VZCZCXRO0921
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHRL #2094/01 3241035
ZNR UUUUU ZZH
P 201035Z NOV 07
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 9836
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 03 BERLIN 002094 
 
SIPDIS 
 
SENSITIVE BUT UNCLASSIFIED 
 
SIPDIS 
 
TREASURY PASS TO FEDERAL RESERVE 
USEU FOR B. MATTHEWS, J. NUTTER 
 
E.O. 12356:  N/A 
TAGS: EFIN PREL PGOV GM
SUBJECT:  GERMAN BANKS WEATHERING SUB-PRIME MORTGAGE 
CRISIS FOR NOW; LONGER TERM OUTLOOK STILL UNCERTAIN 
 
REF:  A. BERLIN 1746, B. FRANKFURT 4944 
 
SENSITIVE BUT UNCLASSIFIED; NOT FOR INTERNET 
DISTRIBUTION 
 
¶1. (SBU) SUMMARY:  Third quarter reports show that 
most German banks appear to have weathered the 
turbulences in the international financial markets. 
Large private banks such as Deutsche Bank and 
Commerzbank reported losses in their investment 
portfolios, balanced by gains in other sectors, 
resulting in overall third quarter profits.  While 
this has not had much effect yet on the liquidity 
crisis, the Association of German Banks believes if 
fourth quarter 2007 reports continue in a positive 
trend, interbank lending should resume on a more 
normal basis by the first quarter of 2008.  While the 
full extent of losses is still unclear, analysts 
cautiously predict that the German banking sector has 
survived the worst of the crisis.  Both government and 
industry lauded the concerted effort to prevent 
further contagion to the banking sector in Germany. 
The Finance Ministry has resisted hastily instituting 
new procedures in reaction to the crisis.  Although 
fears over further contagion were expected to increase 
consolidation pressures in the balkanized German 
financial market at first, the impetus seems to have 
waned in the face of resistance on the part of the 
federal states.  END SUMMARY. 
 
Liquidity Still a Problem 
------------------------- 
¶2. (SBU) On November 16, Managing Director of the 
Association of German Banks Bernd Brabaender told Econ 
Counselor that since no one knows the full extent of 
German banking losses all banks are trying to be as 
transparent as possible with their statements. 
Brabaender added that, while third quarter reports are 
a positive sign, the industry knows the real test will 
be in the 2007 yearly statements.  If the trend of 
overall profits continues, this should have a positive 
impact on the sector's image and ease the liquidity 
crunch.  The real problem now is that trust in the 
banking sector, even among major financial 
institutions, is weak.  Brabaender pointed to the lack 
of interbank three-month loans as evidence of this. 
The lack of liquidity has increased the cost of 
banking, but interbank lending should resume on a more 
normal basis if the positive trends continue. 
Brabaender believes this could happen in February or 
March, depending on the outcome of overall 2007 
results. 
 
Sub-Prime Crisis Impact 
----------------------- 
¶3.  (U) The third quarter reports of all major German 
banks show positive overall performance despite 
turbulence on international financial markets.  The 
top three German banks, Deutsche Bank, Commerzbank and 
Dresdner Bank, all reported either third quarter 
profits or small losses.  This is a striking contrast 
to Switzerland's UBS or CitiBank, which reported sub- 
prime losses in the tens of billions of dollars for 
the third quarter. 
 
¶4.  (U) Deutsche Bank, the largest German bank, 
appears to have weathered the sub-prime mortgage 
crisis reasonably well.  CEO Josef Ackermann warned of 
sub-prime related losses for the third quarter early 
on.  While Deutsche Bank wrote off losses of 2.16 
billion euros ($3.17 billion), overall Deutsche Bank 
figures show an increase in profits for the period of 
almost 30 percent, or 1.6 billion euros ($2.35 
billion).  Sub-prime related losses were more than 
compensated by other portfolios, especially in the 
German retail banking and Asian sectors. 
 
¶5.  (U) Commerzbank, Germany's second largest bank, 
reported 291 million euros ($425 million) in sub-prime 
related losses.  Commerzbank CEO Klaus-Peter Mueller 
has been guarded about the long term impact of the 
crisis on the German banking sector, repeatedly noting 
the full extent of the losses are as yet undetermined. 
Despite this, the company surpassed its overall 2007 
target of 1.5 billion euros ($2.205 billion) in the 
 
BERLIN 00002094  002 OF 003 
 
 
first nine months with profits of 1.72 billion ($2.53 
billion) euros.  Commerzbank CFO Eric Strutz hopes 
these profits will be enough to cover any further 
losses. 
 
Rescue Mechanism Worked 
------------------------ 
¶6.  (SBU) The third quarter results are especially 
welcome in light of the concern for the entire sector 
sparked by the near-insolvency of IKB and Saxony LB at 
the beginning of the sub-prime mortgage crisis. 
Experts view this as a major achievement by private 
and public banks, as well as Finance Minister Peer 
Steinbrueck, to limit the damage early on.  The ECB 
also stepped in on several occasions to inject 
liquidity in the market in order to stave off a 
worsening of the crisis.  At an October 25 banking 
conference, the Chairman of the Association of German 
Savings Banks, Heinrich Haasis, lauded Steinbrueck for 
his initiative to get both public and private players 
to the table to develop a rescue plan for IKB.  At the 
same event, banking representatives confirmed that 
this rescue operation, repeated for Saxony LB a few 
weeks later, helped the German financial market stay 
calm.  "When we look at what happened in Britain with 
Northern Rock, we know what we prevented by our 
action," a banking representative told the Embassy. 
 
¶7.  (SBU) All major German financial players have 
refrained from calling for knee-jerk changes to the 
international financial system to prevent future 
crises.  Both bankers and officials appear to be 
waiting to analyze overall 2007 results before 
adopting any new regulations.  Banking officials are 
concerned that any deepening of the crisis may lead to 
further regulatory burdens on the industry. 
Finance Ministry officials told us that it would be 
well into 2008 before the Ministry would make any 
concrete suggestions for changes to the existing 
regime, and then only after an exhaustive review of 
the situation.  Finance Minister Steinbrueck had 
publicly called for greater transparency of certain 
financial products even before the crisis broke. 
Steinbrueck repeated that call but recently added, in 
language strikingly similar to the U.S. Treasury, that 
he prefers a "code of conduct" developed by the 
industry itself. 
 
¶8.  (SBU) Deutsche Bank's Ackermann, in his capacity 
as Chair of the Institute of International Finance 
(IIF), said his organization would create such a 
mechanism by spring 2008.  The code of conduct would 
address improvements in risk management, transparency 
of banking transactions and seek to avoid liquidity 
shortages. (Note: The IIF represents 370 private banks 
worldwide.)  Haasis meanwhile admitted that some 
financial products have become so complex that banks 
have lost control over their impact on the financial 
markets. 
 
Banking Sector Consolidation: A Long and Winding Road 
--------------------------------------------- -------- 
 
¶9. (SBU) The "early victims" of the sub-prime crisis 
in Germany, notably IKB (reftel A), renewed the debate 
over a necessary consolidation of the German banking 
sector.  The business model of the larger public state 
banks (LB), such as Saxony LB, came under attack. 
Many experts believed the lifting of the state 
guarantees for these banks in 2005 should have been 
coupled with consolidation.  The Association of German 
Banks and others have argued that slim profit margins 
in the domestic market forced state banks to take on 
too much risk in markets they didn't understand, such 
as U.S. sub-prime mortgages.  Consolidation is 
considered by most experts to be the inevitable 
solution. 
 
¶10. (SBU) There are currently 11 such state banks 
which are intended to serve as the extended arm of 
local savings banks, providing services for German 
SMEs investing abroad.  The Finance Ministry and the 
savings banks advocate a merger of the state banks 
into two major entities.  When the troubled Saxony LB 
was saved by the Baden-Wuertemberg LB (LBBW)-- 
 
BERLIN 00002094  003 OF 003 
 
 
effectively LBBW bought Saxony LB -- there were hopes 
that other state banks would merge.  So far though, 
state politicians have prevented consolidation of this 
sector.  This is especially evident in the case of the 
Westdeutsche Landesbank (WestLB).  On November 14, the 
state government of North-Rhine Westphalia, the 
largest single owner of WestLB, stated its intention 
to block the bank's sale.  Given WestLB's 2007 losses 
of more than 100 million euros ($147 million), the 
state government argued it would be the wrong time to 
sell or merge the bank.  A spokesperson for the 
federal agency for banking oversight (Bafin) told us 
that banking sector consolidation in Germany would 
remain "an incremental process, one that has been 
going on since the 1960s but one should not expect any 
dramatic progress." 
 
TIMKEN, JR