Deutsche Bank’s Regulators Know How It Got So Weak

(Bloomberg Opinion) -- Sometime in the foreseeable future, Deutsche Bank AG is likely to present a big dilemma for the people who oversee the global financial system. To a large extent, it’s a problem of their own creation.

Germany’s largest bank is in terrible shape. A succession of chief executive officers has struggled, and largely failed, to cut costs as fast as revenues have fallen. Yet ineffective financial management may be the least of its difficulties, as authorities around the world investigate its possible role in various money-laundering schemes — including ones related to the Panama Papers and to Danske Bank.

If the probes turn up wrongdoing, that will put government authorities in an unenviable position. On one hand, they’ll have to punish the bank for its transgressions, most likely with fines and possibly other sanctions. On the other, they’ll have to tread carefully, lest their punishment destabilize one of the most systemically important institutions on the planet. It’s a classic case of too big to fail meets too big to jail.

So how did Deutsche Bank get so fragile? Actually, regulators never required it to be otherwise — that is, they let it operate with an extremely thin layer of loss-absorbing capital. After the 2008 crisis, they set the minimum capital level at just 3 percent of total assets, not even enough for many banks to have gotten through the crisis. And in Europe, they expanded the definition of capital to include not just equity from shareholders, but also a type of hybrid bonds known as contingent convertibles, which are supposed to transform into equity in an emergency.

Worse, even as the bank was subjected to a series of reorganizations, its supervisors allowed it to keep giving capital back to shareholders in the form of dividends. Combined with payments on the “CoCo” bonds, these distributions added up to more than 6 billion euros ($6.8 billion) from 2010 through 2018, taking a sizable chunk out of the 26.7 billion euros the bank raised in fresh capital during that period.

Deutsche Bank’s Regulators Know How It Got So Weak
This has left Deutsche Bank in a precarious position. As of September, it had just 4 euros in capital for each 100 euros in assets — and poor prospects of raising more, given its low share price, mounting legal issues and uninspiring profit outlook. A loss of 13.3 billion euros could bring it below the already-meager regulatory minimum.  No wonder German officials are getting worried — and looking for a fix, such as merging Deutsche Bank with longtime rival Commerzbank AG.

The painfully obvious lesson: It’s crazy to let a big, systemically important bank operate with so little capital that it can’t take a hit without freaking out markets. Such institutions should be able to weather a severe crisis and still have the resources to do it again. If they can’t persuade investors to give them what they need, one must ask whether they should exist in their current form.

For the Basel III leverage ratio.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Whitehouse writes editorials on global economics and finance for Bloomberg Opinion. He covered economics for the Wall Street Journal and served as deputy bureau chief in London. He was founding managing editor of Vedomosti, a Russian-language business daily.

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