Is Deutsche Bank out of the woods?

After the United States Department of Justice had demanded a USD 14 billion fine from Deutsche Bank in September 2016 for the bank's malpractices from before the financial crisis, which were related to the sale of toxic securities in the US mortgage loans market, Deutsche Bank developed record losses. Many experts virtually prejudged the fall of the German banking giant, especially as the bank's shares plunged, after the information was announced, momentarily to less than EUR 10, which had been the lowest level in 30 years.

The bank's bad situation resulted from a number of events and dates back to 2013, when Deutsche Bank had to pay the EUR 725 million penalty imposed by the European Union for manipulating the LIBOR rate. However, the greatest drivers behind the bank's problems were events in 2015 and 2016. For instance, Deutsche Bank failed US stress tests both in 2015 and 2016; therefore, FED demanded that Deutsche Bank improves significantly its risk control system; otherwise it would fail the stress tests again and would be forced to limit its operations in the USA. Further, the bank had to pay another LIBOR-rigging fine, this time imposed by the USA and Great Britain. The bank's difficult situation enforced a restructuring plan which cut costs by reducing the markets in which Deutsche Bank operated and firing employees both in the country and abroad. Moreover, the lowered rating of Deutsche Bank damages its credibility in the global market.

The information about Brexit escalated the losing streak of Deutsche Bank. The UK market had accounted for 19% of the bank's income till then. On top of that, the International Monetary Fund officially considered Deutsche Bank to be the largest risk for the stability of the global banking system. Besides those events, the European Central Bank's policy based on low interest rates does not help banks' incomes rise. Since banks aim at maximum profit, they become involved in large-scale investment banking operations. One should emphasise though that Deutsche Bank's problems result from its flawed strategy of involvement in the securities trading in the global market.

The report for the third quarter Deutsche Bank published on 27 October 2016 came as a surprise to everybody with the profit of EUR 278 million, mostly from investment banking operations. Further, the bank's management board assures it is prepared for claims up to EUR 5.5 billion. In its press releases, it also admits USD 14 billion is just a starting point for negotiations with the US Department of Justice and it does not intend to pay the fine in such an amount. At the beginning of January 2017 Deutsche Bank reached a settlement with the US Department of Justice – ultimately, it shall pay USD 7.2 billion “only”; Deutsche Bank will pay a fine of USD 3.1 billion for the sale of toxic assets related to the mortgage market and put USD 4.1 billion as coverage affected consumers compensations.

Does the information allow us to claim Deutsche Bank is out of the woods? Hard to say. Firstly, the bank still has other unsettled claims besides the penalty imposed by the USA; approximately 7.8 thousand lawsuits against the bank are pending e.g. for manipulating the price of gold or for money laundering. According to the latest information, Deutsche Bank has agreed to pay a fine for its participation in money laundering in Russia. The bank has to assign USD 425 million for a fine in the USA and USD 204.46 million in the UK. The unknown is how much additional capital Deutsche Bank will need and the fact where it would come from. The citizens of Germany voice their unwillingness to save the bank with public money, especially as Deutsche Bank's operations are governed by the bank and its managers' interest only.

Secondly, the bank has got a strategic problem. Deutsche Bank needs to reduce its operations in the investment banking segment or, in line with the German act called Trennbankengesetz, transfer it to a separate entity. Further, according to the restructuring plan, the bank's major area of operations is supposed to be operations in the segments of corporate clients, payment transactions, retail banking and fixed asset management. Meanwhile the withdrawal of EUR 20 billion (including EUR 17 billion from the fixed asset management area) proclaims the loss of clients' trust in the bank. Moreover, the huge IT modernisation expenditure may be another burden for the bank.

Deutche Bank is systemically important and its fall would cause a crash on the global financial market with much more severe implications than the fall of Lehman Brothers. On that account, the German government will probably not allow for the fall of the German financial giant, especially that Deutsche Bank is a crucial financial institution providing services for the concerns of Germany in foreign commerce. In addition, the fall of a systemically important bank would bring about the domino effect.

We should remember, however, that Deutsche Bank did not use public aid in the financial crisis. It coped with the difficulties by itself – let us hope it will do so in this case as well. The acceptance of financial penalties may also be indicative of its willingness to provide a remedy and struggle to regain consumer confidence.

Anna Dąbkowska

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