Germany's nearly 1,800 banks are being forced to rethink their business models in the face of  persistently low level of interest rates and weak profitability.

"It's an incontrovertible fact that the German banking sector is not profitable enough by international standards," Michael Kemmer, head of the BdB federation for private sector banks, told AFP.

In an economic analysis by the Organisation for Economic Cooperation and Development (OECD) and the European Commission, Germany tends to come out with flying colours -- except for its financial sector.

At the end of 2013, despite massive recapitalisation efforts, banks' return-on-equity stood at just 1.3 percent in Germany, a long way behind 2.2 percent in Britain, 5.8 percent in Spain and 6.0 percent in France, according to data compiled by the European Banking Federation (EBF).

With one bank for every 45,000 inhabitants, "there is a phenomenon of over-banking in Germany," said Kemmer.

And like their European counterparts, German banks are feeling the pinch from very low interest rates, increased regulation and competition from new Internet banking rivals.

As if this were not enough, a wave of scandals and litigation has not only hurt the banks' finances but also severely tarnished their image.

Germany's biggest lender, Deutsche Bank, is stuck in a veritable quagmire of different legal battles. And it has embarked on a number of different restructuring drives to try to catch up with its Anglo-Saxon rivals.

- One bank for life -

Wary of the image of unscrupulous bankers earning breathtakingly large bonuses, Germans are traditionally very conservative when it comes to their choice of bank. They prefer to entrust their savings and the finances of their family-run businesses to their local bank, and it's usually a choice that they stick with for life.
The German model "proved its value during the crisis. Unlike in other countries, credit did not dry up in Germany," said Gunter Dunkel, president of the federation of public-sector banks.

The German banking sector is built on three pillars -- private, public and cooperative. With around 1,780 lenders, it accounts for a third of all banks in the eurozone and a quarter in the European Union.

Private-sector banks make up 36 percent of total German banking assets. The rest is divided up between the regional public-sector lenders, which were hit hard by the financial crisis, municipal savings banks and a vast archipelago of small, local cooperative banks.

"The German banking sector, very closed and isolated, has no equivalent in Europe. In the German vision, its vocation is not to be competitive, but to be at the service of the economy, which explains the very strong links between finance and politicians," said Nicolas Veron, a researcher at the Brussels-based think tank Bruegel and at the Peterson Institute in Washington.

Various elected politicians sit on the supervisory boards of the public-sector regional banks or "Landesbanken", or play leading roles in savings banks, which enjoy a number of special regulatory advantages.

- Consolidation 'inevitable' -

In the debate over tougher financial regulation in Europe, Berlin is keen to point up the peculiarities of the German banking sector and argues that its smaller banks should enjoy special exemptions.

"You can bet that tensions will increase between a sector that is very feudal and Brussels' standardised approach," said Veron.

Since last November, 21 major German banks have come under the direct supervision of the new Single Supervisory Mechanism (SSM) which forms the backbone of the European banking union. And that could prove a severe test for the more fragile economic models of some of them.

The German central bank or Bundesbank insists that banks need to diversify their revenue sources, board member Andreas Dombret told AFP.

"The frequently high dependence on interest income is a drag on banks' profitability, particularly during a long period of low interest rates. For this reason alone, banks must take a look at their business models," Dombret said.

Interest income accounts for two thirds of German banks' operating profit, a factor which makes them very vulnerable during the current period of historically low interest rates.

Martin Hellmich of the Frankfurt School of Finance said a new wave of consolidation in the sector was "inevitable", noting that the number of banks in Germany has already been halved since the 1990s.