Queasy calm is unpleasant, but it beats sickening panic.
Late on September 29, Deutsche Bank’s share price lurched downwards again, to a 34-year low, after Bloomberg reported that “about ten” hedge funds had switched some business away from the troubled German lender.
That capped a stomach-churning fortnight, after America’s Department of Justice (DoJ) requested $14 billion to settle claims that Deutsche mis-sold residential mortgage-backed securities (RMBSs) before the financial crisis.
Hopes that it might settle with the DOJ for $5 billion-odd, though so far unfulfilled, have since brought uneasy respite. On October 5, Deutsche’s shares were some 20 per cent above their nadir.
A swift, affordable agreement would end uncertainty about the bill and quieten chatter, pooh-poohed by government and bank, that the German state might have to prop up the country’s biggest lender. It would also buy breathing space. Despite the recent rally, Deutsche’s shares are down by more than half this year.
Deutsche has a thinner capital cushion than other leading European banks. It may yet have to ask investors for money, although it says not: it plans to sell assets and has begun an overdue restructuring.
But the last thing it wants (apart from the shame of a bail-out) is to go begging now. The DoJ might merely pocket the proceeds.
Simply put, Deutsche’s basic problem is that it is hard to see where profits will come from.
Investment banking is subdued worldwide, and once-buccaneering Deutsche is losing out to American banks. Worse, unlike the Americans, it lacks a domestic stronghold. It is only a bit-part player in German retail banking (and intends to sell Postbank, which it bought in 2008-10).
In a land of 1,750 lenders, mostly local public-sector banks or co-operatives, pickings are slim. Commerzbank, its biggest local rival, is shedding 9,600 jobs.
Some of Deutsche’s difficulties are its own, or shared only with a few other big European banks.
The DoJ is also chasing Barclays, Credit Suisse, HSBC, the Royal Bank of Scotland and UBS over RMBSs. But in its struggle for profitability, Deutsche is far from alone. Especially in the euro area, lenders large and small are suffering.
A prime reason is the currency zone’s slow growth, coupled with ultra-low interest rates – the product of desperate efforts to goose inflation by the European Central Bank (ECB) – and a flat yield curve.
That has squeezed the margin between borrowing and lending rates: although the ECB has pushed its deposit rates below zero, few banks have dared do likewise.
ECB officials argue that their policy has aided banks, because rising bond prices and improved credit quality have offset the crush on margins and cheap money has stimulated lending. Bankers beg to differ.
So far, says Stuart Graham of Autonomous, a research firm, the effects of negative interest rates on banks’ already sagging profitability are hard to pinpoint. But lenders are in for a lot more pain. The degree of tenderness varies from country to country.
Simpler retail banks, relying on deposits for funds and on loans for revenue, notably in Germany and Italy, are most vulnerable (regional banks in Japan, where rates are also negative, are in a similar boat).
Mr Graham reckons that the return on equity of German savings banks will fade from 6.5 per cent to just 2 per cent by 2021. Italian and Spanish banks’ hefty bad debts mean they cannot benefit from the low loan-loss provisions implied by ultra-low rates.
Nevertheless, if blessed by stronger growth and equipped with better business models, banks can withstand negative rates. Swedish banks, notes Mr Graham, returned 11 per cent last year and Swiss cantonal banks managed 9.9 per cent; in some euro-zone countries returns were below 2 per cent.
The Swedes and Swiss depend less on net interest income or deposit funding than do German or Japanese local lenders. According to S&P Global Market Intelligence, Swedish banks boast a cost-income ratio of 46 per cent, against Germany’s 72 per cent and Italy’s 67 per cent.
Some countries have made extensive post-crisis repairs to tattered banking systems. In Spain, where savings banks were bailed out in 2012 and lenders have set aside billions to cover bad debts, non-performing loans have fallen from 13.6 per cent of the total in 2013 to 9.4 per cent.
The number of bank branches has been cut by one-third since 2008. A pickup of GDP growth to 3.2 per cent last year also helped. But profitability remains a worry, in part because Spain’s biggest banks rely more on interest margins and less on fees than the euro-zone average.
Elsewhere, restoration has further to go. In Italy, bankers led by J.P. Morgan are trying to save Monte dei Paschi di Siena, the country’s third-biggest bank and the world’s oldest. The plan involves hiving off €27.7 billion-worth ($31 billion) of bad loans (gross) into a separate entity, and injecting new equity into the cleaned-out bank.
UniCredit, the biggest bank, is reviewing its strategy under a new boss. Atlante, a private fund financed by banks, insurers and others, has taken over two small ailing banks and will also buy bad loans.
Bankers grumble about regulation as well as low interest rates. Italian complaints may be loudest of all. First, whereas Germany, Spain and others gave banks oodles of state money after the crisis, Italy supplied just a drop.
But the economy stagnated and the bad-loan burden grew; meanwhile, European Union rules on state aid were tightened, obliging Italy to rely on private rescues. Second, Italian bankers reckon that a reform of co-operative banks, turning them into joint-stock companies, should have sparked a merger wave.
But they say the ECB’s tardiness in approving the union of Banco Popolare and Banca Popolare di Milano, to which it eventually gave the nod last month, has deterred other potential deals.
And the takeover of four small, troubled banks salvaged by the state last year is reportedly being held up as the ECB insists that the buyer of three of them, UBI Banca, raise €600m in extra capital.
Continuing demands for capital are another general gripe. Few dispute that banks were too thinly capitalised before the crisis. Had today’s definitions been used in 2007, reckons Mr Graham, Deutsche Bank’s ratio of common equity to risk-weighted assets (an important gauge of resilience) would have been just 1.8 per cent.
Now it is 10.8 per cent; regulators want 12.25 per cent by 2019; Deutsche’s own target is 12.5 per cent by 2018. But more changes are coming, which some European banks think too burdensome.
Yet banks protest too much. Between 2007 and 2015, calculates Hyun Song Shin of the Bank for International Settlements, 90 euro-zone banks paid dividends of €223 billion, retaining earnings of just €348 billion.
Had they kept that money, their capital cushions could in theory have been bolstered by 64 per cent. And since stronger banks tend to lend more, Mr Shin adds, profits, earnings and capital would have been even higher.
Doubtless these are hard times for Europe’s banks. But many might have made life easier for themselves.