After failing the Fed’s stress test for the second year in a row, Deutsche Bank received far more damning analysis last week, when none other than the IMF disclosed that Deutsche Bank poses the greatest systemic risk to the global financial system, explicitly stating that the German bank “appears to be the most important net contributor to systemic risks.”
Deutsche Bank which shares hit a record low last week, falling to the lowest level since Germany’s DAX stock index was established in 1988, has been showing increasing signs of weakness. It posted a EUR6.8 billion (USD7.45 billion) loss last year, its credit ratings are being cut, along with 26,000 jobs, and investors are finding it hard to believe that co-Chief Executive Officer John Cryan can turn the bank around after a series of costly scandals and years of risky expansion.
Most worryingly, Deutsche has the highest derivatives exposure (EUR41.9 trillion at the end of 2015, the second highest level in the world after JPMorgan Chase).
The key section from the IMF’s report (click here for the full report):
Domestically, the largest German banks and insurance companies are highly interconnected. The highest degree of interconnectedness can be found between Allianz, Munich Re, Hannover Re, Deutsche Bank, Commerzbank and Aareal bank, with Allianz being the largest contributor to systemic risks among the publicly-traded German financials. Both Deutsche Bank and Commerzbank are the source of outward spillovers to most other publicly-listed banks and insurers. Given the likelihood of distress spillovers between banks and life insurers, close monitoring and continued systemic risk analysis by authorities is warranted.
Among the G-SIBs [Globally Systemically Important Banks], Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse. In turn, Commerzbank, while an important player in Germany, does not appear to be a contributor to systemic risks globally. In general, Commerzbank tends to be the recipient of inward spillover from U.S. and European G-SIBs. The relative importance of Deutsche Bank underscores the importance of risk management, intense supervision of G-SIBs and the close monitoring of their cross-border exposures, as well as rapidly completing capacity to implement the new resolution regime.
The IMF also said the German banking system poses a higher degree of possible outward contagion compared with the risks it poses internally. This means that in the global interconnected game of counterparty dominoes, if Deutsche falls, everyone else will follow.
Notwithstanding moderate cross-border exposures on aggregate, the banking sector is a potential source of outward spillovers. Network analysis suggests a higher degree of outward spillovers from the German banking sector than inward spillovers. In particular, Germany, France, the U.K. and the U.S. have the highest degree of outward spillovers as measured by the average percentage of capital loss of other banking systems due to banking sector shock in the source country.
Here is the IMF’s chart showing the key linkages of the world’s riskiest bank:
The IMF concluded that Germany needs to urgently examine whether its bank resolution, ie, liquidation, plans are operable, including a timely valuation of assets to be transferred, continued access to financial market infrastructures, and whether authorities can ensure control over a bank if resolution actions take a few days, if needed, by imposing a moratorium:
Operationalization of resolution plans and ensuring funding of a bank in resolution is a high priority. The authorities have identified operational challenges (e.g., the timely valuation of assets to be transferred, continued access to financial market infrastructures) and are working to surmount them. In some cases, actions to effect resolution may require a number of days to implement, and the authorities should ensure they can maintain control over the bank during this period, including by using their powers to impose a more general moratorium for a specific bank.
Whilst Deutsche is number one, here are the other banks whose collapse would likewise lead to global contagion:
In light of the UK’s recent vote for a Brexit, Deutsche also appears to be exposed to Brexit risk with 19% of its total net revenue coming from the UK, and 8,000 staff members in London, it’s the biggest European bank in the City. If the UK cannot negotiate a “Norway-style” deal with the European Union, which would allow its banks to operate freely in Europe and allow European banks to operate in the UK, Deutsche will need to move lots of people elsewhere -probably to its Frankfurt headquarters.
For investors, especially those who hold structured notes or products issued by Deutsche Bank, now may be the time to review and fully understand all the underlying risks of such investments. To learn more, speak to one of the Intelligent Investments team today.