Scandals put the banks in the dock: John Eisenhammer reports from Frankfurt on a crisis of credibility for Germany's financial establishment

AS THEY survey the mounting rubble of the first half of the year, Germany's banking establishment may be forgiven for reaching for the Queen's Latin phrase book. The thinning of bank wallets in the bond markets is merely the insult crowning the deep injury inflicted during this annus horribilis by a succession of scandals whose cost runs far higher than the billions of marks in bad debts. Reputation and credibility, as the Bundesbank never tires of preaching, are what really count, and here the German banks face a colossal rebuilding task. Metallgesellschaft, Schneider and Balsam / Procedo add up to a humiliating indictment.

As the banks are at pains to stress, none of these headline-grabbing fiascos was an entirely 'normal' failure. They shared some devious element, a deliberate attempt to hoodwink the system. But over such justifications hangs a sharp whiff of complacency, sloppy control and botched responsibilities.

Late last week, two board members of Deutsche Bank's mortgage arm - the single biggest creditor to the collapsed Schneider property empire - tended their resignations, the first casualties within a shaken and bitter German banking world.

Beneath its black-tie gentility, the recently held International Banking Evening in Frankfurt was a bitchy affair, the air rank with complaints from the smaller banks about boorish behaviour from the big two, Deutsche and Dresdner. In the cases of Metallgesellschaft and Schneider, the smaller banks in the lengthy list of creditors claim to have been threatened with having inter-bank credits cut off and being frozen out of consortiums if they did not jump into the big boys' line.

The ill-feeling was compounded by the revelation that, unbeknown to the others, Deutsche and Dresdner had pushed themselves to the front of the Balsam / Procedo creditor queue with a preferential arrangement.

The rancour within banking circles is dosed, moreover, with a stiff shot of alarm at the international repercussions of the succession of spectacular mistakes. Deutsche Bank heavyweights have been dispatched abroad to purvey the message that all is well in the Teutonic financial garden.

Their efforts notwithstanding, doubts are likely to linger about characteristics of the German system which, having long been praised as strengths, may increasingly be turning into sources of frailty and disadvantage. The close links between banks and industry, which often translated into a cosy relationship at board level, are a hallmark of the mutually supportive German system, as is the tradition of looking after the full range of a firm's interests under the universal banking umbrella.

But this is a tradition under strain. The latest fiascos point up the limits of modern controlling when confronted by the outdated hierarchies of German banks. It is hardly surprising that the specialist credit assessor, even when alerted by dodgy-looking figures, may hesitate to voice concerns when he sees his boss on the board hob-nobbing with the client in question. Recent events have shown how fine is the line between intimacy of ties providing security and engendering complacency.

There is a case for arguing that such a risk is heightened by the confusion of roles within Germany's universal banks. The Chinese walls painstakingly erected elsewhere have few equivalents in Germany.

Whereas it is the norm in London, for example, to require special passes for access to separate parts of the bank performing different tasks, employees can wander at will inside Frankfurt's financial skyscrapers, from the department advising a client on placement, to the equity trading floor. This hotch-potch approach reflects the dominant power of the banks on their home turf, and the customs developed in a credit- based as opposed to capital market economy.

But it is becoming more difficult for the German banks to sit tight inside their trusted system. The globalisation of the economy means companies are changing, and so too are their financial requirements. In the good old days, of building widgets in Oberpfaffenberg and exporting them to the four corners of the globe, the only thing that counted was whether the client liked the product.

Increasingly, however, it is the firm that needs to be liked too, and made attractive to the market. German industry's capital requirements are becoming much more sophisticated and global. Daimler- Benz's listing on the New York Stock Exchange is just the most eye-catching example of a broader transformation, as companies make greater use of foreign banks and the international markets to manage their capital needs. The pressure on the German banks to adapt is likely to mount.

The same could be said of the other matter that dominated the International Banking Evening, the Bundesbank's campaign to have its M3 money supply intermediate target adopted as the Europe-wide standard when a common monetary policy eventually arrives.

It was significant that the argument within the speeches of Hans Tietmeyer, president of the Bundesbank, and Alexandre Lamfalussy, president of the European Monetary Institute, was conducted exclusively in terms of the Anglo-Saxon camp versus Germany. No other European country merited a look-in. Mr Tietmeyer heaped scepticism on the strategy of looking at a host of indicators to assess inflationary risk, describing it as unclear and lacking conviction.

But while the Bundesbank can use its inflation-fighting record to make some strong claims for its M3-based approach, notwithstanding the embarrassment caused by German money supply's recent haywire behaviour, it faces big problems in selling its European- ness, never mind its universality.

As Mr Tietmeyer admits, M3 targeting has functioned well in Germany's conservative credit culture, where financial deregulation has been restrained, where there is a relative absence of pension and insurance funds, and where the indicator, which is essentially a measure of bank assets, covers a large proportion of the financial system. But this is less true of the Anglo- Saxon world, and indeed of other parts of Europe. The pace of deregulation is accelerating; the trend in capital markets is not moving in the Bundesbank's direction.

Like the commercial banks, the Bundesbank is likely to find that the tried and trusted ways of managing affairs at home are coming under increasing pressure from an outside world that is going its own way.

(Photograph omitted)