Deutsche Bank Unexpectedly Found To Have Massive Capital Gap
After the ECB concluded its latest annual stress test, which as expected found no problems with Europe's largest banks instead scapegoating Italy's well-known troubled banks in results that were widely discredited by the market, yesterday in an unexpected outcome, German economic research institute ZEW found that Germany's largest bank, Deutsche Bank, had the highest potential capital shortfall, as much as €19 billion in a study of 51 European banks using U.S. Federal Reserve stress test methods. The capital gap is greater than DB's entire market cap.
Using the Fed's approach, and thus a far more credible approach than that proposed by the ECB, the 51 European banks showed a total capital shortfall of 123 billion euros, with the largest gaps at Deutsche Bank, Societe Generale (13 billion euros) and BNP Paribas (10 billion euros).
"European banks lack sufficient capital to offset the losses expected in the case of another financial crisis," the ZEW said in a statement on Tuesday, cited by Reuters. ZEW Finance Professor Sascha Steffen worked with New York University Stern School of Business and the University of Lausanne researchers to run stress tests used by the Fed in 2016 and the European Banking Authority (EBA) in 2014 to compare capital needs and leverage.
While Societe Generale and BNP have market capitalisations of 26 billion euros and 55 billion euros, respectively, well above the study's theoretical capital gap, Deutsche Bank would find itself in trouble if the ZEW calculation is correct as it has a market capitalisation of less than €17 billion.
Which is why it promptly disagreed with ZEW's calculation. "There is an official EBA stress test that checked the capital backing against very tough and adverse conditions and this showed there was no acute capital need at Deutsche Bank," the bank said in a statement in response to the study.
Deutsche Bank showed a weaker reading in the EBA test than most of its peers, a sign that Germany's biggest lender still has far to go in a revamp it launched last year. Although the EBA gave the banking industry a broadly healthy prognosis in its stress test results published on July 29, it said there was still work to do.
The EBA tests had no pass or fail mark and many observers said they did not remove concerns over capital. This year's EBA stress test was not aimed at uncovering capital gaps, but ZEW's Steffen said the deficiencies revealed by combined stress scenarios could be overcome.
"The USA have drawn their own conclusions and implemented comprehensive measures for the recapitalisation of the American banking sector as early as in 2008," Steffen said."A lack of political will means that this has still not happened in Europe," he added.
Adding insult to injury, Martin Hellwig, director of the Max Planck Institute for Research on Collective Goods, said stress tests carried out by the European Central Bank revealed the Deutsche Bank would be left in a precarious position in the event of another financial crisis, and warned that Germany's biggest bank is teetering on the edge of crisis and they only way to protect it against future shocks is to nationalise it.
While it would probably not go bust in a fresh downturn - he predicted the bank which is crucial to the German economy would face serious equity problems. He said: "Putting it short: for a long and serious crisis there simply wouldn't be enough money."
He said: "Turning banks into community property through public funds is not only possible but also necessary. If a bank is no longer able to help itself, the federal government should take on shares and exercise the related control functions."
He continued: "In Sweden the state stepped in in 1992, filleted out unprofitable divisions and left stable companies. It was a successful, temporary nationalisation. The goal had always been to enable a clean-up and to then get out again." He said nationalisation may not have been part of Germany's plan since the last financial crisis but unusual scenarios sometimes require desperate measures and would be appropriate for banks as such a large part of the economy is entirely dependent on them.
Mr Hellwig said: "I assume that this tool will be used when it comes to an institution where there are fear that a settlement procedure would bring significant system damage." Banks that are "too big to fail" could be saved with tax-euros and the investment might even pay a return for the state.
Another possible effect of state intervention would be the inevitable modernisation that would improve the bank which has seen its retail divisions become barely profitable. Mr Helwigg said: "From the outside, one gets the impression that in the last 20 years the investment bankers controlled the bank and sucked it dry. Nationalisation in an emergency could be a step towards more rationality in the banking world."
Considering DB continues to trade within touching distance of its all time lows, the market appears to be far more in agreement with the ZEW than the ECB, and certainly worries about DB's solvency remain.