1. The specifics of German banking sector and the prerequisites of the failure
The structure of the German banking sector differs greatly from the other counties banking systems. The specifics of the former is on the one hand, the reason why German economy performed well during the crises, and on the other hand, the ground for the failure of land banks.
1.1. German banking sector
The predominant feature of the German banking system is its universality. In contrast to many other industrialized nations, there is generally no separation between commercial and investment banks. Most German banks, though they may differ in size, ownership, legal form, business structure or administrative organization, have one thing in common: they conduct all types of banking business under one roof. There is no institutional separation between lending and deposit-taking on the one side and security business in the other.
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Besides the Universalbanken, a variety of specialized banks offer their services.
To sum up, the universality of German banks provided them an opportunity to use funds gained in deposit and lending business, and invest them in toxic securities. Land banks, which will be discussed in the next chapter, used widely this business model. In consequence, their behavior put the whole German economy at risk.
1.2. The breakdown of land banks
As it was mentioned in the previous chapter, land banks in Germany are universal banks and can perform all types of banking transactions. This fact as well as the following developments gave them an opportunity to conduct a toxic securities transactions, which amid the financial crises almost driven them into bankruptcy.
The reasons for the future instability of land banks began to from in the end of 20th century. As part of the campaign for harmonization of the legal framework of banking supervision in 1999 was adopted the "Plan for the liberalization of financial services". Thereafter, land banks acquired the opportunity to invest abroad, which was clearly more profitable than their main operations. Over time, their operations shifted towards investments in risky assets, and the connection with the real sector of the economy disappeared.
The situation deteriorated further, when in 2005 were canceled state guarantees for land banks. These guarantees meant, that in cases where a bank’s equity capital is not sufficient to cover claims, the government is jointly, and without limit, responsible to the bank’s creditors. This decision to cancel guarantees was taken under the pressure of the European Commission, which considered them as "indirect government subsidization". After the guarantees were cancelled, land banks found themselves in a very precarious position: they had no money to cover the risks.
Generally speaking, because of the government guarantees the land banks felt free to get involved in a risky business. But when guarantees were cancelled, they had to rely just on their assets, which turned to be insufficient. The land banks were extremely unstable, and when the economic situation worsened in the year 2008, they admitted that they are almost bankrupt and need bailout.