One of Germany’s most venerable financial institutions, the state-owned Landesbank, is beginning to crumble from within. It could signal a sea change in the way that Germany does business.

After the crisis at SachsenLB - soon to be swallowed up by the Landesbank of Baden-Württemberg - and the IKB Deutsche Industrie-bank, the German Government is nervous. Both banks were hit by the US sub-prime mortgage crisis and Berlin fears that the corrosion runs deep. “We really have to improve our supervision,” Michael Glos, the Economics Minister, said.

Bankers in Düsseldorf shared that anxiety yesterday, cutting short their lunches to return to the office and catch up on the gossip as yet another Landesbank started to wobble. “WestLB is on the block,” one said, “and there are a lot of jobs at stake.”

WestLB is the once-powerful regional bank that helped to guide the steel mills and the engineering companies of the Ruhr into foreign markets. Now it is close to a merger with the Landesbank Baden-Württemberg (LBBW) and it seems that a chunk of regional economic history is about to disappear. WestLB has more than 6,000 staff on its payroll and is at the heart of Düsseldorf’s claim to be a financial hub.

LBBW took over SachsenLB last week to rescue it from a cash crisis. An Irish affiliate of Sachsen had landed it in trouble with risky investments, including some supported by American sub-prime loans.

SachsenLB had been Germany’s pride and joy: a home-grown Landesbank in eastern Germany that seemed to be contributing to, and profiting from, some of the fastest growth in the country –proof positive that unification was working. Then it fell flat on its face. SachsenLB and WestLB are part of a network of 11 Landesbanks that grew out of the historic savings banks, or sparkassen, movement. When Germany was still a patchwork of hundreds of duchies and principalities, the sparkassenhelped to create a mercantile class. Most, such as the Sparkasse Göttingen founded in 1801, were backed by local civic councils.

The Landesbanks effectively functioned as central banks to the sparkassen and gave the small-town businessmen and savers access to investment opportunities and corporate loans. After the Second World War, it was the Landesbanks that helped family-run provincial companies, the most dynamic part of West Germany’s export trade, to get a foothold in world markets.

It is politicians rather than bankers who have been taken by surprise. Since 2001, when the European Commission ruled to strip Landesbanks of their state credit guarantees, it was clear that they would have to reinvent themselves or perish. The ruling came into effect in mid2005 and there have been signs of struggle ever since. It is the sparkasse-shareholders in WestLB that have been urging it to merge.

“Seen from the ground, there is no choice,” says a banker from a Würt-temberg savings bank that has roots reaching back to the 18th century. “Landesbanks now have to learn how to compete on nonprivileged terms with the the big commercial banks like Deutsche and Dresdner. And learn very fast, indeed.” Some politicians, such as Georg Milbradt, prime minister of Saxony, are scared that the collapse of SachsenLB will become part of a broader indictment against his managerial competence. Heads have been rolling in the bank, including that of Stefan Leusder, the director responsible for capital markets. “Milbradt should go, too,” Andre Hahn, head of the left-wing opposition in the Saxon parliament, said.

Jürgen Rüttgers, the prime minister of North Rhine Westphalia, has only just woken up to the crisis. Fearful that his region will be drained of banking jobs, he is proposing two massive mergers, one linking all of the Landesbanks in the north, the other merging the southern banks. That, he believes, would allow WestLB to retain its clout. Such mergers, however, would be immensely complex and most financial experts reckon that the idea is a non-starter.

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