THE BLOG

Concerning the Future of Deutsche Bank

03/03/2016 12:21 GMT | Updated 03/03/2017 10:12 GMT

Deutsche Bank is a leading global investment bank with headquarters in Germany and indeed is one of Europe's mightiest financial institutions and the cornerstone of the German economy and, in fact, Europe's. Recently, however, the market has started to suspect that there is something seriously wrong at Deutsche Bank and these worries are reflected in the bank's freefalling share price. Chief Executive Officer, John Cryan, has since publicly claimed that the bank is "rock solid" in a letter to the bank's employees and Wolfgang Schaeuble, Germany's finance minister, has also taken the unusual step of backing the CEO's claim by saying "I have no concerns about Deutsche Bank" resulting in a sharp sell-off of shares. Since March 3rd, 2015 Deutsche Bank's share price has fallen by 40.30 per cent from €28.78 to €17.18 leading some to speculate that Deutsche Bank is 'the next Lehman Brothers'.

The remit of this article will be to examine why some speculate that Deutsche Bank will collapse and what the impact of such an event would be if it were to occur. At present Deutsche Bank has a total derivative exposure of $75 trillion, a value which is twenty times greater than Germany's GDP of $3.9 trillion and over five times greater than the GDP of the Eurozone. This paired with the recent announcement that the bank had made a yearly loss of $7.3 billion, which surpasses the troubles the bank faced during the financial crisis, are the root causes of such concern. Such losses have been noted to have been a cost of past wrongdoing which has weighed on it, none the less this surprise announcement has lead some to believe that there is something eerily similar about the trading at Deutsche Bank and the behavior of those involved that lead to the 2008 financial crisis.

Though it might be said that income statement losses must be considered in the right context and might otherwise be dismissed or brushed aside, what we cannot so easily ignore is what Citigroup's' Andrew Coombs had to say. Coombs wrote that "we view the leverage ratio as the binding capital constraint for Deutsche. The current 3.5% is well below peers and the company's own 4.5% target. Post restructuring & litigation charges and a Postbank divestment at 0.6x P/TB, we estimate a proforma leverage ratio of c3.3%. This implies a c€15bn shortfall, of which we expect part to be met by underlying retained earnings and part via AT1 issuance. However this still leaves an equity shortfall - we see a c4% leverage ratio by end-2017 - which is likely to necessitate a capital increase of up to €7bn in our view. In addition, we note the target CET1 ratio of >12.5% only allows for a 0.25% management buffer above the fully-loaded SREP requirement. This provides the company with limited flexibility especially if BaFin were to introduce a counter-cyclical buffer (max 2.5% add-on)".

If Deutsche Bank were in serious trouble then the German government would surely feel obliged to bail it out, just as the United Kingdom bailed out RBS and the United States did so for their banks. This is not a possibility for two reasons for it would increase Germany's debt do GDP ratio of 71 percent to an unprecedented level and secondly it would require Germany to turn its back on the rules it has itself so fiercely been enforcing on the likes of Portugal and Spain as to ensure their debts are managed and kept under control. The alternative, however, would be to let the bank fail with the consequence being that the already fragile Euro being unlikely to survive the collapse of the systemically important bank. Germany's economy too would be unlikely to survive the collapse. Unlike other banks, Deutsche Bank is not a retail bank and instead may be said to exist to support Germany's exporters whom Germany's economy is underpinned by, which in turn underpins Europe's economy.

In the event that Deutsche Bank falters the impact may be three to five times larger than the impact Lehman Brothers' had after it filed for bankruptcy. If you compare Deutsche Bank's assets, which stand at $1.7 trillion, to Lehman Brothers' $639 billion worth of assets, the crude comparison shows that Deutsche Bank is nearly three times larger than Lehman Brother's was in terms of assets. Deutsche Bank also currently has 98,138 individuals under its employ, nearly four times that which Lehman Brothers' had. In short, by any measure, Deutsche Bank is significantly larger than Lehman Brothers' was and so if it fails the implications would too be magnitudes larger.

With rising economic risks investors have been advised by Deutsche Bank that they should "buy Gold for insurance" due to financial stresses and they are right to advise to do so as they themselves, as well as others, are contributing to such economic risks and market volatility. Deutsche Bank is set to face a number of difficulties in the future, its once profitable core business of investment banking accounted for more than 70 percent of the record profits it generated in 2006. Today its corporate and investment banking division is now a lossmaking division whose revenues fell by 30 percent in the last three months of 2015. Deutsche Bank requires a strategic vision and the only way it may achieve this is by looking to diversify its offering. Those who suggest that Deutsche Bank should, if it begins to fail, be taken over do not account for the unlikelihood of approval for the takeover of a systemically important financial institution such as Deutsche Bank. The banks CoCo debt too has caused some serious worries which have lead to the ratings on the debt being cut as repayments come under threat according to Standard and Poor's. A new offering which is sustainably profitable and capable of defining the future of the bank is required to reassure stakeholders, without doing so individuals are right to continue to worry about the future of Deutsche Bank.