Are the German Banks Riskier than the European Competitors - Coursework Example

Are German Banks riskier than their European Competitors? The global recession stemmed by the US sib-mortgage crisis has severely impacted not only American business groups but surprisingly many strong banking companies in Germany also. In this paper, the risk aspects that have arisen out of these challenging developments are being looked into with the research hypothesis reading: Do German Banks have a lesser risk bearing capacity when compared with other European banks? The risk and lowered safety of German banking business is compared by tracing the performance of certain noted German banks like IKB Deutche industriebank, Commerzbank, Deutche bank credits and Hypo real credit Bank, taking parameters like Equity/Total Assets, Return on Average Assets (ROAA), Net Loans to total Assets, Liquid assets/total assets, etc. These figures are compared with leading European banks like Societe Generale Bank AXA Bank Europe, Compass SPA, GE Money Bank. The general consensus based on the comparative paper using these parameters shows that German banks do have lower risk capacity bearing abilities, especially when we consider the case of banks like IKB Deutche industriebank (which had to be bailed out) and several other major banks that had to go under the hammer or have significantly reduced their business, or have become inactive. In the end, certain reconstruction strategies have been provided that could provide a sense of direction and thrust to German banks for the future. Are German Banks riskier than their European Competitors? Table of contents Serial Description Page no 1. Introduction 3 2. Research Hypothesis 4 3 Methodology 6 4. Literature Review 6 5. Analysis and Interpretations 13 6. Conclusions 14 Are German Banks riskier than their European Competitors? Introduction: The main objective of this paper is to understand the working of German banks and whether they are more risk prone than other banks in the European Union. For the comparison of risk, the certain crucial ratios need to be taken into consideration. Basically, these are some of the main risks that need to be borne in mind while considering a comparison between German and other European banking companies in terms of their risk bearing capacity. Research Hypothesis: Do German Banks have a lesser risk bearing capacity when compared with other European banks? “Germanys "three-pillar" banking structure separates ownership of state banks, cooperatives and listed lenders, forcing big players such as Deutsche Bank (DBKGn.DE) to look abroad or to focus on investment banking or other specialized areas for growth.” (Gould, 2007). The German Banks that would be taken up for ratio analysis (Based on latest figures provided) are: 1. Commerzbank AG 2. Deutsche Bank Credit 3. Hypo Real Estate HRXG 4. IKB Deutche sr. bank equity/total assets return aver. assets net loan/total assets net loss/cust. & ST net loan prov/net income loan loss prov./gross loans liquid assets/total assets 1. Commerzbank 98.51 0.75 8.96 - - 0 - 2. Deutsche bank credit 4.56 0.54 99.2 106 6.59 0.186 0.092 3. Hypo real estate 3.05 0 58.78 194.02 -3.35 0.02881 17.36 4. IKB Deutche 4.6 0.38 66.08 177.29 33.2 1.159 3.717 It is now necessary to consider the relative ratios of European banks in order to compare their relative performance based upon their latest fiscal figures. The comparable European banks Societe Generale Bank AXA Bank Europe, Compass SPA, GE Money Bank. sr. bank equity/total assets return aver. assets net loan/total assets net loss/cust. & ST net loan prov/net income loan loss prov./gross loans liquid assets/total assets 1. Societe Generale bank 5.33 0.75 32.05 35.62 7.31 0.30 43.08 2. AXA Bank Europe 2.8 0.13 54.59 61.97 3.13 0.07 6.30 3. Compass SPA 7.93 2.11 83.18 93.8 31.3 3.26 3.65 4. GE Money Bank 6.35 -0.84 96.85 112.23 16.41 0.97 0.78 Research Methodology: The method of analyzing high risk is from the present position of these German banks as against their competitors. First it would be necessary to consider the German bank, Commerzbank. Literature Review: Risk propensity of Commerzbank: “The global economy is developing unexpectedly well in the second half of 2009, but the possibility of setbacks cannot be excluded and the environment remains challenging.” (Press release: commerzbank, 2009). Although market conditions are improving it is also predicted that Commerzbank would end 2009 with a net loss. As one of the premier banks in Germany, having also acquired Dresdner Bank, it is expected to do well. But the parameters speak differently. There is apparently a heavy loan burden for this bank, with debt equity at around 98, when ideally it should be around 3-4. Thus, this bank does carry a high degree of risk. If we were to compare this with a European bank, say, Societe Generale bank, it is seen that the following picture emerges: sr. bank equity/total assets return aver. assets net loan/total assets net loss/cust. & ST net loan prov/net income loan loss prov./gross loans liquid assets/total assets 1 Commerzbank 98.51 0.75 8.96 - - 0 - 2 Societe General bank 5.33 0.75 32.05 35.62 7.31 0.30 43.08 One of the main aspects of risk of a bank is the Debt equity asset ratio, and in this count, Commerzbank is indeed much riskier than other banks. Coming to return on average assets, both are equal at 0.75, while net loan on total assets is only around 9% for Commerzbank, while for other banks it is - Societe General bank (32%), AXA Bank, Europe (55%), Compass SPA, (83%) and GE Capital ( 97%). Thus, considering several parameters of proportion of debt to total assets, average assets and proportion of loans to total assets, it does carry a great deal of risk. Risk propensity of deutsche bank credit: Next it is necessary to consider the creditworthiness and risk of Deutsche bank credit with say AXA Bank, Europe. sr. bank equity/total assets return aver. assets net loan/total assets net loss/cust. & ST net loan prov/net income loan loss prov./gross loans liquid assets/total assets 1. AXA Bank Europe 2.8 0.13 54.59 61.97 3.13 0.07 6.30 2. Deutsche bank credit 4.56 0.54 99.2 106 6.59 0.186 0.092 It is seen that the equity of AXA, Europe, at 2.8 is much better than that of DBC, at 4.56. However, DBC has higher rate of net loan on assets at 99. In other words, it is seen that the majority of assets of DBC are in form of loans, which is indeed a grave risk, in terms of bad debts etc. Besides, its net loss provision is also high at around 7% when compared to that of AXA Bank, Europe 3.13%, Compass 3.13 % and Societe General Bank at 7.31%. The liquidity position of Deutsche bank is lower at less than 1, when compared to AXA at 6%, Compass 4%, etc. Thus overall, it may be considered that even the financial ratios of Deutsche bank credits are far from satisfactory and it runs high risks, especially when it has to compete in a European financial market. However, as far as the European bank is concerned, “AXA Bank Europe’s core business is retail banking based on simple product offers. It is not involved in Investment banking, corporate banking, structured finance or trade finance.” (Hatt, 2008). Risk propensity of Hypo Real Estate Bank: The next German bank that is to be considered for this paper is the German Hypo Real Estate Bank. “Hypo Real Estate Group is headed by hypo real estate holding AG, a public company with headquarters in Munich, Germany, which is responsible for strategic guidance and acts as a gateway to equity and debt markets.” (HRE group: structure, n.d.). sr. bank equity/total assets return aver. assets net loan/total assets net loss/cust. & S.T. Funding net loan prov/net income loan loss prov./gross loans liquid assets/total assets 1. Hypo real estate (German bank) 3.05 0 58.78 194.02 -3.35 0.02881 17.36 2. Compass SPA 7.93 2.11 83.18 93.8 31.3 3.26 3.65 3. GE Capital Bank 6.35 -0.84 96.85 112.23 16.41 0.97 0.78 Although 1.5 is the ideal ratio, below 1 show that liquidity is a critical issue (GE Capital’s liquidity for instance is below 1). However, in this case it could be said that Hypo real estate’s ratio, which is 17. 36, shows that it has not been making good use of its liquid funds in worthy and high yield investments either within banking companies or outside. “The assets of a bank, for instance, are liquid assets when they are not tied up in time loans or in securities which cannot promptly be turned into money.” (Explain liquid assets, 2005). Thus, it has reached a situation where it is overcautious and this could also be a clear case for high risk. In the case of European banks, it is seen that except for Society Generale (SG), the others have liquidity between 3-6 which is indeed a low risk and also goes to show that investments outside liquid assets are being well monitored. Coming to SG, it is “a financial institution relying on solid fundamentals to accompany its clients in their development and supports the economy across sectors and industries.” (A European Corporate and Investment Bank with a global reach, n.d.). A high liquid asset ratio could also mean that debtors may not be paying in time and may be mounting up. Thus, it is necessary that these German banks be in a position to bring their liquidity between 1.25 – 1.50, but not less than 1. In the case of parameter of net loss as proportion of customers and ST funding, this is abnormally high at 194, as compared to Compass’s 93.8 and GE Capital 112. “Through three major business units – Corporate Banking, Retail Banking, and Wealth Management – Compass offers customers unique and industry-leading products and services with a focus on providing customers with financial solutions to fit their lives.” (About BBVA compass, 2009). Thus, it is evident that this could indirectly impact upon risks; as such high risks could translate to detriments later. Thus, it could be seen that the net loss when compared to a major item like book losses/customers and Science and Technology (ST) Funding could mean that such losses are high since they are around 194. Thus, it is important that Hypo Real Estate (German bank) should be in a position to match returns with liquidity, risks with revenues.. Risk propensity of IKB Deutche IndustrieBank.: It is indeed surprising to note that a German bank has also been a major loser in the US sub-mortgage crisis, and that is the case of IKB Deutche IndustrieBank, which finally had to be bailed out as “IKB Deutsche Industriebank, which has become Europes highest-profile casualty so far of the U.S. sub prime crisis.” (Shockwaves continue to rattle German banks after 1KB bailout, 2007). When we compare the performance of this bailed out bank with others, the following facts emerge: sr. bank equity/total assets return aver. assets net loan/total assets net loss/cust. & ST net loan prov/net income loan loss prov./gross loans liquid assets/total assets 1. IKB Deutche 4.6 0.38 66.08 177.29 33.2 1.159 3.717 2. Societe Gen 5.33 0.75 32.05 35.62 7.31 0.30 43.08 3. AXA Bank 2.8 0.13 54.59 61.97 3.13 0.07 6.30 4. GE Capital 6.35 -0.84 96.85 112.23 16.41 0.97 0.78 Perhaps, one of the main reasons for IKB debacles would have been the fact that the large value of US promissory notes securities held by them turned out to be worthless after the sub- mortgage crisis. This could explain the high net loss as a proportion to customers and ST account which is higher at 177 as compared to Societies Bank (35.62), AXA Bank (61) and even GE at 112.39. Even its net loan provision against total income is higher as compared to the other European Banks. Coming to net loss provision as a proportion of gross loans, while other banks have less than 1, IKB has a figure as high as 1.159. Analysis and Interpretation: From the above it is clear that banks like IKB Industrial bank, Commerzbank, and to a smaller extent, Hypo real estate and other major banks in the country were impacted since they had investment links with crises- ridden American sub-mortgage business. In other words, in the likely event of a liquidation of the bank, how much each shareholder would receive, which is a major indicator of its risk, because the lower the shareholder would receive, the less are the funds available to pay off liquidation claims. Ser GERMAN BANKS Equity asset % Ser. EUROPEAN BANKS Equity asset % 1. Deutche Bank Credits 4.56 1. Societe Generale 5.55 2. Hypo real estate 3.05 2. Compass SPA 7.93 3. IKB Industriebank 4.60 3. GE Capital 6.35 Total/average 12.21/ 4.70 Total/average 19.83/ 6.60 Thus, even on the major risk factor of equity/total assets, European banks have an average of 6.60 as against only 4.70 of the German banks. “The asset/equity ratio is one of the standard formulas used to ascertain the overall financial stability of a company.” (What is the asset/equity ratio?, 2009). Conclusion: Thus, it is clearly seen from the deliberations above that the German banks do have a lower risk bearing capacity and high risk propensity than their European counterparts. It is seen that over the period of survey “Asset-liability dependency is lower for private commercial banks with higher provision income, savings banks with lower ROE volatilities and cooperative banks with higher ROEs.” (Schertler & Memmel, 2009). The main aspects that have to be considered in plans and proposals for rehabilitation and rejuvenation of German banks need to be drafted on the following “Ensure Corporate Finance Capital adequacy and avoid competitive disadvantages Enable banks to be wound up in an orderly way Financial transaction tax : avoid burdening customers Make the remuneration more objective.” (Schmitz, 2009). Reference List About BBVA compass, 2009. BBVA Compass [Online] Available at: http://www.bbvacompass.com/compass/ [Accessed 17 December 2009]. A European Corporate and Investment Bank with a global reach, n.d. Societe Generale, Corporate & Investment Banking. [Online] Available at: http://www.sgcib.com/about-us [Accessed 17 December 2009]. Explain liquid assets, 2005. Teach Me Finance.com. [Online] Available at: http://www.teachmefinance.com/Financial_Terms/liquid_assets.html [Accessed 17 December 2009]. Gould, J., 2007. Subprime exposes chronic German bank profit woes. Reuters. [Online] Available at: http://www.reuters.com/article/idUSL0993527620070809 [Accessed 17 December 2009]. Hatt, H., 2008. Word of the chairman. AXA Bank Europe. [Online] Available at: http://www.axabankeurope.com/ [Accessed 17 December 2009]. HRE group: structure, n.d. Hypo Real Estate. [Online] Available at: http://www.hyporealestate.com/eng/808.php [Accessed 17 December 2009]. Press release: commerzbank: operating profit up by EUR 345 m to EUR 122 m in Q3, 2009. Commerzbank. [Online] Available at: https://www.commerzbank.com/en/hauptnavigation/presse/archiv_/presse_mitteilungen/2009/quartal_09_04/presse_archiv_detail_09_04_6262.html [Accessed 17 December 2009]. Schertler, A. & Memmel, C., 2009. The dependency of the banks’ assets and liabilities: evidence from Germany. SSRN, Social Science Research Network. [Online] Available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1353927 [Accessed 17 December 2009]. Schmitz, A., 2009. Press conference following the meeting of the board of directors of the association of German banks. German Banks.org, Association of German Banks. [Online] Available at: http://www.german-banks.org/html/15_press/statement_00_091123.asp [Accessed 17 December 2009]. Shockwaves continue to rattle German banks after 1KB bailout, 2007. The New York Times, [Online] 3 Aug. Available at: http://www.nytimes.com/2007/08/03/business/worldbusiness/03iht-gbank.4.6978701.html [Accessed 17 December 2009]. What is the asset/equity ratio?, 2009. Wise Geek. [Online] Available at: http://www.wisegeek.com/what-is-the-assetequity-ratio.htm [Accessed 17 December 2009]. Read More