Oct. 2, 2016 2:47 p.m. ET
It’s tempting to see the current turmoil surrounding Deutsche Bank as the latest installment of Europe’s interminable banking crisis. Tempting—but wrong.
The steep slide in the German banking giant’s share price in recent weeks has little in common with previous episodes of banking stress. It wasn’t triggered by fears of a wave of credit losses or a sudden evaporation of liquidity—Deutsche has access to more than €200 billion of central-bank funding at zero cost. Nor was it primarily driven by concerns over capital, even if the latest selloff was sparked by fears that the Justice Department wanted to levy a $14 billion fine on it for pre-crisis misconduct.
What lies at the heart of Deutsche’s troubles is the market’s loss of confidence in its business model: Investors doubt whether the bank can ever earn an economic return on its equity, particularly when the amount of equity it is required to hold is proving a moving target as regulatory demands rise ever higher. In recent years, Deutsche’s returns have been crushed by a combination of tougher regulation, higher capital requirements, negative interest rates, flatter yield curves, less corporate activity, lower asset-management fees and lower trading income.
These aren’t symptoms of European malaise but a wider crisis of globalization, which has hit international banks particularly hard. The lesson of the global financial crisis was that hyperglobalized finance hadn’t so much spread risk as created new channels for contagion, leaving taxpayers on the hook for bank failures and economies vulnerable to sudden stops in funding.
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Long before antiglobalization became a fashionable political cause, financial policy makers had already vowed to “take back control,” forcing banks to insure themselves against future crises by carrying far-higher levels of capital and by ringfencing operations. The resulting fragmentation of the financial industry has piled costs on banks, including Deutsche, which has been obliged to put its giant U.S. operations in a ringfenced U.S. subsidiary. Brexit is likely to lead to further fragmentation.
At the same time, banks have seen their revenues crushed by a double blow of stagnating global trade and reduced deal making, which has reduced the global investment-banking fee pool, and a new world of negative interest rates and flat yield curves. Both these trends also reflect challenges with globalization.
Ultralow rates are a reflection of the inability of central banks to generate domestic inflation in a globalized economy in which wage costs and interest rates are no longer set by forces at home. Deutsche’s business model is particularly vulnerable since it is obliged to invest much of its large German deposit surplus in German government bonds. At the same time, low inflation and stagnant wages are creating a political climate in which firms are reluctant to invest and governments reluctant to pursue productivity-enhancing reforms.
Deutsche has also paid a high price for its global ambitions. From its roots in German corporate lending, it set out to challenge the U.S. investment-banking industry leaders. That meant building a presence in the U.S. market, the world’s largest investment-banking fee pool, where it tried to buy market share through aggressive pricing, acquiring a reputation among its rivals as the “dumb money” in the market.
Nor did Deutsche abandon its ambitions after the global financial crisis, seeing instead an opportunity in the misfortunes of its rivals to gain market share. As the regulatory onslaught against investment banking gathered pace, Deutsche was one of the last to see the writing on the wall.
Of course, policy makers could ease the immediate pressures on Deutsche at any time, simply by setting the fines for its past misconduct at levels that won’t put the bank’s viability at risk and by providing clarity on its long-term regulatory capital targets. Deutsche could also help itself by cutting its cost base more aggressively.
But the questions over its business model will likely persist. After all, its domestic rival Commerzbank last week announced a plan to cut 20% of its workforce, which it hopes will enable it to deliver a return on equity of just 6% by 2020.
Faced with persistent low returns, the pressure will be on Deutsche and other banks to continue to shrink their balance sheets and pull out of low-margin businesses. But this is easier said than done: Banks can’t simply walk away from assets that may take years to run off, forcing them to carry high costs that will further depress returns. Nor is consolidation a solution to the industry’s over-capacity problems: New regulatory “barriers to exit” in the form of new capital surcharges to discourage banks from getting too big. Bank boards are, in any case, wary of acquisitions, given the potential hidden risks from past misconduct or poor lending.
Besides, as the industry shrinks, the risk is that the supply of credit will shrink, financing costs will rise and banks will charge higher fees, merely adding to the pressures on the global economy—and so the crisis of globalization feeds on itself.
Tags: Justice Department, Deutsche Bank, German government bonds, banking crisis, Investors doubt the bank can earn an economic return on its equity, Crisis of Globalization Lies Behind Deutsche Bank’s Troubles, EU Market, Ultralow rates, inability of central banks to generate domestic inflation in a globalized economy, globalized economy, Deutsche’s business model, reluctant to pursue productivity-enhancing reforms., regulatory onslaught against investment banking