VZCZCXRO8034
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHRL #0469/01 1061531
ZNR UUUUU ZZH
P 151531Z APR 08
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 0903
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 03 BERLIN 000469 
 
SIPDIS 
 
SIPDIS 
 
TREASURY PASS TO FEDERAL RESERVE 
USEU FOR B. MATTHEWS, J. NUTTER 
 
E.O. 12356:  N/A 
TAGS: EFIN PREL PGOV GM
SUBJECT:  SUB PRIME CRISIS GETTING COSTLY FOR GERMAN 
BANKS: THE LATEST VIEW FROM BERLIN 
 
REF: (A) FRANKFURT 1001  (B) BERLIN 112, (C) BERLIN 
 
161 
 
¶1. SUMMARY:  With all major year-end reports of German 
banks now in, the impact of the U.S. sub prime crisis 
on German banking is beginning to reveal its full 
extent of damage.  The story emerging is one of a 
sector largely intact, but bruised and ripe for 
consolidation.  Set for a record profit year, German 
banks lost much of their margin in the second half of 
2007 due to the deepening sub prime impact.  Despite 
significant write-downs, most German private banks 
managed to remain in the black for the year.  However, 
several German state banks, as well as SME lender bank 
IKB, were on the brink of collapse and various rescue 
packages needed to be constructed.  The federal 
government now supports more consolidation in the 
industry, which the states (Laender) continue to 
resist.  Banking and financial authorities are also 
calling for more transparency and Finance Minister 
Steinbrueck wants more regulation.  The banking 
industry has countered by proposing a voluntary "code 
of conduct" to better prepare the financial markets 
for future crises and stave off further regulation. 
END SUMMARY. 
 
2007 - Not Bad Until... 
----------------------- 
 
¶2.  Eight months into the sub prime mortgage crisis, a 
clearer picture of its impact on the German banking 
sector is emerging as major banks publish their 2007 
reports. According to the Head of the Association of 
Private Banks, Klaus-Peter Mueller, the 2007 reports 
show that it would have been an "extraordinary year" 
if not for the crisis; despite write-downs due to the 
U.S. sub prime turmoil, almost all major German banks 
posted profits in 2007. 
 
¶3.  This is all the more impressive when the full 
extent of exposure of German banks to U.S. sub prime 
loans is known.  Standard & Poors calculates that 
Germany's 16 largest banks face write-downs of more 
than 18 billion euros in the second half of 2007 
alone.  As a result, S&P estimates that German banks' 
profits fell by 80 percent between July and December 
of 2007 to 3 billion euros. 
 
State Banks and IKB - The System's Achilles Heal 
--------------------------------------------- --- 
 
¶4.  While Germany's private banks weathered the crisis 
relatively well, a number of state banks 
(Landesbanken), jointly owned by one of the German 
states and regional savings banks, were severely hit 
by the international financial crisis.  Three of the 
seven state banks that invested heavily in U.S. sub 
prime securities -- Sachsen LB, WestLB and BayernLB -- 
had to be rescued from insolvency with public money. 
While SachsenLB escaped bankruptcy by being bought by 
Germany's largest state bank, LBBW (Baden- 
Wuertemberg), WestLB and BayernLB are still in limbo 
with reported losses of 5 billion and 4.3 billion 
euros respectively.  A Bundestag financial expert told 
the Embassy that in the case of WestLB, the federal 
government was approached to bail out the bank. 
Finance Minister Steinbrueck rejected such calls, 
pointing to the responsibility of the German states to 
rescue "their" own banks.  The Finance Ministry told 
us that the government would like to force a merger 
among state banks, but feared that the states would 
then seek compensation for their attempts to bail the 
banks out. 
 
¶5.  The SME lender IKB (Industrie Kreditbank) was the 
first bank to be hit by the sub prime crisis in July 
¶2007.  Since then, IKB's losses have mounted and 
federal government-owned KfW bank (together with the 
Association of Private Banks) is now on its third 
attempt to keep the bank afloat.  The rescue operation 
has depleted the 5 billion euro KfW emergency fund and 
currently totals eight billion euros, with no end in 
sight.  "In the end, the federal government will have 
to come in directly with taxpayer money; it can't and 
won't allow the bank to go under," a representative of 
the Association of Savings Banks told the Embassy.  On 
April 8, KfW's handling of the crisis led to the 
 
BERLIN 00000469  002 OF 003 
 
 
resignation of KfW Chief Ingrid Matthaeus-Maier, who 
was criticized for her handling of the IKB operation. 
 
Consolidation: Much Speculation - Little Action 
--------------------------------------------- -- 
 
¶6. Germany's banking industry has long been regarded 
as ripe for consolidation.  The current crisis is 
viewed by many analysts here as the trigger to finally 
set the wheels in motion.  There is widespread 
consensus within the industry and the federal 
government that state banks lack a sustainable 
business model.  Their embrace of risky U.S. sub prime 
securities is seen as ample proof that these banks 
were forced to take on risk they didn't understand in 
order to generate profits to stay afloat.  Analysts 
favor a merger of all state banks into one institution 
that could then aid the savings banks in financing 
overseas investments by German SMEs.  So far, however, 
state governments (mainly those of Bavaria and North 
Rhine Westphalia) have blocked any meaningful merger. 
As a prominent Budnestag deputy from Bavaria told 
Embassy, "the issue is still taboo." 
 
¶7.  Most of the merger dynamic appears to be coming 
instead from the stated intention of Deutsche Post to 
sell its subsidiary "Post Bank."  With more than 10 
million customers, Post Bank is one of Germany's 
biggest retail banks.  Deutsche Bank and Commerzbank, 
with their notoriously weak retail business, have both 
expressed interest in buying Post Bank.  Another 
potential buyer is  Allianz, which has for years been 
unhappy with the performance of its subsidiary 
Dresdner Bank.  So far though, there is much talk and 
little action.  Both Deutsche Bank and Commerzbank 
have already failed with earlier take-over attempts 
and are likely to approach the matter with caution.  A 
contact at the German Savings Bank Association in 
Berlin told us that a merger of Postbank with a 
private bank would require a lot of time, money and 
energy since two distinctly different business 
cultures would have to be combined. 
 
Reactions: Risk Management is Gold, Equity is Key 
--------------------------------------------- ---- 
 
¶8.  In recent weeks Steinbrueck, German Banking 
Supervisory Authority (BaFin) Chief Jochen Sanio, and 
Bundesbank President Axel Weber have called separately 
for banks to fully disclose their exposure to U.S. sub 
prime investments and to list related write-downs. 
According to all three, such a step is needed to 
restore confidence in financial markets.  Bundesbank 
President Weber used a Berlin April 7 event of the 
Association of Private Banks to stress the importance 
of risk and liquidity management by banks. "In the 
recent boom years, there was not a great need for 
either", Weber said, "but the crisis has shown that 
one cannot neglect them without increasing the risk of 
being caught off guard when a crisis approaches." 
 
¶9.  Steinbrueck and BaFin Chief Sanio emphasize higher 
equity underwriting of risk-prone investments.  They 
intend to propose changes that would further tighten 
Basel II banking regulations which came into force on 
January 1, 2008.  Bundesbank's Weber and 
representatives of private banks reject calls for a 
so-called Basel III agreement, arguing that current 
rules have not had time to take full effect.  In a 
possible move to counter mandated government actions, 
the IIF (International Institute for Finance) at an 
April 9 meeting in Berlin proposed a voluntary "code 
of conduct" for banks that incorporates suggestions 
made by regulators and government representatives. 
Apart from improved risk management by banks, the IIF 
also calls for changes in the IFRS accounting system. 
The IIF and the Bundesbank regard the IFRS requirement 
for frequent evaluations of bank assets as "pro- 
cyclical." "Especially in the very volatile 
environment we currently have, Weber said, repeated 
reports of write-downs make the markets even more 
nervous." 
 
Comment 
------- 
 
¶10.  The emerging dynamic of a push and pull between 
 
BERLIN 00000469  003 OF 003 
 
 
the federal and state governments on consolidation and 
federal government and the private banks on tighter 
regulation can be expected to continue over the next 
several months.  Where the state banks and regulators 
eventually land is a story still in progress.  How it 
ends will no doubt be largely shaped by the ability of 
German banks to recover from their bruises.  More bad 
news -- always a possibility -- will continue to drive 
the momentum for fewer German banks and more 
regulation. 
 
TIMKEN, JR