Germany’s savings banks under fire from European watchdogs

Europe’s main financial regulators are on a collision course with Germany’s dominant savings banks as a push to reform their deposit protection scheme threatens to shake up decades-old privileges at the country’s largest and most politically entrenched banking group.

The European Central Bank and the German financial regulator BaFin have been for much of this year urging the savings banks to overhaul the sector’s safety net that is meant to protect individual lenders from collapse, but have so far met stiff opposition.

With 50m clients, Germany’s 377 municipally owned Sparkassen and their larger siblings, the crisis-prone Landesbanken, are the dominant force in the country’s banking system, controlling a quarter of its banking assets between them. Sparkassen deposits total €742bn.

While most of Germany’s Sparkassen are individually too small to be among the banks supervised by the ECB, the central bank has responsibility for checking that national deposit insurance schemes are sufficiently robust and there is a level playing field across the bloc.

Supervisors have long been concerned about the lack of clarity over who is responsible for stepping in to support a public sector bank in Germany when it runs into difficulties, said a person briefed on the matter.

“This has been a known issue for years,” a person familiar with the discussion said, adding that German financial watchdogs ignored the problem because of political lobbying from the Sparkassen. “This issue is really a case in point why a pan-European regulator is necessary,” this person said. 

Should regulators ultimately lose confidence in the Sparkassen protection scheme, they might strip the group of one of its most important institutional privileges.

While each Sparkasse is a legally independent entity, the whole group is still treated like an integrated, nationwide bank by regulators in one important aspect — each Sparkasse does not have to put equity aside for loans to other members of the group. “This privilege has been an important competitive advantage for the Sparkassen sector,” said a former regulatory official.

The issue also has a wider political sensitivity because the Sparkassen have long lobbied the German government against proposals for a pan-eurozone deposit insurance scheme, which they fear would supersede their own support system.

Since the 1970s, the Sparkassen have operated an “institutional protection scheme” that is designed to prevent the collapse of an individual lender, rather than just to guarantee clients’ deposits in case of the demise of a Sparkasse.

Other countries that have similar institutional protection schemes between groups of co-operative and savings banks include Spain and Austria. 

The German system is highly fragmented as it consists of 13 different regional funds. Moreover, the protection scheme does not act automatically should a member run into trouble. Instead, it only comes to the rescue if a qualified majority of its other members agrees to do so.

“The fact that there is no binding obligation to act is a fundamental design flaw,” said the former regulatory official, adding that nobody can rely for sure on the scheme.

In a letter to Helmut Schleweis, the president of the German Savings Banks Association (DSGV), the ECB and BaFin pointed out shortcomings in the deposit insurance system, people familiar with the letter told the Financial Times. The contents of the letter were first reported by Handelsblatt. 

The regulators are calling for sweeping changes such as the creation of an additional rescue fund on top of the 0.8 per cent of deposits the Sparkassen is building by 2024. 

The regulators worry that the institutional protection scheme operated by the Sparkassen has not been properly stress-tested to ensure it has enough money to handle a crisis. 

The DSGV has dismissed the regulatory demands. “Over the past 50 years, not a single client lost his deposits or needed to be reimbursed,” the association said in a statement, adding that it was confident it could convince regulators of its point of view. The DSGV declined to comment on details, pointing to the confidentiality of the talks. 

The ECB is expected to communicate its final decision to the German savings banks this summer after central bank officials made little progress during months of discussions with sector representatives, according to one person briefed on the talks.

The ECB and BaFin declined to comment. 

Jan Pieter Krahnen, professor of finance at Goethe University in Frankfurt, welcomed the regulatory scrutiny. “The Sparkassen’s institutional protection scheme has evolved over decades but has become outdated,” he said, adding that it needed to be revamped urgently.

Mr Krahnen pointed to the costly bailouts for publicly owned Landesbanken HSH Nordbank and NordLB, which cost the German taxpayer billions of euros. “These examples show that the institutional protection scheme does not work properly.”