Consolidate or crumple

German co-op bank M&A shows Landesbanken the way

It took German cooperative lenders DZ Bank and WGZ Bank 10 years and four aborted attempts to eventually agree on a merger. While slow by the standards of international finance, the deal announced on November 19 is still light years ahead of the country's ropey Landesbanken.

Germany has three types of bank: private players like Deutsche Bank, state-owned Landesbanken, and 1,047 local cooperative lenders. Having two rival institutions like WGZ and DZ unnecessarily duplicates many co-op functions and inflates costs. The duo estimate that the pooling of resources will generate at least Euro 100 million of synergies per year. Actions like standardising processes and simplifying IT systems can squeeze yearly administrative expenses by three per cent. That's a much-needed shot in the arm at a time when persistently low interest rates weigh on margins and tighter regulatory scrutiny pushes up equity requirements.

The country's ropey public banking sector should take note. While the local cooperative banks streamline their overhead organisation into one national group, the 400 Sparkassen still treat themselves to six different wholesale banks. Those Landesbanken are co-owned by regional governments.

Until a decade ago, the lenders were banking on cheap government funding. Brussels shot down this privilege in 2004 and effectively killed off the old business model. In search of yield, the lenders gobbled up risky assets in shipping and real estate, turning them into one of the worst casualties of the financial crisis. Now, while notorious WestLB has been wound down and SachsenLB merged into LBBW, the six survivors are resisting further consolidation.

However, their post-crisis track record is dismal. Between 2010 and 2014, LBBW, BayernLB, NordLB, Helaba, HSH Nordbank and Landesbank Berlin have earned a joint positive post-tax return on equity only once - a measly 2.8 per cent in 2014, data by SNL Financial shows. The cooperative banks earned double-digit returns in three of the past five years.

If Landesbanken were able to replicate DZ/WGZ's synergies as a percentage of their combined administrative expense, annual benefits would be around 400 million euros. They cannot afford to leave this money on the table much longer.