Last week the International Momentary Fund signalled out Deutsche Bank as the most dangerous bank in the world. In banking, danger stems from the business, size and linkage. All three are a problem for the firm, the German and the European economy.
Too big to fail
First of all, it is too big to fail. In February the Executive Director of the Bank, John Cryan, was assuring Bank employees that the bank is “rock solid” and the German Finance Minister, Schaeuble, was saying that “I have no concerns about Deutsche Bank.”
The latter was a political assurance, not a matter of fact statement. Schaeuble was linking German state credibility with Deutsche Bank’s credibility, in a national version of Mario Draghi’s “whatever it takes.”
Deutsche Bank became gigantic in the evil 1990s when other behemoths like Leman Brothers were surging in size. It gradually started accumulating skeletons in its closet. In April 2015, the Bank was fined $2,5bn for its role in manipulating the Libor interbank offered rate; and it set $1,5bn on reserve to pay for anticipated costs. In time, the “setting aside” became €5,5bn.
The size of the problem
2015 closed with over €8 bn in litigation costs. That is a lot.
Deutsche is a bank with €1,64 trillion liabilities and €1,58 trillion in assets. In sum, it is a few billion in the red and could be worth very little if its share value continues to fall. Its book net value now is little over €20bn. The bank costs twice what it paid in fines and lawyers last year.
On Wednesday, the banks stock tumbled to levels unseen since 1989. It is conceivable that the bank could fail.
It all started when the bank announced the 2015 annual earnings report, and it did not look good. It was the worse report in seven years with net losses of €6,8bn. In February, the markets were panicking.
Then came the Schaeuble statement, which everyone takes with a pinch of salt. The bank has a €9,6 trillion exposure in government bonds and is seating on trillions of derivative bets that are multiple times over the size of the German GDP. So, Schaeuble’s word is good as gold, but not quite as good.
Too big to bail?
Although it has an overall capitalisation of 11%, the bank is also exposed to dangerous assets. It does not do retail, which some consider less risky. Since the beginning of the year, its share value fell by 50% since the beginning of 2016 and an overall 70% year on year.
Credit rating agencies are not trusting DB as much as the German economy. In May Moody’s downgraded the ratings of DB across the board, long term and short term. Moody’s also downgraded the ratings of US-based Deutsche Bank Trust Corporation.
Deutsche Bank failed the US stress tests earlier this year.
Linkage
The cost of going down does not come merely from direct investor exposure, but also from the networking effect. The interconnection with other financial institutions and the state is rarely transparent or easy to risk assess.
The problem with Deutsche Bank is that it is cornered in a position in which its fate is not entirely in its hands.
It is undergoing “structural reform” which mean pain, pain, and pain. It is simplifying investment portfolios, fortifying controls, bolstering capital buffers, and strengthening its balance sheets to stabilise earnings.
However, Deutsche Bank’s performance over the last several quarters is weak, because the global economy is weak. Brexit did not help; Chinese growth deceleration and the collapse of the commodities market did not either. DB cannot control the economic climate.
And so there may come a time when the German government may need to extend a hand. The cost of Lehman falling ensured that no government would make that mistake again, one would think. When it comes to bailing out, impossible is nothing. But, at what cost?
