It’s been around eight years since the great financial crisis first erupted. However, rather than celebrating how much the world has changed since, financial markets are currently being stalked by another demon in the form of Deutsche Bank.
This week, concerns about the health of Deutsche have stalked financial markets. Shares in the German lender have plunged to a post-crisis low, and there’s been talk of state aid for the group. The bank’s management and German policymakers have tried to reassure investors and markets regarding the health of the group, but it would appear that traders just aren’t willing to buy their ‘nothing to see here’ rhetoric.
Fine troubles
Deutsche’s troubles re-emerged this month after the US Department of Justice slapped the bank with a $14bn litigation settlement for past mistakes. After recent declines, the bank’s market capitalisation is approaching $16bn. That’s not the worst part. According to some estimates, Deutsche has €42trn of gross derivative exposure, three times more than the GDP of the European Union. If Deutsche’s troubles extend into this derivatives book, the systematic damage could be unprecedented as it would leave the other leading European banks such as Barclays (LSE: BARC) with a large hole in their balance sheets.
The Barclays Group controls one of the largest investment banks trading out of the UK after acquiring the American assets of failed Lehman Brothers.
Running into problems
Just like its German, peer Barclays is also struggling under the weight of massive fines from regulators, a high cost base, sluggish performance at its trading arm and a lack of confidence among investors.
Barclays only has a slightly better capital position than Deutsche. The bank’s common equity Tier 1 capital ratio came in at just under 11.5% at the end of the first half. Deutsche’s Tier one ratio is under 11%.
One area where Barclays is making slightly better progress than its German peer is with disposals. Alongside first half results, the bank reported a £1.9bn loss from its non-core division as those assets that had been deemed to be surplus to requirements are hived off.
Nonetheless, as Barclay’s takes one step forward, it’s being forced to take two steps back. Record low and even negative interest rates are making it almost impossible for banks to generate any income from their reserves. Meanwhile, a benign economic environment is reducing the demand for lending. Traditionally lucrative lines of business such as share dealing, fixed income trading, and investment banking are being squeezed as the market for these industries become more fragmented and commoditised.
As sales come under pressure, costs are creeping higher. At the half-year, Barclays’ staff costs were £4.6bn, up from £4.2bn. Management expects so-called ring-fencing laws, which banks must adopt by 2019, will cost the group £1bn and rating agency Standard and Poor’s estimates that the UK’s four biggest banks will have to pay out a further £19.5bn in fines, compensation, and legal expenses by the end of 2017.
The bottom line
Overall, for the time being, Deutsche’s problems may be the focus of the financial world but Barclays is facing similar pressures and a collapse in Germany could quickly spread to the UK.
