DEUTSCHE BANK IS GERMANY’S biggest bank by far. The bank’s assets are valued at about €1.8tn (£1.5tn), which is half the size of the German economy, Europe’s most successful economy. Yet it is in trouble. Like most other banks in the period leading up to the global financial crisis in 2008, it engaged in selling bonds backed up by American home mortgages to its clients. Of course, it told its clients that these bonds were as ‘safe as houses’ (sic) and there was nothing to worry about. As we know, it turned out the bonds were ‘toxic’ and worth little once the American housing market collapsed. Since then, the American justice authorities have not arrested or convicted any executive of the big banks for ‘mis-selling’ or defrauding their clients. Instead they have gone for big fines on bank shareholders.
Now it’s Deutsche’s turn. It has received a demand for an eye-watering $14bn in fines. As a result Deutsche is in crisis. The value of its shares is only $19bn, reflecting expected future profitability - and falling. If it were forced to pay this fine, its share capital value would fall well below the minimum required by the global banking regulators to operate as a bank. The fear that this could bring Deutsche down has led to various clients, hedge funds, to withdraw their accounts from the bank. Deutsche Bank CEO John Cryan complained: “In banking, trust is the basis of everything. There are currently some forces at play in the market that want to weaken this trust in us.” For good reason, it seems.
Deutsche’s situation is instructive for the whole global banking system. The big banks have not been engaged in providing a public service for householders and businesses in holding deposits and providing credit for investment and production. Instead the vast bulk of their business is in so-called ‘investment banking’, namely speculating with their own and clients’ money on the stock and bond markets and inventing ‘derivatives’ to sell to customers and other banks to ‘diversify’ risk. This eventually led to the global financial crash.
Deutsche’s investment banking arm is its speculative part and it generates 85% of its revenue. It has suffered a string of scandals. In addition to the mortgage bond mis-selling, six current and former managers of Deutsche Bank have been charged for colluding to falsify the accounts of Italy’s third biggest and bankrupt bank, Monte Paschi. Monte Paschi used deals with Deutsche to hide losses, leading to a misrepresentation of its accounts between 2008 and 2012.
The other side of the equation is that, since the global financial crash, the big banks have been told to increase their capital backing (more money from shareholders to cover any potential losses). At the same time, central banks have cut interest rates to zero or below. That means banks cannot make enough profit on charging interest to clients. So they engage in more speculation.
This problem is rife in European banks, in particular. The Italian economy has been contracting, not recovering, since the end of the Great Recession. Italy’s banks have run up €200bn in bad loans to Italian companies and now require a massive injection of capital to survive. Europe’s banks have the highest ratio of ‘non-performing loans’ of the all banking regions of the world, with Italian banks holding one third of these bad debts - and German banks have plenty too.
Deutsche’s business model is particularly vulnerable. Back last June, the International Monetary Fund did a report on German banks and concluded that: “Deutsche Bank appears to be the most important net contributor to systemic risks in the global banking system.” In other words, because it is so big, if it goes down it will take many other banks with it. Yet in July, the European Central Bank, in its bank ‘stress tests’, reckoned that Deutsche Bank was fine.
Deutsche Bank probably won’t go bust. It will reach agreement with the Americans to reduce the fine (to $5bn?). The bank still has huge deposits and the backing of the ECB for funding. The bank’s businesses are being sold off and the shareholders will be asked for more cash. Also, if necessary, the German government will use taxpayers’ money to bail out the bank. This would be a sick joke given that the German government has opposed such a bailout for the already stricken Italian banks.
The world economic slowdown and legacy of huge bad debts from the global financial crash weighs down on a banking system that continues to speculate in what Marx once called ‘fictitious capital’, assets with no relation to real value in productive sectors. It is a business model designed to fail.
- Michael Roberts blogs here.
works in the City of London as an economist.