Following long battles with the European Commission, Germany's 11 public-sector regional state banks lost their state guarantees at midnight on Monday, a privilege that enabled them to refinance themselves via the capital markets at very favorable conditions and pass on the cheaper borrowing costs to their customers.

The state guarantees -- which mean that if a Landesbank were to go bust, the regional state government (that is to say, the taxpayer) would be left to pick up the tab -- were long seen as a red rag to a bull for the banks' private rivals.

Indeed, it was private-sector banks such as Deutsche Bank, HypoVereinsbank and Commerzbank that started the ball rolling by lodging a complaint with the European Union executive arm in Brussels in 1999 against what they saw as the unfair advantages enjoyed by state-owned rivals such as WestLB and the public-sector "Sparkassen", or savings banks.

The state guarantees enabled the Landesbanken to enjoy top-notch credit ratings from rating agencies such as Standard and Poor's or Moody's.

Slow process

In 2001, the EU Commission ruled that the practice should be abolished. But in order to give the Landesbanken time to adapt, it was agreed that the state guarantees would only cease at midnight on July 18, 2005.

Furthermore, any debt issued prior to that date would continue to be backed by the state until 2015. So, while the playing field is indeed being levelled, the process is still happening only very slowly.

Nevertheless, the Landesbanken now find themselves increasingly exposed to the fierce wind of competition, and not all of them may be able to survive in future, analysts believe.

As a result, some of the banks are already joining forces. The Landesbanken of Baden-Württemberg and of the Rhineland-Palatinate merged recently, as did the banks of Kiel and Hamburg. Frankfurt's Sparkasse is being taken over by the Hessische Landesbank and WestLB and NordLB are also collaborating closely.

"We need to attain a critical mass," WestLB chairman Thomas Fischer said recently.

In fact, German Chancellor Gerhard Schröder recently predicted that only three Landesbanken could be left in the long run.

Rivals not satisfied

Despite the mini-revolution that the abolishment of the state guarantees constitutes, private-sector rivals are demanding even further changes to the German banking sector, which is divided strictly between the public sector, the private sector and cooperative banks.

"In Germany, the law allows public banks to buy private ones, but not vice versa. It's a one-way street. That's not fair," complained Manfred Weber, head of the private banking federation BdB.

However, the dam that divides the Landesbanken from the private sector looks as if it might break soon.

The regional state of North Rhine-Westphalia, a major

shareholder of WestLB, plans to sell its 25-percent stake in the bank to help replenish its public coffers. And press reports suggest that private-sector rival Commerzbank is in the running to buy the stake.

Furthermore, Brussels is also pushing for the Landesbanken to open themselves up to private investors.

The EU Commission has ruled that the Landesbanken must repay around a billion euros ($1.2 billion) in public subsidies received during the 1990s.

The banks have agreed to do so, but hope their public owners will immediately fill the gap by injecting fresh capital.

However, EU competition commissioner Nellie Kroes insists that the reinvestment be substantially lower and private investors must also be involved.

But so far, the Landesbanken reject such suggestions and argue that Brussels is not in a position to impose conditions.

As long as the savings banks and regional state governments that owned the Landesbanken financed the banks at market prices, the EU did not have the right to impose additional conditions. The public sector owners should not be put at a disadvantage to private investors, the Landesbanken argue.