Uncle Sam May Tip Deutsche Bank Over the Edge

On September 16, 2016, the US Justice Department threatened Deutsche Bank with a $14 billion fine for bond sales practices from before the 2007 Financial Crisis. Predictably, the share price immediately collapsed 8% and the financial markets went into a tizzy over equity holders losing value. This also rippled into other parts of the banking sector, for example hitting share prices of the Royal Bank of Scotland by 4%. For reference, the total market valuation as of this writing, September 29, 2016, for Deutsche Bank is 16 billion Euros, meaning the penalty the Justice Department is seeking is 88% of the total valuation of the bank and the announcement has wiped out 20% of the market value since the beginning of September.
While the financial markets and media outlets are lamenting the loss of share valuation, there is a major stakeholder in this whole operation that is outright ignored. Because of the practice of fractional reserve banking, Deutsche Bank has managed to maneuver itself into a position where the leverage ratio is 3.5%. What this means is that, effectively, Deutsche Bank only has enough high quality assets to cover 3.5% of their liabilities. From a pure depositor standpoint, the FY2015 Annual Report shows that there are 567 billion Euros deposited in Deutsche Bank accounts but just 97 billion Euros of cash and central bank deposits to cover this. If this announcement were to cause just 18% of the deposits to be withdrawn, this would effectively cripple Deutsche Bank. Depositors aren’t the only risk, either, as hedge funds are also asking the bank to return their assets. Roughly 1.3 trillion Euros of assets is tied up in various loans, derivatives and investments. What this essentially means is that Deutsche Bank has only 97 billion in Euros as cash to cover 1.8 trillion Euros of promises to various entities. To put this in perspective, the entire GDP of Germany is 3.8 trillion Euros. On top of this, those existing revenue-generating assets are insufficient to cover the operating costs of the bank, so the justice Department’s fine creates a financial double-whammy that will almost certainly cause its collapse in the absence of some sort of bailout.

This post was published at Ludwig von Mises Institute on October 15, 2016.