Stadtsparkasse Bad Sachsa is the smallest of some 400 savings and loan banks spread across Germany. The little bank in the idyllic town in the Harz Mountains, a rugged and rural terrain in northern Germany, has 45 employees and just over €120 million, or $134 million, on its balance sheet.
It may not be the smallest for much longer. That’s because the community-backed Stadtsparkasse Bad Sachsa is open for merger talks, according to its chairman, Bernd Gottschalk.
The savings bank’s board has yet to make a decision, but Mr. Gottschalk is keenly aware of what’s going on around him. Three neighboring savings banks in this sparsely-populated region have merged this year. The new combined institution, serving the towns of Hildesheim, Goslar and Peine, is more than 50 times bigger than Mr. Gottschalk’s own mini-bank in Bad Sachsa.
And they’re hardly the only ones. Germany’s community-backed savings banks, often described as the backbone of the country’s financial industry, are in merger fever.
It’s a major shift that could decide the future of this beleaguered branch of German banking, one that perhaps more than any other has been driven into a corner in the past few years by new financial regulations, record low interest rates and the European Central Bank’s penalty interest for overnight deposits.
And it’s arguably high time, too. Germany has more banks per household than any other major developed country. Most of them are loosely aligned with one of two massive networks across the country: The savings banks owned by their communities, or cooperative banks that are owned by their customers.
Several smaller savings banks have already carried out mergers this year. There were still 413 savings banks at the end of 2015; now the number has dropped to 408. Altogether, about 20 possible mergers have been reported to the savings banks’ IT service provider, Finanz Informatik, industry sources told Handelsblatt.
“Savings banks are the lifeblood of the German economy.”
Savings bank mergers are not a new phenomenon in Germany, but the 20 planned mergers are well above the average of recent years.
The new merger push comes after the publicly-backed financial institutions emerged as winners following the 2008 financial crisis. The locally-connected banks were seen as stable with low risk, and few of them had taken the kind of chances on complex mortgage products that led to defaults and state bailouts.
The banks are still low risk. The trouble is that many of them are no longer profitable. As a result, a spokesperson for the German Savings Banks Association, or DSGV, said they now expect “an increase in mergers,” in part because of cost pressures “caused by increasingly complex regulations and a prolonged period of low interest rates.”
Mergers, therefore, might be a good thing if they help these these financial institutions survive for the long haul. Without them, Europe’s largest economy could suffer a serious blow.
“Savings banks are the lifeblood of the German economy,” said Stuart Graham, who heads Autonomous Research. Together with the country’s Landesbanks — the larger regional banks owned by the savings banks and the German states — they extend more than 40 percent of loans to small and medium-sized companies in the country.
How many have to merge? The DSGV wouldn’t put a number on it, since the outcome of such talks is pretty hard to predict. Many mergers also held up by complex local issues, which are part of the reason there hasn’t been a serious effort by these banks to merge in the past.
The biggest issue is ownership, since the shareholders of savings banks are the municipalities they serve. City and district council members, who sit on the governing boards of savings banks, are not always enthusiastic about mergers. It could mean they earn less of the spoils.
Savings banks aren’t the only German financial grouping facing the pressure to join forces these days.
Germany’s credit unions and cooperative banks, which have business models similar to savings banks and in some cases are much smaller even than Stadtsparkasse Bad Sachsa, are in a similar merger fever. Their federal association counted 1,019 credit unions and cooperative banks at the end of 2015. This year the association expects up to 50 mergers.
The record low interest rates in Europe and tougher financial regulations since the financial crisis are impacting all financial institutions – just ask Deutsche Bank – but in many ways it’s a lot harder for smaller institutions to react. Finding ways to cut costs is not as easy as it is for big banks, while the additional paperwork to meet new regulatory requirements tends to eat up more resources, relatively speaking.
Mr. Gottschalk, who spends half of his working time with regulatory matters, said he needs every single employee “just to meet the steadily increasing regulatory requirements.”
Compliance costs time and money, and is pressuring smaller institutions to “think more and more about mergers,” according to the DSGV. “Already today the cost of regulating bureaucracy is eating up as much as 10 percent of an average savings bank’s yearly results,” said the savings bank association.
But mergers are “not a cure-all,” the DSGV said.
Tomas Rederer, a bank expert and partner at Capco consulting, also expects more mergers among savings banks. He said low interest rates and other external factors “have massively increased the pressure.”
Mr. Rederer said savings banks must constantly consider “whether a merger is the best way or whether they should outsource certain functions.” Outsourcing or bundling some business transactions could help “achieve synergies without a merger,” he noted.
The need for mergers can be seen in a study by Mr. Graham of Autonomous Research. An extension of the ECB’s bond buying and penalty interest would “exert extreme pressure on the banks’ earnings,” Mr. Graham said.
In Mr. Graham’s assessment, that particularly applies to banks with traditional private and corporate client businesses in Germany and Italy.
All things being equal, Mr. Graham forecasts that savings banks’ return on equity will decline from 6.5 percent currently to just 1.9 percent by 2021. Mr. Rederer, the Capco consultant, backed Mr. Graham’s findings.
“The scale is correct – if savings banks in fact don’t do anything to counteract it,” he said. “This is however true to a lesser degree for most banks.”
The reason the ECB’s monetary policy hits savings banks particularly hard is that they are extremely dependent on income from interest. It’s their most significant source of revenue, which can’t be said for banks that are active in, say, investment banking or asset management.
About 80 percent of their total revenues come from the business of lending and deposits. But margins in the lending business are melting away. In addition, it is difficult for savings banks to still earn anything with their proprietary investments.
Deutsche Bank might have its own problems. But many private bankers say they are glad not to be stuck in a savings bank director’s shoes.
Zero interest rates mean that, “for a business model with 80 or 90 percent of income from interest, you actually can only lose,” Carola Gräfin von Schmettow, head of HSBC Trinkaus, told Handelsblatt.
One positive: Savings banks don’t face the same kind of shareholder pressure that a private bank might face. Returns on equity aren’t as important strageically speaking for a public bank.
But there’s still serious pressure. The DSGV points out that return on equity isn’t just being impacted by low interest rates. Many are being forced to build up more equity reserves.
“Savings banks are very much aware of that and they are actively taking counteractions, on both the revenue side and cost side,” the lobby group explained.
On the cost side, dozens of savings banks across Germany have already announced the closing of branches, often accompanied by staff cuts.
It may not be enough. Mr. Graham said he doesn’t believe savings banks will be able to maintain their return on equity at current levels — neither through mergers nor higher fees nor purely through cost-cutting.
According to his calculations, savings banks will have to lower costs by about 30 percent within six years just to stay at their current earnings levels. That’s impossible, said Mr. Graham, because for the most part it’s a matter of personnel costs, in a sector and a country where employees typically have high job security.
In addition, the banks are also being forced to invest money in going digital – a critical shift if they want to keep young financial start-ups, called fintechs for short, at bay.
It’s not that they’re about to collapse, however. Mr. Graham noted that savings banks are sitting on large contingency reserves, which they can tap and use in an emergency. But doing that would come at the expense of their long-term stability.
Another warning: Most savings banks have set aside small amounts in risk provisions for loans, since Germany’s economy is chugging along pretty smoothly. Should these very low risk provisions be forced to increase again in future, Mr. Graham calculated their return on equity would even drop to 1 percent.
That could pose a major risk to the entire German financial sector and economy: “We believe that it simply isn’t sustainable when 30 to 35 percent of German banks have such a low return on equity,” he warned, adding it would mean many of them will suffer losses or will have no choice but to cut back on lending.
It’s a serious dilemma, and one that could come back to haunt the European Central Bank in Frankfurt, which many Germans already blame for harming rather than helping savers across the country.
If the central low-interest rate policy pushes the country’s retail banks to the brink, Mr. Graham warned, there’s a risk that German lawmakers or voters could say: “Enough is enough.”
Elisabeth Atzler is a banking correspondent for Handelsblatt based in Frankfurt. Christopher Cermak of Handelsblatt Global Edition contributed to this story. To contact the author: firstname.lastname@example.org