When the financial crisis hit Germany

Bankers worldwide, including in Germany, still have vivid memories of July 2007. There had been repeated reports since spring that year about nonperforming real estate loans in the US. More and more homeowners appeared unable to meet their deadlines for credit repayments as incomes stagnated or fell. Those ill-insured subprime mortgages were then bundled up with more secure credits worldwide in a bid to find buyers.

Among the buyers was the Düsseldorf-based IKB bank, which slithered into an existential crisis toward the end of 2007 after investing heavily in what later turned out to be toxic subprime mortgages. The lender thus became the German victim of the global financial crisis. It was bailed out, though, by the state-owned KfW bank, other lenders and the taxpayer.

Deutsche Bank pulling the plug

Back then, Axel Weber was head of the German central bank, the Bundesbank, and was as such involved in managing the crisis.

Weber remembers well that the decision to rescue the IKB was made on a weekend after the country's largest lender, Deutsche Bank, stopped a credit line it had granted and informed Germany's financial watchdog, BaFin, about the step it had taken vis-a-vis the IKB.

"We only stopped the credit line because the damage had already been done, Deutsche's then-CEO Josef Ackermann said in self-defense when later confronted with the issue, some arguing that Deutsche had been responsible for IKB's near collapse," Weber said.

"IKB was just the beginning; other regional lenders followed quickly, such as WestLB, which had to be bailed out by the regional government of North Rhine-Westphalia, and SachsenLB, which was taken over by the state of Baden-Württemberg. All those lenders had invested in subprime mortgages," he added.

"Ten years ago, the credit services sector was confronted with huge imbalances," said Herbert Grüntker, head of the lender Landesbank Hessen-Thüringen.

Banks were hardly regulated at all at the time, Grüntker went on. "But policymakers stepped into action when the financial crisis widened and US investment bank Lehman Brothers collapsed."

Within a short time, lawmakers in Germany adopted new legislation to stabilize financial markets via generous state guarantees and shots in the arm for many banks. And because a run on banks by consumers seemed likely, German Chancellor Angela Merkel and then-Finance Minister Peer Steinbrück insisted on the record that people's bank deposits were safe.

More regulation, more core capital

Policymakers and regulators have since  tightened banking regulations, with most lenders agreeing there is a need for it.

Weber believes that the new legislation should prevent a 2007/08 crisis from happening again. Banks are safer now, Elke König, head of the European Single Resolution Board, concurs.

"Banks today have significantly better and more core capital," she says. But the lenders' profitability has certainly suffered. Profits are not as high as they used to be as banks are no longer allowed to invest so heavily in high-risk operations.

This low profitability is a headache, according to Weber, who now heads up the board of directors at Swiss bank UBS. But he also views the lax monetary policy of the ECB as a problem, arguing it is "simply inappropriate."

Central banks worldwide started pumping huge sums into financial markets to cope with the crisis and they're still doing so. Weber believes that the boom many capital markets have experienced on the back of expansive monetary policy is not sustainable.

He has predicted an adjustment on stock markets and a normalization of fixed-income yields. Weber called on central banks to start "returning to normality." But just how difficult that is becomes obvious when looking at the ECB's recent attempts to do just that.

Danger still there

Bankers agree that politicians have in principle guided financial sector regulation in the right direction. Commerzbank's CEO Martin Zielke argues, for example, that no further regulation is required. Rather, the rules now in place should be better harmonized, he says.

But we have not yet seen the end to weak banks - think of Italy. Existing rules are not adhered to in Rome as the taxpayer is again being used to bail out troubled lenders.

"You really have to define existing rules much clearer," demands Jan-Pieter Krahnen, director of the Center for Financial Studies at Goethe University.

"Just like during a marathon, the last mile is always the most difficult," he said. That's very important for consumers whose life insurances and pension funds often serve as banks' creditors. It's not yet sufficiently clear to what extent their money would be used when push comes to shove.

All of which tends to show that Weber was right when he said the crisis is not yet fully played out.