Is Deutsche Bank a systemic risk? The answer seems blindingly obvious.
On Thursday, after another brutal day for Germany’s biggest bank, which saw its shares tumble 6.7 per cent, US financial stocks lost almost 2 per cent. In London and New York, market sentiment verged on panic. Comparisons were made with the collapse of Lehman Brothers in 2008.
The International Monetary Fund had pointed at Deutsche back in July, describing it as the world’s most systemically risky bank. In an unusual analysis that looked at the influence of banks’ share price volatility on each other, it found that movements in Deutsche’s share price carried over to rivals more than was true for any other big bank. It is a second-hand measure, but it could be seen as a proxy for the intricacy of the bank’s counterparty relationships and the fallout that could be expected in a disaster scenario.
The market has spent the past two weeks betting that the time for that scenario has come. On Friday September 16, it emerged via a leaked report in the Wall Street Journal that the US Department of Justice was seeking $14bn to settle accusations the bank mis-sold mortgage securities. Deutsche’s shares have been falling ever since. But on Friday, after falling again in the morning — losing 20 per cent in a fortnight — they regained 6.5 per cent in the afternoon on rumours of a much smaller $5bn settlement.
And yet the systemic contagion theory does not stack up. Until the past couple of days, the shares of most other big banks had been largely unaffected, shrugging off the Deutsche settlement issue — and the attendant pressure on capital — as an idiosyncratic risk.
When modest tumbles did come at Barclays and Credit Suisse, traders said it reflected hedge funds trying to replicate the short selling wins made with Deutsche stock, rather than a market fright about counterparty risk between Deutsche and the rest of the banking sector.
This is a long way from the kind of contagious virus that spread a full-blown crisis in September 2008 — for two reasons.
First, more robust regulatory defences have been put in place during the past eight years. Capital levels are three or four times what they were, liquid asset reserves are vast — €215bn in Deutsche’s case — and monitoring has been stepped up. Deutsche, along with 50 other European banks, went through a region-wide stress test over the summer. It emerged in 42nd place, relatively weak, but still better than some had feared.
Second, this is Germany’s biggest bank, with a brand that hammers home the connection with its domestic market. Whatever a politically pressured Angela Merkel might have to say in public, there can be little doubt that if it became necessary, the German chancellor would bail out the country’s biggest bank — albeit within the limitations of European law and its requirement that market conditions are respected and bondholders bear some burden, too.
That could translate into losses for holders of Deutsche’s contingent convertible bonds, its senior bonds, and its equity (though there is widespread, and justified, scepticism that any policymaker would have the chutzpah to “bail in” investors aggressively for fear of exacerbating market panic.)
Either way, the situation would be Deutsche specific. Contagion across the sector would be illogical, since counterparties should be safe.
All of that said, there is another kind of contamination that has been gradually spreading across much of the banking sector, especially in Europe. The root cause is not Deutsche Bank, or any other commercial entity, but central banks such as the ECB. Their zero interest rate policies have added to all the other pressures on banks and left them unable to generate anything like the level of profitability that equity investors would like.
Whatever happens with Deutsche’s DoJ settlement, expect depressed share prices to persist at Germany’s biggest bank — and across much of the sector — for a good while yet.