Deutsche Bank Could Impale Merkel, As It Risks Taking Down the European Union

By World Economic Forum [CC BY-SA 2.0], via Wikimedia Commons

Deutsche Bank continues to grab all the headlines but for all the wrong reasons. Its share price has fallen by more than 50% in 2016 to record lows, currently standing at €10.20. As if to add salt to its wounds, the German Chancellor Angela Merkel announced that Berlin would not sanction a government bail-out of Deutsche Bank.

Deutsche Bank Share Price

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A Deutsche Bank spokesman said that John Cryan, its chief executive, had “at no point” asked Berlin to intervene in the issue with the US Justice Department, concerning the $14 billion dollar fine imposed for mortgage-backed security sales. The spokesman continued saying that a government bailout was “not on our agenda” and added, “Deutsche Bank is determined to meet such challenges on its own.”

Whatever the case is with regards to this denial, Deutsche Bank are going to need to raise additional capital to shore up their reserves when set against the backdrop of ongoing internal structural reforms which are having teething problems that continue to impact revenue and profitability and ongoing litigation. Deutsche Bank is now trading at 25 per cent of the bank’s value which suggests there is something seriously wrong in determining the values of assets contained on their balance sheet. Whilst Deutsche Bank has €2 trillion in assets, crucially it has the deposit base of a second-tier bank in e.g. Italy. This means that it relies on short-term loans to finance riskier investments, a banking model that both Bear Sterns and Lehman Brothers deployed.

Deutsche Bank is Germany’s largest financial institution and regarded as one that is “too big to fail.” However the ECB introduced legislation in 2014, which intends to prevent the kind of bank rescues that occurred during the financial crisis of 2008. Europe established the Single Supervisory Mechanism (SSM), which states that those banks who find themselves in trouble are required to ensure that bond investors bear the principle responsibility in such losses as well as depositors, i.e. a bail-in.

Given the ECB stance over Greek and Italian banks, they have little choice than to apply these same rules to Deutsche Bank and hence why Merkel was keen to stress that Berlin would not permit any government bailout. Merkel was also keen to stress that she would not intervene in relation to the recent $14 billion fine imposed by the US Justice Department.

However, it is quite clear that whilst Merkel is keen to be seen to play an even hand in terms of Deutsche Bank with respect to ECB legislation, there is now a real risk that Deutsche Bank could well collapse and should the German government refuse to step in then the damage to her own nation would be severe. Furthermore, Commerzbank, which is Germany’s second biggest bank, is arguably not in a healthy position either given it has just announced its intention to lay-off 18% of its workforce.

There is then the obvious contagion risk, which would engulf European banks initially in France, Italy and Spain. This in turn would lead to a global financial crisis and given the precarious nature of the Eurozone economies it is likely to take down the European Union in the process.

Merkel has a clear choice. Is she prepared to risk sacrificing Deutsche Bank, her nation’s economy and the Eurozone project to save political face in the short-term but ultimately end her chancellorship in catastrophic circumstances? The alternative is to blink and bailout Deutsche Bank, risk the wrath of the ECB and damage her political reputation irrevocably. Ironically, either solution is still likely to bring about the demise of the Euro and the Eurozone. With that in mind it would appear Merkel’s very political future is caught between a rock and a hard place.

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