Cease of Westphalia

Germany's problem banks are running out of friends

Germany's Landesbanken are getting even less popular. The notoriously hapless regional lenders long since lost the faith of state owners that had to spend billions of euros propping them up during the financial crisis. Now they are starting to lose the support of their other key stakeholder - the Sparkassen savings banks.

The 416 municipally owned Sparkassen and the six state-controlled Landesbanken together control a third of German bank deposits. The Sparkassen are small but generally solid, thriving on loyal customers and deep knowledge of local business. The clumsy Landesbanken are mostly hobbled by political interference and lack a sustainable business model. They lost their previous one a decade ago when Brussels vetoed their cheap state funding.

The current flashpoint comes courtesy of 71 savings banks in the Muenster area of Westphalia - the same region that had to cough up euro 4.5 billion to help wind down WestLB, a Landesbank that collapsed during the crisis. They have had enough of a mutual Sparkassen/Landesbanken pledge to guarantee each other's existence. It's not hard to see why: the safety net gives Landesbanken incentives to take on excessive risks, and little scope for savings banks to stop them. Moreover, Landesbanken headquartered in southern Germany are chasing the Sparkassen's corporate clients in Westphalia.

The savings banks have proposed a cap. The plan is to limit their potential exposure to any Landesbanken loss to euro 200 million - meaning that any future busts wouldn't hurt Sparkassen lending capacity too badly. If they don't get their way, the Sparkassen threaten to leave for good a deposit insurance scheme that also benefits Landesbanken. The obvious risk is that other regional savings banks follow suit and cut their exposure.

This all sounds like bad news for the Landesbanken. The more Sparkassen firewall themselves, the more Landesbanken funding costs will increase. New capital would have to come from either shrinking their numbers via mergers or temporarily tapping the funds of their deposit insurance scheme: even if federal states offered to help, European reforms would require a bail-in of creditors.

But it sounds good for other stakeholders. The German government will like savings banks being protected. The European Central Bank that now regulates Eurozone banks will appreciate a potential source of instability being addressed. Most of all, Germans won't have to put even more money into the Landesbanken.