'A Real Free Lunch' How German Banks Are Cashing In on the Financial Crisis

Central banks are making trillions in unusually cheap money available to banks in a bid to restore liquidity to the financial system. But institutions are not passing on the cash to their customers, choosing instead to invest it and make a fat profit.

By Beat Balzli, Armin Mahler and Wolfgang Reuter

These days, bankers are used to bad press and being scolded by politicians. There's been no shortage of either in the past week.

Frankfurt skyline: German banks are hoarding money at the expense of their customers.
Getty Images

Frankfurt skyline: German banks are hoarding money at the expense of their customers.

"Banks Hoard Money," was the headline on the cover of the Financial Times Deutschland, while the tabloid Bild sharply condemned the "Outrageous Overdraft Interest Rates." Consumer Protection Minister Ilse Aigner railed: "It is unacceptable that the financial industry takes months to pass on reductions in the key interest rate, when it only takes a few days to pass on key interest rate increases."

The new attacks on banks have been prompted by the fact that base rates are at a historic low and that central banks are injecting money into the market like never before. In the last week alone, the European Central Bank (ECB) allocated the record sum of €442 billion ($619 billion) to 1,100 financial institutions -- at a paltry 1 percent interest rate.

And yet the money is not going where the central banks want it to go, namely into the pockets of businesses and consumers -- at least not at reasonable interest rates.

Instead, many companies are struggling to survive because their loans and credit lines are not being extended. Meanwhile, citizens are outraged that they are still expected to pay double-digit interest rates on their overdrafts.

It seems clear that the banks would rather invest the cheap money they can borrow from central banks in safe investments, such as German government bonds offering 2.5 percent interest, than lend it to companies whose prospects, in the middle of a recession, are anything but rosy. And they are also lining their pockets with the fees they charge customers who are forced to go overdrawn as a result of the crisis.

Are the banks taking advantage of the crisis to turn a profit -- at the expense of the very citizens to whom they owe their survival?

Previously Unimaginable Sums

It is now almost two years since the financial crisis began in Germany with the government's dramatic bailout of IKB Deutsche Industriebank. IKB was one of the many banks around the world who had speculated unwisely, investing billions and even trillions in new, supposedly safe securities that were essentially nothing but repackaged and securitized loans to so-called subprime borrowers. When the bubble burst, the financial world teetered on the brink of collapse.

If the government had not come to their rescue with previously unimaginable sums, many banks would no longer exist today. The German government has already spent a total of €760 billion ($1.06 trillion), in the form of loan guarantees and bailouts, and it even took a 25 percent stake in Germany's second-largest bank, Commerzbank. To limit the consequences for the real economy, the government also spent billions on economic stimulus programs.

The bill for taxpayers is equally enormous. In the coming year, the federal government will have to borrow €86 billion ($120 billion) -- as opposed to the €6 billion ($8.4 billion) figure that was planned before the crisis. Politicians, as well as central bankers, business owners and, most of all, citizens, expect something in return: a functioning financial system -- and low-interest loans.

This is especially true now that the banks seem to have survived the worst of the crisis. In the United States, many banks have started to repay the money they received from the government under the Troubled Asset Relief Program (TARP). After last year's record losses, many institutions have reported respectable profits for the first few months of 2009, and the banks' share prices, which had fallen to all-time lows in January, have since doubled.

Nevertheless, the economic crisis threatens to get even worse, because the credit system is still not working the way many politicians specializing in financial issues believe it needs to, if greater damage is to be prevented.

Graphic: Comparison of selected interest rates

Graphic: Comparison of selected interest rates

Ilse Aigner has asked officials in her ministry to carefully examine and document the behavior of financial institutions. She plans to release the results of the study to the public. In her view, banks that do not pass on interest rate reductions to their borrowers are operating in legally shaky territory. Her position is based on an April ruling by the German Federal Court of Justice, according to which banks cannot set variable interest rates and fees at their own discretion.

Even Axel Weber, the chairman of Germany's central bank, the Bundesbank, is relying on public pressure. He knows that banks have steadily tightened their requirements for the creditworthiness of borrowers in recent weeks and months. And he also knows that much of the money the banks have borrowed from the ECB is not reaching businesses and bank customers.

In a startling move, Weber called upon the banks to pass on interest rate reductions. Otherwise, he said, "central banks will be forced to circumvent the banks and take direct measures to support the economy."

That's something they will in fact probably have to do, should politicians fail in their attempts to stabilize the financial sector. Despite the current profits and rising share prices, the banking crisis is far from over.


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