In recent weeks, euro-zone investors have experienced a sense of disbelief. Could banking turmoil really stay confined to America and Switzerland? On March 24th, as European bank stocks slumped, the disbelief faded. By the end of the day Christine Lagarde, president of the European Central Bank, had commented that Europe’s banks were safe and liquid enough to withstand market scrutiny.
The sell-off started with Deutsche Bank, a German lender that has, over the years, been dogged by trouble. Its credit-default swaps, tradable insurance against defaults on a bank’s debt, jumped to near-record levels. In response, investors dumped the firm’s shares, which fell by 14%. Fear spread. By mid-afternoon the Euro Stoxx 600 banks index, which contains the region’s biggest lenders, had lost 5%. After the collapse of Credit Suisse, which ended in a tie-up with ubs on March 19th, investors wondered if another fateful weekend lay ahead.
How bad do things look for Deutsche Bank? Start with the immediate comparison between it and Credit Suisse. The 300km separating Frankfurt from Zurich is not the only thing that sets the two institutions apart. The Swiss bank was unprofitable and faced enormous legal strife. But what really made Credit Suisse a prime candidate for a lightning-fast bank run was that nearly all its deposits were uninsured.
By contrast, after a prolonged and painful restructuring, Deutsche Bank is profitable. Some 70% of its retail deposits are insured and firms that park cash with it are sticky, too. In 2016, when a mix of poor results, probes and scandals shook the bank, deposits barely budged. Should push come to shove, the lender has plenty of high-quality, liquid assets it could exchange for cash at the European Central Bank. The Credit Suisse scenario, of a self-propelling bank run, seems unlikely.
There are, however, other threats. These include rising interest rates, which were what brought down Silicon Valley Bank (svb). Rate rises are good for banks in the short run, since income from interest increases. Indeed, Europe’s banks have posted bumper profits. Deutsche Bank’s net profits of €5.7bn ($6.1bn) in 2022 were double those of the year before.
But as the cost of funding increases, banks’ assets, such as long-term bonds, lose value. Luckily for Deutsche Bank, European regulators have demanded lenders hedge this risk. Last year the European Central Bank reported that net duration risk—how much banks lose if rates rise—was a low share of local banks’ regulatory capital. According to Autonomous Research, a firm of analysts, even if Deutsche Bank’s risk is on the high end, it does not pose much danger.
Another worry is about fallout from svb affecting Deutsche Bank’s American portfolio. Commercial property looks set to suffer as mid-sized lenders tighten the credit taps. Deutsche Bank owns nearly $17bn of such assets, ranking it among the most exposed European banks. But the lender’s commercial-property portfolio, which is well diversified, carries limited debt and is equivalent to just 35% of its high-quality capital. Deutsche Bank may have a large book of derivatives, which are dangerous instruments in volatile markets, but these are traded openly and often enough to make it unlikely they are severely mispriced.
Perhaps the biggest cause for concern is Deutsche Bank’s cost of funding, which may rise in the wake of Credit Suisse’s demise. Although Deutsche Bank has more capital than Europe’s tight rules require, investors in Additional-Tier 1 (at1) bonds, who were wiped out in the ubs takeover of Credit Suisse, will now demand higher premiums. And at1s count for a higher share of Deutsche Bank’s risk-weighted assets than at other banks.
Yet the main reason for the sell-off is not a dreaded skeleton in Deutsche Bank’s closet. Instead, it is the sort of “uncertainty that produces overreactions to weak signals”, says Corrado Passera, a European-banking veteran. The market for Deutsche Bank’s credit-default swaps is illiquid, meaning a few trades can move prices fast. After a weekend that saw investors lose their shirts, traders will have wanted to sell anything remotely risky in order to enjoy a few days’ peace. ■
