Will Flailing Deutsche Bank Be The Next Lehman? Nah! It’s Too Big To Fail

If you are worried about the sorry state of Indian public sector banks, spare a thought for Deutsche Bank, the largest German bank. A few days ago, its shares hit a 33-year low and the bank’s valuation is currently just under $16 billion. That’s less than one-third the value of our own HDFC Bank, which is valued at $49 billion at current prices.

The worry is that Deutsche Bank is close to the point where it could become another Lehman, whose failure triggered the global financial crisis of 2008. Deutsche Bank is systemically a “too-big-to-fail” bank in the European Union. If it goes down, the world will tip into a further slowdown.

So it won’t be allowed to go down, but that does not mean it won’t be shaken and stirred (for more on the Deutsche Bank crisis, read here and here).

The markets have been savaging the bank’s share in part because the US Justice Department has proposed a fine of $14 billion for mortgage-securities market fraud. The second reason is its weak capital base, with $75 billion of equity backing $1.8 trillion in assets. That’s a 25:1 leverage, as this New York Times article points out. JP Morgan’s leverage is a more sensible 9:1.

But the third reason must be the follies of the European Central Bank itself – which is running a zero and negative interest rates policy to revive growth and inflation. Neither has happened, and banks, meanwhile, are carrying the can for this policy.

Zero interest rates are fine in theory, but they ruin any bank’s ability to make money. Ask yourself: which bank can make a decent margin by borrowing at zero and lending at super low rates, and that too when demand for loans is weak? Which depositor will want to save with you when you are planning to deny him any income, and, in fact, charge him for doing business with you?

Jamie Dimon, CEO of JP Morgan, has gone on record that the time to return to normal interest rates has come, but the US Fed is still wary of rushing into higher rates.

Some weeks ago, John Cryan, Deutsche Bank CEO, warned the German government that the European Central Bank’s zero-rate policy would have “fatal consequences” for savers and pension plans. He emphasised that “monetary policy is now running counter to the aims of strengthening the economy and making the European banking system safer.”

These warnings could not have calmed the markets down, though the bank’s share prices have been looking up over the last two days on whispers about a settlement with the US Department of Justice under which Deutsche Bank will pay penalties of only around $5 billion.

Actually, the US Department of Justice is hardly in a position to act tough with Deutsche Bank precisely because a high fine could end up pushing the bank over the edge.

Having taken eight years to just about make Lehman survive and stabilise the US economy where another rate hike can be contemplated, the last thing the US needs is another major bank failure. It cannot afford another Lehman, this time in Europe, which has been teetering on the brink of another recession for years now.

The markets and the US Department of Justice may be holding a gun to Deutsche Bank, but Deutsche is itself holding the gun of financial market chaos to their heads.