Germany’s banks have had a tough week. Deutsche Bank, the country’s largest lender, saw its share price drop sharply on Monday and Tuesday following news of a possible $14 billion fine from the U.S. Department of Justice for misselling mortgage-backed securities before the 2008 crisis. On Thursday, Germany’s second-largest lender, Commerzbank, announced plans to cut nearly 10,000 jobs and scrap its dividend as it undertakes a strategic overhaul. And in between, European Central Bank President Mario Draghi spent much of Wednesday at the Bundestag enduring a grilling from German lawmakers convinced that his monetary policies are undermining their country’s economy. But even with the week it had, Germany’s banking sector is not alone in its problems.
Deutsche Bank’s struggles did not begin this week, of course. Like so many of its peers, it spent much of the decade leading up to 2008 getting further and further away from its roots in retail banking, trading ever more exotic and complex derivatives across the Atlantic Ocean. Its profits grew until the great financial crisis threw back the curtain on its new products — which turned out to be composed entirely of other complex products without real value — and the whole structure came crashing down. Deutsche Bank emerged from the crisis with a balance sheet more loaded with exotic derivatives than most, an opaque mixture of products that are both hard to value and easy to disparage, considering the experience of 2008. Since then, the bank’s shares have been on an inexorable downward slope, falling from 50 euros (about $67 at the time) in 2010 to just over 10 euros (about $11) on Tuesday.
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The most recent drops have taken share prices low enough to set alarm bells ringing. Over the weekend, a German magazine reported that Chancellor Angela Merkel had met with Deutsche Bank executives to discuss a possible bailout. The government and bank both denied the reports, but the damage was already done: Newspapers around the world took the rumor and ran with it, publishing stories of 2008-style government bailouts and systemic dangers.
In truth, these fears are probably overblown. For one thing, there are other steps Deutsche Bank can take before resorting to a government bailout. It could, for instance, go to the market in the hope that shareholders might be willing to pump more money into it. Failing that, if the bank’s share price continues to drop, other German institutions may agree to pool together and provide funds to support their ailing larger peer, much as Italian banks have rallied around Monte dei Paschi. Even if a bailout were necessary to save Deutsche Bank, it would look much different from the bailouts of 2008. In the wake of the 2008 crisis, the European Union changed its banking rules to require that a bank’s investors be “bailed in” by taking a hit on their investments before any government money can be used. Furthermore, global banks are now much better capitalized than they were before the crisis, making them considerably more resistant to the same type of contagion that led to the 2008 banking collapse.
But this is not to say that all is well in the banking sector. Deutsche Bank’s woes are not unique, and many of its peers are experiencing similar problems. In the years since the financial crisis, banks around the world have been buffeted by strong headwinds. Not only did they discover that much of their balance sheets were worth far less than they thought, but they have subsequently had to operate under increased regulation and higher capital requirements. Though these new conditions make the industry safer, they also reduce profitability. And then there are the fines. In addition to Deutsche Bank, Bank of America has been slapped with a $16.6 billion penalty. Investors, meanwhile, are turning away from banks in search of clearer rewards, and the world’s best and brightest are choosing technology firms over investment banks as they enter the workforce. The global banking sector is losing profits and influence.
On top of these challenges, European and Japanese banks are facing additional discomforts. In the past two years, the central banks of Europe and then Japan plunged their interest rates into negative territory as they struggled to achieve their inflation targets. Research on the subject remains scant, but evidence suggests that such unconventional monetary policies further undermine banking profitability, a factor that appears to have influenced the Bank of Japan’s latest adjustment to its quantitative and qualitative easing programs. In the eurozone, German and Spanish banks have suffered the most from the European Central Bank’s policy, since their hyper-competitive banking sectors have already reduced their margins. Given the circumstances, it is unsurprising that Draghi would get such a hard time in the Bundestag.
At the same time, it is unlikely that another global banking panic is nigh. Instead, a structural adjustment is underway, diminishing banks’ profits and reducing their sway in modern developed economies. This transition will not be easy for banks or their governments, which will work to protect and support a sector that will always be deeply engaged with their citizens.