Banks Are Pushing Germany to the Brink

You would probably imagine that the banks would wisely invest workers' funds in a diverse cross-section of industries, but events have proven that notion na¿ve. Both German and Japanese banks have been heavily involved in the ownership of their countries' major corporations since 1946, when relationships between a handful of leading families and businesses was replaced with a relationship between a handful of government-controlled banks and businesses. As a result, Deutsche Bank(DB Quote), Dresdner Bank and others are not just lenders to companies, but also to their majority owners -- an often-toxic conflict that has led repeatedly to misallocation of capital.

Exacerbating this problem are German banking rules that permit loans to companies whose capital structure consists of as little as 8% to 10% equity, with the rest composed of debt. And Von Schirach-Szmigiel says that banks regularly circumvent this regulation by allowing clients to issue stock at times when the balance is in danger of being breached.

This compares to a worse practice in Japan, where banks may lend to companies at which equity makes up just 5% of the capital structure. In both cases, instead of forcing companies to solve their problems with responsible growth plans, banks keep throwing workers' hard-earned money at them, hoping the problems go away. By contrast, a U.S. bank would generally be nervous about lending to a company if it had less than 20% of its own funds on its balance sheet, and 15% is an absolute nonstarter.

Because there are so many interlocked relationships between German banks and their families of industrial customers, diminished equity values at the companies will ultimately lead to huge problems in the country's overall financial structure. Commerzbank(CRZBY Quote) Germany's third-largest bank, lost a quarter of its value in a single week in October after a number of its borrowers failed to deliver on payments and a liquidity crisis was feared.

The incipient collapse was staunched when the federal Bundesbank hinted it would back the bank's credits and provide liquidity. But after a brief recovery, it is in danger of sliding back into the abyss. "German banks have by far the lowest margins of any industrialized country in the world," Commerzbank chief Klaus-Peter Mueller said last month.