Analysis: Brewing model saves Germany from bankers' droop

FRANKFURT (Reuters) - Raise a glass of beer in a German bar and the chances are it was made just down the road to a simple, ancient formula.

German banking works in much the same way, rooted in local communities and structured in a way that discourages aggressive international expansion, innovation and complexity.

Local banks dominate savings and loans in Europe's largest economy. There are hundreds of small players, which by their very existence help limit the economic fallout from bank failures and makes sure banks do not get 'too big to fail.'

The prevalence of municipally-owned savings and customer-owned cooperative banks, the microbreweries of the banking world, ensures a steady supply of business loans, reducing the likelihood of a credit crunch and helping to protect Germany's coveted triple-A sovereign debt rating.

"You have two strong pillars in the system, savings banks and cooperative banks, which will always support the economy and not cause an issue for the sovereign," said Michael Dawson-Kropf, senior director of Financial institutions at Fitch Ratings.

The strength of Germany's economy is, of course, a big factor too. Bank holdings of domestic sovereign debt are not the drag they are in other euro zone countries. But analysts see the savings and lending culture itself as part of a virtuous circle.

"Ongoing market tensions have affected German banks less to date than peers in other euro area countries, as German banks benefit from the deep domestic savings market and investor confidence in the German sovereign," Moody's said in a recent report on the German banking system.

So just as brewers stick to the 'Reinheitsgebot' purity protocol which demands a beer be made from only water, malt and hops, savings banks keep their business simple, returning personal saving to the regional economy by extending loans to enterprises and private customers.

Germany has 2,000 banks, while Britain has just 405, Spain 415, Italy 785, Ireland 590 and France 1,147, according to European Central Bank statistics.

Data from the central bank, the Bundesbank, shows that Germany's big two, Deutsche Bank (DBKGn.DE) and Commerzbank CBKG.DE, have to compete with 1,200 cooperative banks, 438 municipally-owned savings banks, and 10 Landesbanks -- regional banks which belong to their respective governments and whose main purpose is to support the region's economy.

SAVINGS BANK SAVIOURS

Savings banks are the biggest lenders by bank type in Germany, with a 20 percent market share, followed by the Landesbanks, which command a 17 market share, and cooperative banks which provided 12 percent of loans in Germany in December.

According to central bank statistics, banks defined as "big" provided only 12 percent or 495.9 billion euros worth of a 3.941 trillion euros in total loans given to non-banks in Germany in December.

And during the past two years, cooperative and savings banks emerged as a valuable source of loans for the German economy as larger banking groups were forced to cut back lending to boost their capital strength.

Between 2008 and 2011, German cooperative banks increased lending by 4 to 5 percent annually. Savings banks supplied 43 percent of all business loans in Germany, the savings banks association said.

Savings and cooperative banks also enjoy long standing ties with the backbone of Germany's economy - the small to medium sized company sector, known as the Mittelstand.

Like the banking sector itself, the Mittelstand consists of mainly unlisted players with between 50 and 500 million euros in annual revenue, but employs between 70 and 90 percent of the German workforce.

"The structure of Germany's financial sector follows the structure of the economy," said Stefan Marotzke, spokesman for the German savings bank association. "This is why we have a fragmented banking sector."

Smaller banks are just as able to serve the needs of smaller regional companies as large multinationals, particularly if they do not spend money on potentially risky expansion plans, said Martin Faust, Professor of banking at the Frankfurt School of Finance.

"For the German economy, bigger banks are not always better. If Deutsche Bank does business in Brazil or China that's nice for their shareholders, but it's not much benefit for a small German company," Faust said.

SMALL IS BEAUTIFUL

Germany has had its share of bank failures. In the aftermath of the collapse of Lehman Brothers, billions were spent rescuing

Hypo Real Estate, Commerzbank CBKG.DE, WestLB WDLG.UL, and IKB.

But these did not trigger a wave of large scale bankruptcies, nor did they shake confidence in the underlying system the way bank collapses in Britain did.

And cracks in the euro zone still pose a threat to the sector, which has forced banks to improve their capital ratios and prompted Berlin to revive bank rescue fund SoFFin.

But with plans to make 70 billion euros available for rescues, it will have enough clout to absorb even the largest banks Deutsche Bank (DBKGn.DE), and Commerzbank CBKG.DE, which have market valuations of 32 billion euros and 10.8 billion euros.

The industry as a whole is relatively modest in scale too.

Germany had 7.28 trillion euros ($9.69 trillion) in bank assets at the end of June 2011, and a gross domestic product of 2.47 trillion euros at the end of 2010.

At 2.95 times GDP, the ratio is lower than that of Switzerland, the Netherlands, Britain, Spain and France based on data from the OECD, the European Central Bank, and the Swiss National Bank.

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Bank assets/GDP ratios: link.reuters.com/xuw56s

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SAVING BANKS FROM THEMSELVES

After years of subsidising the activities of the Landesbank sector, savings banks were also responsible for ending the Wall-Street style ambitions of some of these - most famously Westdeutsche Landesbank (WestLB).

In 2009, savings bank manager Rolf Gerlach refused to grant guarantees to save WestLB which was struggling to avoid meltdown after another attempt at international expansion backfired.

The structure has also made it tough for big foreign banks to establish a foothold.

In 2008 Citigroup sold its German retail business to France's Credit Mutuel for almost 5 billion euros. In 2010, Sweden's SEB Group sold its German retail bank to Santander for approximately 555 million euros.

A similar trend can be seen with corporate loans, where players like Britain's Royal Bank of Scotland (RBS.L) spent years aggressively lending in a bid to gain market share, before pulling back to fulfil new banking rules demanded by the European Banking Authority (EBA).

TOAST TO MODEST PROFITS

Savings and cooperative banks are strong competition for listed banks like Commerzbank because of their stranglehold on current accounts, mortgages and deposits. This competition keeps a lid on profits.

After losses in 2008 and 2009, the German banking system generated a net profit of ?12.5 billion under local GAAP in 2010 and a net profit margin of only 0.15 percent on total assets, low by European standards according to the rating agency Moody's.

"Competition among brewers keeps beer prices low, to the disadvantage of market players, but to the benefit of German beer drinkers," according to Peter Hahn, managing director of the German Brewers Federation, which represents around 1,300 breweries.

As small and medium-sized businesses around the rest of Europe struggle to get the loans they need, Germany's corporates will continue to raise a glass to its banking 'Reinheitsgebot'.

(Reporting By Arno Schuetze and Edward Taylor, additional reporting by Andreas Kroener, Philipp Halstrick, Jonathan Gould and Mia Shanley; Editing by Alexander Smith and Andrew Callus)