* Substantial scope for joint solutions -savings banks body
* Urgent need for cost savings in face of profit squeeze
* Cooperation model is not without risk
* Merger route could prove unavoidable in long term
By Andreas Kröner
FRANKFURT, March 22 (Reuters) - Just as a wave of burdensome financial regulation and rising competition seemed to make consolidation among Germany's five big regional public sector lenders inescapable, the landesbanks have come back with their own solution: cooperation.
Analysts, regulators and bankers have predicted for years that Germany's clutch of landesbanks, which provide wholesale loans and capital market services to savings banks in their regions, would eventually be pared down to, well, a pair.
But with the state governments that dominate ownership of the landebanks reluctant to take the merger route and the banks themselves more willing to share resources and swap expertise, the pressure to consolidate has eased, for now.
"We want our approach to be as decentralised and as close to our customers as possible," said Georg Fahrenschon, president of the DSGV association of German savings banks, which are typically major landesbank shareholders alongside state governments.
There is substantial scope for joint solutions in back-office operations, Fahrenschon said. A number of lenders have outsourced IT operations to a joint venture called FI and there has been further cooperation in regulation and digitalisation.
There is also an urgent need for cost savings. The formidable cost advantage of Germany's public banks over private rivals is disappearing. Much of the cheap, government-backed debt they relied on before Brussels decided in 2001 that it amounted to illegal state aid has either run out or is due to be refinanced at market rates.
RETURN ON EQUITY
With profit prospects limited by an overcrowded market, record low interest rates and the cost of government guarantees given during the financial crisis, cost-cutting is crucial. Return on equity at the landesbanks hits mid-single-digit percentages at best, compared with the 10-12 percent usually sought by investors.
Martin Faust, of the Frankfurt School of Finance, acknowledges that cooperation usually serves to lower costs, but he has reservations.
"In many cases, I don't think it will be enough in the end," he said.
On the revenue side many public sector lenders have entered cooperation agreements with private sector players to improve their product ranges.
BayernLB has teamed up with Berenberg Bank, drawing on the Hamburg-based lender's investment banking expertise when customers seek takeovers, capital increases or flotations. In return, the deal gives Berenberg access to the financing power of the country's second-biggest landesbank.