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Q&A: Will Deutsche Bank become the next Lehman?

By on September 30, 2016

 In this Dec. 10, 2015 file photo the headquarters of Deutsche Bank is photographed in Frankfurt, Germany. (AP Photo/Michael Probst, file)

In this Dec. 10, 2015 file photo the headquarters of Deutsche Bank is photographed in Frankfurt, Germany. (AP Photo/Michael Probst, file)

FRANKFURT, Germany — Germany’s biggest bank is looking shaky and some investors fear it could collapse and endanger the wider financial system.

Some even wonder whether it might become the next Lehman Brothers, the U.S. bank whose failure heralded the worst of the global financial crisis in 2008.

Experts warn against drawing such quick conclusions. Deutsche Bank’s shares are down 51 percent so far this year and it’s negotiating a multibillion fine in the U.S. that it could have trouble paying.

But it’s exactly because it is so big and important that it is unlikely to be allowed to simply fail, the way U.S. authorities did with Lehman.

Here are some questions and answers about the bank and what it might mean for the rest of the world.



The recent turmoil was triggered by a demand by U.S. authorities that Deutsche Bank pay $14 billion to settle an investigation in mortgage-backed securities, the investments that turned out to be duds and helped trigger the global financial crisis. That sum is about the same as Deutsche Bank’s entire market value as of Friday.

It’s unlikely the bank would pay the full amount — industry peer Goldman Sachs paid $5 billion in a similar investigation. But the fact that it could get hit with a big bill increased the possibility that it may have to tap investors to raise the cash. That would dilute shareholders’ stakes and send shares down even farther.



No, Deutsche Bank also has more fundamental problems.

It is loaded with risky financial trades called derivatives and has struggled for years to turn its business around, particularly its investment banking unit. Before the financial crisis of 2007-2008, it earned much of its money from investment banking. New regulations have pushed banks to hold larger financial buffers and reduce their risky investments. That has made investment banking less profitable. And compliance with all the rules has imposed costs as well.

Like other European banks, its profit margins have been squeezed by record low benchmark interest rates. Low rates reduce the difference at which a bank can borrow money and lend it out.

The International Monetary Fund said in June that Deutsche Bank was the biggest source of systemic risk among the globe’s big financial institutions.



It’s too soon to tell.

One of the things that unnerved investors this week is that the German government has refused to say it would rescue the bank, if needed. But that’s likely because there’s a general election next year in Germany and politicians don’t want to be seen promising taxpayer money to save a bank after spending billions during the financial crisis.

If push comes to shove, experts say, the German government would be under pressure to step in to help. Deutsche Bank is the country’s biggest financial group and has links to many other banks. As such, it is considered systemically important — its failure could conceivably endanger the stability of the European or even global financial system.

Yet new European rules on bank bailouts could limit the government’s choices and expose investors to losses. The rules, which went into effect Jan. 1, are intended to protect taxpayers from failing banks. In some circumstances they require shareholders and creditors to take losses before a bank can turn to taxpayers.



That’s the big question, but analysts say probably not.

Lehman Brothers was, like Deutsche Bank and other major financial groups, closely connected to other banks. But Lehman’s finances were, by some accounts, far shakier. After Lehman imploded, inquiries showed that the company used accounting tricks to mask $50 billion in debt, making it look like it was in better shape than it really was.

Deutsche Bank has passed a “stress test” this year that has required it to open up its books to regulators. It has more reserves it can readily tap — over 200 billion euros ($224 billion) — whereas Lehman had trouble paying back customers who wanted their money back.

Also, the European Central Bank can make available big, ultra-cheap, short-term loans for banks if the system as a whole gets into trouble.



Burned by the experience of the financial crisis, it seems investors may be faster to respond to perceived dangers. “In banking, perception is everything, and in times of stress investors tend to shoot first and ask questions later,” said Michael Hewson, chief market analyst at CMC Markets.

At the very least, it looks like Deutsche Bank will have to raise capital, and that tends to hurt the share price. The bank has tried to bring in money this week by selling a subsidiary for 1 billion euros ($1.12 billion). But analysts say that ultimately it will likely have to tap shareholders for cash. Others have suggested it merge with another weak German group, Commerzbank, which this week announced it was cutting thousands of jobs to save on costs.

More broadly, Deutsche Bank’s problem highlights how weak many European financial groups still are. Unlike in the U.S., where banks were made to restructure aggressively in the wake of the financial crisis, European banks have been slow to clear out soured investments from their books and to readjust their business models.

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