Germany: IKB Deutsche Industriebank Emergency Liquidity Program, 2008

In the summer of 2007, IKB faced heavy losses owing to the liquidity support it had provided on commercial paper issued by its Rhineland off-balance-sheet vehicle, which held distressed collateralized debt obligations backed by US subprime mortgages (Moody’s 2007). In July 2007, Deutsche Bank and other counterparties began to suspend transactions with IKB and alerted regulators to the bank’s precarious position (EC 2009). The failure of IKB posed a particular threat to KfW, a publicly owned German development bank that held a 38% stake in IKB (EC 2009; Mitchell 2016, 78).

Authorities pursued several public-private intervention measures throughout 2007 and early 2008 (see Key Design Decision No. 2, Part of a Package) (Mitchell 2016, 78–80). To keep the bank liquid in preparation for its sale, KfW provided two collateralized liquidity facilities in January 2008 and July 2008, which allowed IKB to access up to EUR 3 billion of liquidity (KfW 2009b).   

After becoming aware of the problems at IKB in July 2007, authorities moved quickly to put together a public-private support program for the bank (FCIC 2011).

On July 31, 2007, a group of German regulatory bodies and banking associations collaborated with KfW to produce a risk shield for IKB (Mitchell 2016, 78). Under the arrangement, KfW would take over IKB’s EUR 8.1 billion liquidity facilities to Rhineland; it would also cover EUR 0.85 billion in indirect exposures that IKB had to Rhineland and up to EUR 1 billion of IKB’s potential losses on a EUR 6.8 billion on-balance-sheet portfolio that largely consisted of subprime-linked securities. Three German banking associations participated in the risk shield, which required them to absorb up to EUR 1 billion of any losses. KfW and other authorities announced a second risk shield on November 30, 2007, covering EUR 350 million. KfW provided EUR 150 million of this second guarantee, EUR 54.3 million of which took the form of a convertible bond. The conversion of this convertible bond into equity a few months later resulted in an increase in KfW’s stake to 43% (EC 2009).

Despite the two previous interventions, IKB continued to show weakness in early 2008. Banking associations had less incentive to support another intervention because the primary motivation for saving IKB was the danger of its failure causing the failure of KfW, rather than the German banking system as a whole (Mitchell 2016, 80). Lacking full support from the banking associations, KfW provided a EUR 2.3 billion capital injection in February 2008, which brought its stake to 90.8% (EC 2009; Mitchell 2016, 80). This capital injection is discussed in greater detail in the corresponding YPFS case study (Swaminathan and Vala 2024).

The Law Concerning Kreditanstalt für Wiederaufbau (KfW Law) outlined the operations and funding of KfW (KfW 2006). Article 2 of the KfW law dictated that KfW was responsible for providing financing for the achievement of economic and social goals for the German and European economy. The specific areas under KfW’s mandate included small and medium-sized enterprises, risk capital, housing, environmental protection, infrastructure, technical progress and innovations, internationally agreed promotional programs, development cooperation, and other promotional areas stated in laws, regulations, or state economic policy assigned by the Federal Republic or a Federal State (KfW 2006, art. 2).

Section 3 of Article 2 of the KfW Law permitted KfW to pursue other financial operations to the extent that they were directly related to the core functions described in Section 1 of Article 2, including those designed to manage and safeguard its liquidity (KfW 2006, art. 2). Given KfW’s substantial equity stake, the failure of IKB would have posed a serious threat to the continued viability of KfW (Mitchell 2016, 80).

All German intervention measures were subject to European Commission (EC) State Aid rules. Regarding the KfW liquidity facilities, the EC stated that KfW could not “plausibly revert to a market-economy investor argument” (EC 2009, 44). Deeming the liquidity support to be inseparable from the capital injections and the risk shield, the EC asserted that a private investor would not have accepted significant exposure to IKB without the risk shield (EC 2009).

Regarding the private liquidity facilities provided by the two German regional banks, the EC stated that the facilities were not provided under the direction of the state. The EC did not find any indication that the terms conferred an advantage on IKB, and did not find reason to conclude that these facilities implied granting of State Aid (EC 2009).

Ultimately, the EC’s investigation confirmed the view that IKB’s issues were a result of “company-specific events” (EC 2009, 47). Furthermore, the EC was not convinced that any systemic effects resulting from IKB’s insolvency could have reached the size of “a serious disturbance” in German economy as defined in Article 87(3)(b) of the EC Treaty (EC 2009, 47). With regard to the long-term viability of IKB, the EC determined that the restructuring plan, in particular the sale of IKB to Lone Star, would result in the successful restoration of IKB’s long-term viability. Following the sale, Lone Star presented a new business plan that aimed at stabilizing IKB’s short-term financial circumstances by securing required liquidity and to restore the bank’s long-term stability by reducing its risk exposure and concentrating on its core business. Lone Star (as well as the German government before IKB’s sale) planned a number of actions to reduce IKB’s risk exposure during the restructuring process, including the withdrawal from involvement in international portfolio investments as well as compensatory measures such as exiting the real estate financing business and divesting a number of subsidiaries (EC 2009).

The KfW administered the two public liquidity facilities provided to IKB. Additionally, two large US banks provided a liquidity facility as did two regional German banks (EC 2009).

The German federal republic and federal states jointly owned KfW, with the federal republic owning 80% and the federal states the remaining 20% (KfW 2006, art. 1). A board of supervisory directors oversaw the conduct of KfW’s business and the administration of its assets. The federal minister of finance and the federal minister of economics and technology were appointed by the federal goverment on a rotating basis as chair and deputy chair. The rest of the body consisted of other federal ministers, appointees of the Federal Council and Parliament, representatives of the private mortgage banks, industry representatives, municipal representatives, and trade union representatives (KfW 2006, art. 7). The board of supervisory directors appointed an executive board which administered KfW’s day-to-day business (KfW 2006, art. 6).

Media coverage reporting a lack of interest for IKB among buyers led to a decline in its share price at the end of January 2008 (AFP 2008). In press conversations following the announcement of a further state capital injection in February 2008 (the third bailout package), the German federal minister of finance emphasized that IKB was stable and that German authorities hoped to facilitate a quick sale. The federal minister of economics and technology said that authorities were aware of multiple parties potentially interested in buying IKB (Sobolewski 2008). Germany notified its intervention measures to the EC on January 15, 2008 (EC 2009).^FNThis disclosure included information updates to a previous notice sent to the EC on August 3, 2007 (EC 2009).

KfW funded the liquidity facilities for IKB. Public documents do not provide any indication about the peak usage of the facility by IKB. KfW’s total cash outlays for the IKB rescue, including the risk shield and recapitalization, greatly exceeded the size of the liquidity facilities.

Article 4 of the KfW law permitted KfW to fund itself by issuing debt securities and taking loans (KfW 2006, art. 4). The IKB rescue was small relative to KfW’s total borrowings, which were EUR 348 billion at the end of 2008.

In its 2007 annual report, KfW reported raising EUR 27.5 billion during that year on capital markets, including EUR 4 billion in US dollars (KfW 2008). In its 2008 annual report, KfW reported increasing its financing volume by 3.6%, providing an additional EUR 2.5 billion to the “German and global economy,” though this was largely related to the risk shields and capital injection given their greater size and scope (KfW 2009a, 7).

On February 15, 2008, the German Ministry of Finance announced a EUR 1.2 billion extraordinary payment to KfW as partial compensation for losses related to the support of IKB. On September 30, 2008, Eurostat announced that KfW rescue measures were being classified as a public sector expenditure ex-post (see Key Design Decision No. 11, Impact on Monetary Policy Transmission) (Deutsche Bundesbank 2009).

The IKB rescue contributed to the erasure of Germany’s small fiscal surplus in March 2008, though the debt-to-GDP ratio remained virtually unchanged (Deutsche Bundesbank 2009; Eurostat 2009).

All public and private liquidity facilities charged rates based on the European Interbank Offering Rate (EURIBOR). Limited information on specific rates is available because the EC documents describing them are redacted. The EC documents say that the January KfW liquidity facility charged a premium based on EURIBOR, noting that it was in a range, and that the July facility also charged a premium based on EURIBOR that was never less than 100 basis points (bps). The private facility provided by two large US banks also charged EURIBOR plus 100 bps or more (EC 2009).^FNEC documentation gives a range in which both the lower and upper limit are at least 100 basis points (EC 2009).

The EC addressed the risk premium applied to IKB’s liquidity assistance using its “Communication on Reference and Discount Rates” document (EC 2009,44). According to this communication notice from January 2008, and to be made effective in July 2008, the EC adopted a methodology of setting lending rates using a base rate derived from one-year money market rates plus a risk premium. The premium was calculated using the borrower’s creditworthiness and collateral. Figure 2 displays the recommended risk premiums to be applied depending on the borrower’s level of credit rating. The EC said that the credit ratings did not need to be obtained from specific ratings agencies, and national ratings systems or systems used by banks to reflect default rates were acceptable (EC 2008).

The original termination date of the two KfW facilities was not disclosed. The KfW extended the end date for both public facilities to March 31, 2011, following the sale agreement with Lone Star (KfW 2009b). Annual reports for 2009–10 for both IKB and KfW stated that the two liquidity lines from KfW had been terminated ahead of schedule (IKB 2010; KfW 2010).

The US and German banks offered their liquidity facilities at various durations. The large US banks renewed their facility on a monthly basis, and the documentation does not specify an end date. Both of the regional German banks limited their facilities to one year (EC 2009).  

IKB transferred to KfW commercial loan receivables amounting to EUR 1.9 billion as collateral for the first EUR 1.5 billion credit line in 2008, according to its 2007–08 financial statement, meaning it over-collateralized the loan by about one-quarter. The bank did not provide similar information about the second credit line (IKB 2008). EC documentation restricts specific information on collateral requirements, but all facilities had required coverage to be greater than 100%.^FNEC documentation does not explicitly mention greater than 100% collateral requirement for one of the two facilities provided by one of the regional German banks (EC 2009). Authorities established collateral requirements for IKB liquidity facilities with the intention that the collateral would cover KfW even in the worst-case scenario (EC 2009).

The EC stated that the collateral provided by valuable IKB assets was structured in such a way that it would de facto never fall below 100% and therefore there was “an apparent high collateralization and relatively low risk of the liquidity provision” (EC 2009, 44).

As a public development bank, KfW did not participate in guiding German monetary policy. KfW funded its operations primarily through international financial markets (see Key Design Decision No. 7, Source and Size of Funding) (KfW 2009b). KfW’s typical operations included financing small and medium-sized enterprises, housing, and infrastructure projects (see Key design Decision No. 3, Legal Authority) (EC 2009).

The liquidity line was available in euros or dollars (IKB 2008).