Banking Lessons from Berlin

The crisis at Germany's Bankgesellschaft Berlin, which urgently needs $1.8 billion in fresh capital if it is to avoid insolvency, shows just what can go wrong when politicians start meddling in the financial sector. Established in 1994, when the city-state of Berlin merged seven small state-controlled banks to form a behemoth with $180 billion in assets, BGB was meant to be a world-class bank for a world-class city. Instead, it has become a huge and costly embarrassment, not just for the cash-strapped capital, which owns more than half of its shares, but for the country as a whole.

Urged on by city politicians, several of whom had seats on the bank's supervisory board, the bank lent billions of dollars to the East German property market, which boomed after unification--and then went bust. It also set up property funds, which foolishly promised hefty returns from sky-high rents. But those collapsed as well. More trouble came in May, when Klaus Landowsky, who was leader of the Christian Democratic faction in the city's parliament as well as chairman of BGB's mortgage unit, resigned when it emerged that he had accepted $18,000 in undeclared political campaign contributions from developers who had been given loans by the bank. Private-sector bankers, who oppose the involvement of local and regional governments in the finance industry, are indignant. "Give politicians control of banks, and you have a recipe for sleaze and corruption," says one.

He's right. BGB's humiliation shows that it's high time to force German politicians out of bank boardrooms. The best way to do that is to privatize the many banks--together controlling half the country's banking market--that are controlled by the federal states and municipalities. With privatization, politicians won't be able to appoint themselves to the banks' supervisory boards and interfere with their decision-making.

Another lesson German politicians need to learn is that their arcane banking laws are woefully inadequate. Those laws need to be reformed. One reason BGB made so many bad loans is that German law currently treats public sector, private sector, and mortgage institutions differently. And it forbids managers from one class of institution from being actively involved in the activities of another. That meant that top management at BGB, legally a private-sector institution, didn't have a complete picture of what was going on at Berliner Hypothekenbank, its own mortgage-lending subsidiary.

Meanwhile, Germans should reflect on their political process. The problems at BGB surfaced at a time when Berlin was run by a grand coalition of Christian Democrats and Social Democrats. That meant there was no effective opposition to scrutinize the government's behavior. Had there been, the BGB crisis might never have happened.

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