Deutsche Bank is again in the centre of attention. This time due to the Department of Justice penalty. The stock price of the German giant has now fallen to the levels last seen in the '80s . Investors started to question DB's future. Will DB fail just like Lehman Brothers?

Situation today

Fears are growing about the fate of DB after DOJ punished DB with 14 bn USD penalty. Before 2008 Deutsche was selling mortgage bonds and many of them were not paid back. According to the US government the bank never properly informed clients about the risk.

The situation is very grim especially because the market capitalisation of DB is only 17 bn USD. When the fine is going to be subtracted from this sum there will not be a lot of money left. On the other hand, the amount of fine can be the answer of the US to the way the EU is prosecuting Apple. The European institution applies pressure on Apple to pay 14 bn USD in taxes to the Irish government. Given this retaliatory nature of the fine, it may be lowered. Other banks (apart from BOFML) were given penalties of several billion. HSBC received only 1.9 bn USD fine for money laundering for drug cartels.

Deutsche Bank has more scandals under its belt. Back in 2015 it was penalised for LIBOR manipulation. We still are waiting for any punishment for gold and silver price rigging. All in all, DB has 7000 suits to win or settle.

The biggest bank in Germany cannot boast solid financial results. Last year DB recorded the first loss in 7 years. ZIRP environment makes it harder for banks to generate profits.

Another reason to worry is the DB derivatives exposure equal to 42 tn EUR (end of 2015). This is a 14-fold higher sum than GDP of Germany. Most of them are bets on interest rates and even the loss of 0.5% would mean bearing the cost of 210 bn EUR. It is very hard to estimate the result of such an exposure.

Media still compares the case of German bank to Lehman Brothers before it collapsed. DB has liquidity on its side – 12% to 7.5% when compared to Lehman’s. There is a problem with this number.  It is from June. Additionally, banks can book asset values at their nominal prices even if the market price is much lower. That sums up the reasons why it is very hard to compare DB and Lehman in terms of the financial condition.

Political Background

DB is the only German financial institution being globally systemically important bank (G-SIB). The bad news spurred a debate asking how and who should help this company. The most probable scenario is one in which the government helps the bankrupt. It is far from easy in this case. Parliamentary elections are due next year in Germany. With Angela Merkel losing approval thanks to her way of handling immigration crisis, contender party AfD (Alternative for Germany) is on the rise. Germans are against the governmental help given to DB and Merkel in her situation cannot ignore it.

If German government decides to help DB through bail-out it would lead to further disintegration of the EU. At the end of the day, it was Germany pushing for a restrictive policy of state aid (for banks) nearly erasing the possibility of aforementioned bail-outs. If Merkel gives green light to save Deutsche it would put German hypocrisy in the spotlight. In no time, Italy, Portugal or Spain would join the bailout queue.

Grand finale - possible scenarios

This complicated chessboard still puts the help from the government as the most probable endgame. Die Zeit reported about a plan in which government would take 25% shares in DB. It may not be enough.

We cannot rule out a division of the bank into two entities. First one, consistent of healthy assets enabling DB's existence. Second entity filled with all toxic, junk assets can be bought by the ECB. Again, just like the previous solution, it is possible but consequentially more countries would queue for the help. The trust in EUR will be hurt badly then.

We have to also explore a possibility of help coming from outside Europe. In 2010 the FED was able to print 16 bn USD out of thin air to help European banks. When Ron Paul asked Ben Bernanke where exactly this money went, chairman of the Federal Reserve said he didn't know. Linking significant control over the ECB and FED’s inclination to print money out of thin air, we can assume that it may be the US helping Deutsche.

If we are talking about help coming from another continent we have to include China in this equation. Beijing tries to enter the European market and this may be their opening. Hypothetically, even if DB share price doubles it would put a price tag of only 10 bn USD on 25% of all of its equity. China’s currency reserves are worth 3.2 trillion USD.

Of course, there is always a bail-in on the table. This would mean a takeover of a share of deposits to fund bank's liabilities – mechanism used in Cyprus a few years ago. Counter-intuitively I do not think this is what is going to happen. The operation would be a very vivid proof of how important free access to money is. It could be the last piece of evidence for the people to stop trusting the financial system.

Last option – DB fails. This one definitely will not happen due to the domino effect the bankruptcy could start. In the end, it can bring the whole system down. Also, no politician wants to be linked to the failure of the biggest German bank.

Summary

Deutsche Bank's problems are not new and you could have read about it already three years ago on this blog. Since then the bank only made its position more complicated. Looking how communicating vessels of the banking system turned risk of the bankruptcy of a single bank into a systemic one. The significance of DB is considerably bigger than Lehman Brothers'.

Politicians will avoid any eventuality of Deutsche's bankruptcy like fire and this reason alone makes the argument about German government intervention almost a sure thing. Maybe DB will sell off some of its assets to other banks?

This conundrum is increasing the tension inside the EU and will lead to a vacuum of enforceable rules when it comes to banking sector policies. We must remember that the further Germany moves from European neighbours the closer it gravitates towards Russia.

To prevent additional DB-like issues a return to Glass – Steagall regulation is imperative. According to this US bill, institutions could not combine their commercial banking activity (offering deposits and loans) with investment banking. Soon after this legislation was repealed TBTF (“too big to fail”) banks started emerging. With Glass – Steagall revived and the biggest banks divided into 10 smaller ones the competition can once again return to the banking sector in a way not threatening the collapse of the system. Banking supervisory bodies in each country would be finally able to effectively control the majority of banks. If the bank wants to take part in a big investment it can do so through a joint venture with other banks.

Lastly, deposit guarantees result in consumers not caring for the financial situation of the bank of their choice. Without deposit guarantees, the competition between banks would force companies to prove the safety of their deposits. This is the direction we should be heading.