For the past few weeks, everyone has been talking about Deutsche Bank. It is not only Germany’s largest bank, but it is also considered a key element of the global financial system. As you may have heard, the bank is on an edge if a liquidity crisis, which could affect the entire global system. As a trader, you need to follow the current developments as they continuously keep volatility on the rise.

How This All Started

It all started in the US. The US government is considering imposing a fine of $14 Billion US Dollars, claiming that the bank sold faulty mortgage-backed securities in the run-up to the financial crisis. Yes, this story is almost a decade old now. Yet, the US decided to impose the fine just now.

Why The Bank Is At Risk

Deutsche Bank and most other European banks have been struggling since the ECB imposed negative rates to fight deflation and low growth, which is shrinking their profits. What is more important now is that the fine proposed by the is very near to the bank market cap, which increased the expectations that the bank will need a bailout from the German Government. What’s even worse is that the German Chancellor Angela Merkel refused to help the bank saying “no bailouts for Deutsche Bank” .

Who Should Be Worried?

You might think that Germany should worry the most about Deutsche Bank’s potential failure. However, American investors should be more worried than anyone. The reasons why are explained below.

1. Deutsche is too connected to fail:  the bank is exposed to many financial institutions in the US and globally.
2. Huge derivatives portfolio: the bank is holding the world’s largest derivatives book, with a value around $46 Trillion US Dollars – this is 20 times larger than the German GDP.
3. According to the ECB’s requirements, the bank is not well capitalized.
4. Negative outlook: the banking sector in Europe and around the world already does not look that bright. Interest rates are on the downside and some countries are already in negative rates, while others are still cutting rates. In the US, the Fed is looking to raise rates, which would hurt the banks again through a fall back in lending.

Deutsche Bank Is Not Lehman Brothers

Well, this is a key question, but history taught us not to take anything for granted. Back in September of 2008, no one believed that the US will allow Lehman Brothers to file for Chapter 11 bankruptcy protection. Yet, it happened and the world went into chaos. Of course, the market cap of Lehman Brothers was way higher than Deutsche Bank before the collapse. Yet, Too-Big-To-Fail seems to be off the table after the financial crisis. Therefore, traders should always expect the worst before being optimistic.

Solutions

It is too early to discuss a solution, but hopefully, it is not too late. For the time being, the bank is in negotiations with US authorities, trying to decrease the fine. However, even with the current negotiations, the fine is likely to remain very high and near the bank’s value. Therefore, a bailout is a must, either through the government, a merge with another bank and/or sell a stake. In all cases, the bank is likely to suffer for some time, at least until this situation is settled.