German commercial banks have been remarkably successful at slashing costs and improving efficiency over the past two years. Both Commerzbank and Dresdner Bank, for example, have cut costs by 20 per cent, surpassing similar efforts in the supposedly more ruthless Anglo-Saxon banks.
However, their profitability remains weak by international standards and low market value restricts their strategic options. In fact, German banks are worth so little that many have been relegated to the role of spectator or target in the restructuring of the global banking industry. In March this year the shares of the largest and most successful, Deutschebank, rallied by nearly 10 per cent on rumours that Citigroup would make a takeover bid.
So why, despite all the cost-cutting, has the lot of Germany’s commercial banks not improved? The answer lies with the role of non-commercial banks in suppressing profit in German banking.
Pushed towards the margins
Over 60 per cent of the German banking market is represented by non-commercial banks: Sparkassen (savings banks), Genossenschaftsbanken (mutual banks), and Landesbanken (state banks). These banks are especially powerful in the retail and small-to-medium business segments of the market, and dominate the high street.
Research conducted by PA Consulting Group shows that commercial banks make high profits in countries where non-commercial banks have a low market share – the US, Australia, the UK – and low profits in countries where non-commercial banks dominate – Germany.
Non-commercial banks use their dominant market position to set the price for both deposits and loans. Unable to meet shareholder requirements, commercial banks are pushed toward business lines with a higher risk profile or out of the country altogether.
The removal – on the insistence of the EU – of the state guarantees to German public-sector banks in 2005 is a blow to the wholesale Landesbanken, but an irrelevance for the Sparkassen, which are awash with retail deposits and do not need the prop of a state guarantee. Lobbying to remove the guarantee does not tackle the root of commercial banks’ problem.
The removal of overcapacity does not help German commercial banks. Indeed, cutbacks in the already modest branch networks of commercial banks reduces still their ability to attract retail deposits and further marginalizes them from a customer point of view.
Received wisdom says that what Germany needs is more market consolidation: fewer banks, more profit. Yet consolidation is not a guide to profitability. It is the nature, not the number of competitors that is critical – the US banking market remains unconsolidated, just like Germany’s, yet is highly profitable.
The way forward
The key to improved profitability is revenue enhancement. German commercial banks cannot compete with noncommercial banks on price so they need to differentiate on services and products. In Germany, with its underdeveloped retail-credit sector and service culture, the space exists for this sort of expansion.
Differentiation requires banks to develop propositions that customers want and will pay for. Citibank leads the consumer-credit market in Germany by targeting customer value. Its success is especially interesting in that Citibank achieves higher margins from delivering credit products to blue-collar customers than German commercial banks achieve from their preferred target of higher-net-worth customers.
In the UK, the main supermarket chains collaborate successfully with bank partners. Leveraging the retailer’s brand strength and distribution capacity, the supermarkets offer deposit, loan and insurance products through stores, while the bank partners manufacture and service the products. Both parties win.
Above all, German banks need to plan for growth. To be a major business in a nation of 80 million people requires a market share of 10 per cent, a customer base of 10 million and a branch network of 2,000. Having arrived at an efficient operating model and differentiated customer offerings, commercial banks need to start winning.
