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Tags: deutsche bank | germany | lehman | damage

What Should Worry Us About Deutsche Bank

What Should Worry Us About Deutsche Bank

Mohamed El-Erian, Bloomberg Opinion By Monday, 03 October 2016 07:24 AM EDT Current | Bio | Archive

My Bloomberg View column last week focused on the headwinds facing the European banking system and the broader implications of Deutsche Bank's fall from grace, including the decline in its stock price by more than half.

Let's now takes a closer look at factors that are specific to the bank, including what may happen, and what probably won't, starting with the scary -- but in my view implausible -- prospect that Deutsche Bank's woes could become a "Lehman moment."

The phrase is derived from the traumatic effects of the 2008 global financial crisis. A Lehman moment denotes a "sudden stop" to the global economy -- that is, a simultaneous collapse in trade, investment and consumption. The proximate cause is the loss of trust within the financial system as institutions disengage, worried about "counterparty" risk in interactions with their peers. The means of transmission within the banking system become clogged, credit dries up, and even the most creditworthy borrowers have difficulty arranging simple trade financing.

These events are the economic equivalent of a heart attack. If it is not treated quickly, many other organs of the body lose their ability to function normally, spreading cascading failures throughout the system.

For both institutional and contextual reasons, Deutsche Bank is unlikely to provoke the 2016 version of a Lehman moment.

Yes, there are questions about the bank's balance sheets, including the complicated valuations of "level 3" assets. But Deutsche Bank's sources of funding are much more diversified and its balance sheet is significantly more robust that Lehman's ever was. Also unlike Lehman, Deutsche Bank has access to emergency funding at a central bank, in this case, the European Central Bank.

And it has internal means of generating capital (including through asset disposals and even a rights issue), even though the more such methods are used, the less attractive they are to management and existing shareholders. Moreover, given its accumulated litigation reserves, the pressures would also lessen if, as was hinted at in some news reports at the end of last week, the bank reached a settlement with the U.S. Justice Department that required it to pay far less than the original fine of $14 billion.

The environment is quite different, too. Deutsche Bank is not part of a growing storm making its way through the global financial system. Although some European banks remain fragile, others around the world have notably strengthened their capital cushions, are deploying more prudent liquidity-management approaches, and have made significant progress in cleaning up their liabilities. Importantly in terms of systemic effects, this is particularly the case for U.S. banks.

But even if Deutsche Bank doesn't threaten a Lehman moment, that doesn't mean its troubles couldn't have any systemic effects.

There are at least four factors that should be kept in mind:

  • The saga deals yet another blow to the already frail reputation of the banking system. Understandably, it fuels the politics of anger, enticing some politicians to make statements that could undermine trust in the financial intermediation process.
  • By highlighting remaining gaps in the macro-prudential architecture – that is, the regulatory and supervisory structure aimed at ensuring the safety and soundness of the financial system -- Deutsche Bank's travails also put central banks and regulators on the spot, yet again. This exposes them to greater threat of political interference at a time when there are already lots of questions and growing irritation at the ECB’s use of negative policy interest rates and its balance sheet for large-scale asset purchases.
  • Renewed concerns about European banks are likely to be yet another headwind to the region's already-tentative growth prospects. Expect European financial institutions to become more prudent as they place balance-sheet robustness ahead of making loans, especially when it comes to lending to small- and medium-sized enterprises. History shows that such shifts cannot be easily compensated for by central banks and governments.
  • Because of the inherent interconnectivity of banking operations, the risk of equity and bond market contagion is greater than for most other sectors. In combination with the spread of hybrid securities, such as contingent convertible bonds that initially act as internal amplifiers, Deutsche Bank's difficulties transmits volatility to other banks' capital structure, potentially enlarging the group of institutions that attract short-sellers. In turn, this raises the possibility of broader market instability.

The benefits of stabilizing Deutsche Bank extend well beyond one institution that is being forced to redefine its business model by internal and external challenges. Fortunately, there still are tools for restoring stability. And while a Lehman moment is unlikely, time is running short for Europe and the banking sector to contain and minimize the risk of other collateral damage and unintended consequences. 


Mohamed El-Erian is the chief economic adviser at Allianz SE. To read more of his blogs, CLICK HERE NOW.



© Copyright 2023 Bloomberg L.P. All Rights Reserved.

The benefits of stabilizing Deutsche Bank extend well beyond one institution that is being forced to redefine its business model by internal and external challenges.
deutsche bank, germany, lehman, damage
Monday, 03 October 2016 07:24 AM
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