Germany's big banks appear headed for less than spectacular earnings this year.

But they'll also avoid the massive surge in problem loans that has plagued banks in the United States, Britain, Australia, and even Japan.

"There was no real estate frenzy in Germany, there were no highly leveraged transactions, and the savings and loan associations remained regulated and stayed within the confines of their regional markets limits," said Jens A. Westrick, executive vice president at Norddeutsche Landesbank Girozentrale in New York.

"Bucking the trend of global depression, German banks were able to report improved profits for 1991," noted Bernd Voss, managing director at Dresdner Bank in a recent presentation in New York.

Dresdner was no exception, he added, posting a 23% increase in operating profits.

Steady as She Goes

Analysts and bankers predict that German banks will continue holding to a slow but steady course.

"If you look at the performance of German banks -- from no matter what angle you look -- it's not likely to change radically in the next few years," said Matthew Czepliewicz, a European banking analyst at Credit Suisse First Boston in London.

However, few analysts believe that earnings at German banks this year will be as good as in 1991.

Although asset quality at German banks remain generally sound, Germany's economy is slowing, lending is slowing, and margins are shrinking.

Meanwhile, operating costs, including salaries, are among the highest in the world and rose even further under a labor contract signed in April. That pact gave about 680,000 bank employees an averaged 6.3% pay raise.

Downward Profit Trend

"Looking at German banks' partial operating profit -- that is, profit before trading activities and provisions to loss reserves -- for all banks except Deutsche Bank, the trend is down," Standard & Poor's Corp. reported recently.

"Interest margins in particular have been under pressure because customers are shifting deposits to accounts that pay better interest," S&P said, "while many of the long-term [loans] by German banks to local and regional institutions, although riskless, are being made at razor-thin margins."

In fact, according to S&P estimates, interest margins have dropped by as much as 40 basis points since 1986.

"Lending growth is slowing," said Mr. Czepliewicz. "It won't go negative, but it will go to low single digits."

Problem Loans in East

And German banks have not escaped unscathed from the lending mistakes of the '80s.

They have yet to deal with more than $20 billion in problem loans to the Soviet Union and other Eastern European countries - excepting East Germany - according to some estimates.

The experience has been sobering.

Bankers like Hilmar Kopper, chairman of Deutsche Bank, adamantly insist that there will be no new lending to Eastern Europe without government guarantees.

"There is no scope for other finance until we see a satisfactory solution to the debt problem," he said recently.

Serving Multinationals

Banks face other challenges, as well.

One of the largest is offering German multinational corporations more sophisticated financial products.

At the top of the list are investment banking and hedging transactions such as derivatives, swaps, futures, and options - the kinds of activities German banks have long considered suspect and been slow to develop.

The most advanced in developing activities so far is Deutsche Bank.

The bank, director Ronaldo Schmitz said in May, intends to become a leading player in key wholesale sectors in the United States and around the world. It will offer both commercial and investment banking services, he said, including corporate lending, capital markets issuing, treasury activities, foreign exchange trading, money market, swaps and derivatives, and private banking.

In a step toward reaching this objective, Deutsche Bank this year set up a U.S. holding company and is rapidly reorganizing and expanding its activities in the United States.

Still, German banks have a long way to go before they can hope to catch up with other players in the derivatives markets.

And for most, the top priorities remain building up business in the former East Germany and expanding their European networks.

Expansion into eastern Germany has taken several forms.

Building Branch Networks

Big institutions like Deutsche Bank have aligned themselves with former East German government-owned organizations.

Deutsche Bank, which has acquired more than 100 branches from Deutsche Kreditbank, the commercial banking arm of the former East German state bank, is building a 300-branch commercial and retail banking network.

Other banks are also developing eastern German networks.

Dresdner Bank, for example, now employs 7,600 people in 218 branches in eastern Germany with 1.4 million customers, and it plans to increase the number of branches to 270 by yearend.

"The banks were pushing into a vacuum and were quite successful in getting most of the business out there," said Gunther Stur of Moody's Investors Service.

Similarly, German savings banks have established links to the roughly 3,000 savings banks in the former East Germany.

Further expansion by West German banks into the old East Germany is likely, bankers predicted.

They noted that eastern German branches have an average of 3,100 customers, compared with 1,400 customers per branch in western Germany.

After eastern Germany, Europe is the next main target for German banks.

Again, Deutsche Bank is the most advanced in building a pan-European network.

The bank is firmly planted in Italy and Spain, where it has acquired local banks - and it is seeking to buy a bank in France.

Other banks have taken a more cautious approach, restricting their expansion to opening or acquiring branch offices or setting up joint ventures.

Seeking Strategic Allies

Westdeutsche Landesbank, for example, had acquired the European branch network of Standard Chartered Bank PLC, and Dresdner Banks is striking a strategic alliance with France's Banque Nationale de Paris.

Meanwhile, Commerzbank, Germany's third-biggest, is exploring a strategic alliance with France's Credit Lyonnais.

Some German banks believe that, given their strong capital base and a shortage of funding worldwide, the time is ripe for international expansion.

But German bankers are the first to admit that they can never hope to dominate European banking in the same way they dominate banking at home.

"In the single European market, we do not intend to reach the same level of market penetration in the near future or have as dense a branch network as we have in Germany," said Mr. Voss of Dresdner Bank. "On the contrary, we plan to expand our business through a diversity of distribution channels where we see potential and can exploit our own particular strengths."

Small Impact Worldwide

"If you concentrate on the three major countries in Europe -- France, Italy, and Great Britain - significant physical penetrations into these markets are scarce," said another German banker. "In none of these three countries has any German bank made inroads into the lucrative retail banking sector."

Nor have German banks made much of an impact on the international scene.

With the exception of Deutsche Bank, which has built up a strong Eurobond business, German banks have a long way to go before they can match the global reach and expertise of international competitors like J.P. Morgan & Co. or Bankers Trust New York Corp.

But German banks could well argue they haven't lost much by not venturing far from home or engaging in complex and highly risky financial transactions abroad.

"German banks are among the most stable and most solid banks in the world," said Mr. Stur, the Moody's analyst. "Of course, all banks, and Germany is no exception, will be subjected to increasing pressures, but they are certainly in a better position to face these challenges." [Tabular Data Omitted]

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