(Bloomberg Opinion) -- The radical restructuring of Deutsche Bank AG unveiled at the start of July will be a monumental task for the lender’s senior managers. The job of the European Central Bank’s finance industry supervisors, who have to make sure the revamp goes smoothly, won’t be easy either.
Deustche’s plan is a last-ditch attempt to make sure the troubled bank avoids more serious problems in the future. The ECB will need to use its regulatory stick and carrot wisely. This means standing by the lender in its sensible efforts to downsize, but being ready to demand more capital if the attempt doesn’t go according to schedule.
Andrea Enria, head of the Single Supervisory Mechanism (the ECB’s banking supervisory body), dodged a bullet in April when Deutsche and its domestic rival Commerzbank AG decided not to merge. The combination would have created a mega-lender that was too big to fail and one that had little credible prospect of shrinking any time soon. The collapse of the talks left Deutsche’s executives with little alternative but to scale down on their own, which was always the best route.
So far the supervisors have been supportive of the bank’s restructuring. Deutsche will target a core capital ratio (CET1) of 12.5%, which is above its minimum level of 11.8% but below the 13.7% in the fist-quarter and a previous full-year target of higher than 13%. This concession means the lender won’t have to raise extra capital on the market, a boon for its shareholders. The message from the ECB seems to be that so long as the bank is willing to address its problems and become less risky, the supervisors will support it.
Such leniency makes sense but it cannot last forever. Deutsche’s strategy involves several uncertain steps, including the creation of a “bad bank” to hold 74 billion euros ($83.2 billion) of risk-weighted assets. This move accompanies the courageous decision to shut down Deutsche’s equity trading and sales business, which became a liability as the lender tried unsuccessfully to compete with Wall Street’s giants. Some of these assets will have to be sold and the central question for supervisors is what price Germany’s largest bank will be able to command. Should it be too low, this might create a capital hole.
This issue is acute because Deutsche will start from a position of weakness in any sale negotiations. Some of the assets are illiquid and there may not be many buyers queuing up for them. Deutsche’s bargaining power will be weakened further because potential purchasers know it’s under pressure to sell.
The unwinding of Deutsche’s equity business could bring to the fore a controversy that has long tormented the SSM. Some – notably the Bank of Italy – have argued that the illiquid assets sitting on the balance sheets of large lenders like Deutsche are a far bigger problem than the ECB has dared acknowledge. The central bank has always insisted supervision has been adequate and that there’s been no special treatment for certain countries or lenders.
Supervisors certainly can’t afford for this restructuring to go wrong. In 2016 the International Monetary Fund singled out Deutsche as “the most important net contributor to systemic risks” to the global financial system. For now the German lender appears to have enough capital and plenty of liquidity, although its profitability has been poor. In the absence of a convincing turnaround, the ECB may face uglier questions in the future, including whether Berlin should be allowed to rescue the bank. While the EU has vowed to ensure that any bank can be wound down safely, this is untested in the case of mega-banks such as Deutsche.
Enria’s legacy at the helm of the SSM will hinge on how well he oversees Deutsche’s reset. For the sake of the EU’s financial stability, one hopes he gets it right.
To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net
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Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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