Irecent weeks, Eurozone investors are in disbelief. Will the turmoil in the banking sector really be limited to the US and Switzerland? That skepticism faded on March 24 as European bank stocks tumbled. At the end of the day, European Central Bank President Christine Lagarde commented that European banks are safe and liquid enough to stand up to market scrutiny.
The sell-off started with Deutsche Bank, a German lender that has struggled for years. Its credit-default swaps, tradable insurance against default on bank debt, jumped to near-record levels. In response, investors dumped the company’s shares, sending the stock down 14%. Fear spread. The Euro Stoxx 600 bank index, which includes the region’s biggest lenders, was down 5% by mid-afternoon.After the collapse of Credit Suisse, with Swiss bank On March 19, investors wondered if another fateful weekend was just around the corner.
How bad is the situation at Deutsche Bank? Start with its direct comparison to Credit Suisse. The 300 km distance between Frankfurt and Zurich isn’t the only thing that sets these two institutions apart. The Swiss bank was unprofitable and faced a huge legal battle. But what really makes Credit Suisse a prime candidate for a lightning-fast run is that nearly all of its deposits are uninsured.
By contrast, Deutsche Bank is profitable after a long and painful restructuring. About 70% of its retail deposits are insured, and the companies that park cash in them are also sticky. Deposits were little changed in 2016, when a confluence of poor performance, investigations and scandals rocked banks. In case of a pinch, the lender has a large pool of high-quality liquid assets that can be exchanged for cash at the European Central Bank. A self-propelled bank run scenario by Credit Suisse seems unlikely.
However, there are other threats. These include rising interest rates, which is what led to the collapse of Silicon Valley banks (SVB). Higher interest rates are good for banks in the short run because interest income increases. In fact, European banks have posted fat profits. Deutsche Bank’s net profit of 5.7 billion euros ($6.1 billion) in 2022 is double that of the previous year.
But as funding costs rise, banks’ assets, such as long-term bonds, depreciate. Fortunately for Deutsche Bank, European regulators have required banks to hedge against this risk. Last year, the European Central Bank reported that net duration risk — how much banks would lose if interest rates rose — was low as a percentage of local banks’ regulatory capital. According to analyst firm Autonomous Research, even if Deutsche Bank’s risk is on the high end, it doesn’t pose much danger.
Another concern is from SVB Affects Deutsche Bank’s U.S. portfolio. As mid-sized banks tighten credit, commercial real estate looks set to suffer. With nearly $17 billion in such assets, Deutsche Bank is one of the most exposed European banks. But the lender has a well-diversified commercial real estate portfolio with limited debt equivalent to only 35% of its high-quality capital. Deutsche Bank may have plenty of derivatives, which are dangerous instruments in volatile markets, but these are traded publicly and often enough that they are unlikely to be significantly mispriced.
Perhaps most worrisome is Deutsche Bank’s funding costs, which could rise with Credit Suisse’s collapse. Although Deutsche Bank has capital in excess of strict European regulated requirements, additional-tier (Additional-Tier 1) investors (exist1) Bonds, in Swiss bank Buying Credit Suisse will now demand higher premiums.and exist1 Deutsche Bank has a higher share of risk-weighted assets than other banks.
However, the main reason for the sell-off wasn’t the dreaded skeleton in Deutsche Bank’s wardrobe. Instead, European banking veteran Corrado Passera said it was an “uncertainty overreacting to weak signals”. Deutsche Bank’s credit default swap market is illiquid, meaning some trades can move prices quickly. After a weekend in which investors lost all their money, traders may want to sell anything with little risk in order to enjoy a few days of peace. ■
