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What Deutsche Bank Tells European Investors

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Thursday, 29 September 2016 07:15 AM Current | Bio | Archive

Shares of Deutsche Bank, Germany’s largest bank, have lost more than half their value in the last year, and have been subject to exceptional volatility. Its bonds have also had a rough ride.

The decline is fueling lots of speculation about the adequacy of the bank’s capital cushion, its strategic positioning, the need to dispose of non-core units and its relations with the German government. More generally, the bank’s struggles hold important lessons for investors in the European banking sector, as some institutions continue to struggle to overcome the legacy of the global financial crisis.

Deutsche bank is battling three simultaneous headwinds that also are roiling other financial institutions:

  • Ultra-low interest rates, including negative ones on a significant portion of European and Japanese government bonds, are undermining the ability of bank to generate steady income from traditional intermediation activities.
  • A persistently sluggish economy is putting pressure on the creditworthiness of some of the banks’ borrowers.
  • Financial-market distortions, including interventions by central banks that were deemed improbable not so long ago, together with tighter regulation, have eroded the scope for revenue generation from capital market activities.

These headwinds are not going to die down soon. As a result, banks must have, and must be perceived to have, robust capital cushions to avoid the kind of rough treatment by markets that Deutsche Bank continues to experience. This is particularly true of the European banking system, where, unlike its U.S. counterpart, comprehensive efforts to overcome past slippages were hampered at times by the urgent need to address a sovereign debt crisis that even threatened the integrity of the euro zone.

Market volatility is amplified by the more fluid capital structure brought about by the influence of new “hybrid” instruments, such as CoCos (contingent convertible bonds that turn into equity at a pre-specified price level). These were designed to counter the systemic effects of strains in the banking sector, including by reducing the need for costly government rescue plans. Yet they can also  raise additional concerns about shareholder dilution when markets are already under pressure.

Bank investors have also been reminded that legal issues remain, most recently by the $14 billion penalty claim against Deutsche Bank announced earlier this month by the U.S. Department of Justice. This disclosure, along with the cross-selling scandal at Wells Fargo, is a further setback for banks that are still struggling to regain the public’s trust and respect.

It's no wonder that European bank chiefs -- including, this week, Credit Suisse Chief Executive Tidjane Tiam -- have highlighted the challenges facing the sector in the months ahead. Banks must not only realign their businesses to compete in a tough economic and financial environment, they must contend with a regulatory system that, responding to past excessive risk taking, is focused on a multi-year effort to push these companies into a less-exciting “utility model.” And all this while trying to regain public confidence.

Deutsche Bank may be an extreme case but its travails are indicative of a broader reality for the European banking sector as a whole. Unlike their U.S. counterparts, some European institutions haven't regained a sufficiently firm post-crisis footing. That means investors will need strong stomachs as they seek to differentiate among companies and opportunities in a sector that will inevitably remain vulnerable to bouts of unsettling market contagion, volatility shocks and reputational risk.


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

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Shares of Deutsche Bank, Germany's largest bank, have lost more than half their value in the last year, and have been subject to exceptional volatility. Its bonds have also had a rough ride.The decline is fueling lots of speculation about the adequacy of the bank's capital...
deutsche bank, european, investors, germany
Thursday, 29 September 2016 07:15 AM
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