Why Germany Won't Save Deutsche Bank (But Might Have To)

This article was written by Lucas Hell, a student at the Frankfurt School of Finance & Management. He has worked in development finance and asset management and is currently working in restructuring. His interests concern Fintech , environmental finance and Microfinance .

Rumors

Last week saw rumors that Deutsche Bank might need a state bailout after the DOJ’s threat of a $14 billion penalty.

The allegations over residential mortgage-backed securities (RMBS) date back as far as 2005. The fine however was seen by many political analysts as a first step in more intricate negotiations to follow. Deutsche Bank is likely to see its prospective payment reduced in the end.

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For the DOJ , it was important to show its tough stance at the beginning of the negotiations, as Deutsche Bank's case is one of the first cases of a European bank over RMBS. Barclays and Credit Suisse, among others, are to follow.

Nevertheless, with its stock price falling to €10 per share at the end of September, investors started to become wary of whether Deutsche Bank would be strong enough to cope with the financial burden of future litigation. Deutsche Bank’s market cap is around $19 billion and it has laid back $5.5 billion in provisions for legal settlements.

Bailout

Last week, German press speculated about a state bailout which was immediately denied by government officials. However, as several newspapers reported, employees at the German Finance Ministry are working on an emergency plan in case Deutsche Bank runs out of money.

The harsh and instant denials of these plans show the nervousness of the German government. Chancellor Merkel faces a dilemma in foreign as well as interior policy. In the EU Merkel has spoken out several times against a bailout of Italian banks which are still sitting on bad loans amounting to €360 billion.

Her harsh stance in this matter has not only brought her strong criticism from Italian premier Matteo Renzi but also from the French president Francois Hollande. A state bailout of Deutsche Bank now might be seen as hypocrisy and weakness. The consequence would definitely be a strengthening of the Southern European bloc and bank bailouts in further states. For Chancellor Merkel this is equal to opening Pandora's box and further derailing the stability of the eurozone.

Political Climate

Apart from the problems a Deutsche Bank bailout poses regarding foreign policy, one should not underestimate the domestic political climate.

As in the whole Western world, German voter sentiment regarding banks has become increasingly hostile since the financial crisis. In 2009, Germany’s second largest private bank, Commerzbank, was partly nationalized and up to today the state has not sold all of its shares. Additionally, several federal states had to step in with taxpayer money to save federal state banks which would have otherwise collapsed.

A bailout of Deutsche Bank would definitely cause uproar among Merkel`s traditional CDU voters. In 2017 Germany will hold elections for the Bundestag and although Merkel has not officially declared whether she will run again, it is widely expected. Therefore she would under no circumstance want to give the impression that she is frivolously wasting taxpayers’ money for saving 'greedy bankers'.

In the recent federal elections this year, the far-right anti-immigrant party AFD (Alternative for Germany) was able to score highly, thanks to a great degree to disappointed Merkel voters and nonvoters. Merkel`s CDU is thus under enormous pressure from the right.

Lehman Brothers

To come back to the headline, despite pressure from the national and international level, there might be under certain circumstance no other recourse for Germany than to bail out Deutsche Bank. The bank still has the biggest derivative exposure in the world, with around $47 trillion, and one would not want to imagine the effects on the financial markets if Deutsche goes down uncontrolled.

The experience with Lehman Brothers (which had a tiny derivative exposure compared to Deutsche Bank) has led many officials in Europe to believe that a bank bailout is the lesser evil, and pressure on Germany to bail out Deutsche Bank will substantially increase once the market has lost confidence.

The IMF in its latest summit branded Deutsche Bank as one of the biggest threats to the global economy. No matter how desperately the German government tries to give credible assurance that it does not consider any government intervention, in the end it will have to if Deutsche Bank cannot manage its problems on its own.

Nonetheless, it is clear that a potential government step-in will not only have consequences for Germany, but also be a blueprint for the newly created institutions in Europe for banking supervision following the financial crisis.