit margin slumped to 1.3 percent, the same level as in the crisis year of 2008.

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The situation is exacerbated by other problems the banks have created for themselves. "German banks have a lot of catching-up to do when it comes to cost efficiency. They need to exploit potential for savings in this area through greater process automation," said Gerold Grasshoff at Boston Consulting Group. Automation and efficiency are often closely linked. Spanish bank BBVA began taking its business online at an early stage, and it’s paying off: the bank's online customers are twice as profitable as its other customers. To earn one euro, BBVA had to spend only 49.5 cents last year, compared with 93 cents at Deutsche Bank and more than 77 cents at Commerzbank.

Experts also blame delays in restructuring for the banks' difficulties. "German banks sometimes simply don't have the consistency to just close down areas of business that are unprofitable - not in three years and a bit, but straight away," said Dirk Müller-Tronnier, head of the banking and capital markets division at consultancy EY. Mr. Müller-Tronnier said one reason for this is that German banks often have confusing structures with a lot of sub-committees, all of which need to be involved in decisions.

However, simply cutting costs will not be enough. "Banks also have to do something on the earnings side," said Mr. Grasshoff. He believes prices are too low overall in Germany and that there is not sufficient differentiation between customers. Yet it will be difficult for banks to do away with the culture of free banking services that they previously introduced themselves. "I wish private German customers were willing to pay as much for banking services as in Italy, but I fear it will be very difficult," Deutsche Bank CEO John Cryan said a few days ago at the bank's annual media conference.

The German subsidiary of Dutch banking giant ING is proof that large banks can do good business in Germany. The German arm, ING-Diba, started off with phone-based banking but has been expanding its services for years and is aiming to become one of Germany's biggest universal banks. Last year it achieved its fifth record result in a row with a pre-tax profit of €1.3 billion. "ING-Diba got a lot of things right. It has concentrated on a few products that are easy to understand and combines that with a visible focus on customers," said Mr. Müller-Tronnier, adding that sticking to its strategy has paid off in a highly competitive market.


Michael Maisch is currently the deputy editor of the finance section for Handelsblatt in Frankfurt. Yasmin Osman is a financial editor with Handelsblatt’s banking team in Frankfurt. Andreas Kröner covers financial services for Handelsblatt in Frankfurt. To contact the author: [email protected][email protected], [email protected]