by Mario Lettieri and Paolo Raimondi * –
As Deutsche Bank (DB) is Germany’s largest bank, understanding why its recent serious problems is also in our interest. Its 2022 balance sheet was enthusiastic: a profit of 5.6 billion euros, the best result in 15 years. The record profit had been in 2007 of 8.7 billion. But the 2008 global crisis had left deep wounds to heal and losses for five consecutive years up to 2019.
Since 2019, the management claimed to have tried to carry out a profound renewal of the group, reducing the activities of its investment banking, i.e. the sector that seeks high profits with the riskiest speculations. Therefore, fewer “exotic” businesses and fewer hedge fund clients. The idea, at least on paper, was to go back to being a more European bank and “for entrepreneurs”. The DB has also continued the integration of the Postbank, which, like our BancoPosta, has a very high number of customers, families and small-medium sized businesses.
The reversal in interest rates has boosted the bank’s assets to €27.2 billion, an increase of more than 7% compared to 2021. Despite inflation and economic slowdowns, there were no fears of insolvencies on loans granted. In 2022, against this risk, the bank had set aside as much as 1.2 billion, more than double compared to 2021.
Everything was rosy in 2022 and it should have been even more rosy in 2023. The best ratings from the rating agencies after their downgrades in previous years had also contributed to the success.
However, not all voices agreed so much. The bank’s internal supervisory board complained that the planned improvements and sustainability objectives had not been fully achieved, so it decided to reduce the million-dollar bonuses for managers by 5%. In particular, in February he had raised serious concerns about the management of derivatives.
The history of the bank matters and must never be forgotten. Last April, German police visited its Frankfurt headquarters during a money laundering investigation. In the past years, his name had appeared in almost all investigations into various international financial frauds and embezzlements. In 2016, remember, he had paid a $7.2 billion fine for fraudulent transactions with mortgage-related derivatives, in exchange for closing the investigation.
Something was wrong in DB if the cost of its credit default swaps, the derivative securities that cover the risk of bankruptcy, increased significantly. Its shares have lost about a quarter in value since the beginning of the year.
It is true that the whole European and international banking system is under pressure but Deutsche Bank seems to be affected more than the other banks. It cannot be compared to Credit Suisse, saved from bankruptcy, except for the fact that they are two of the largest European banks considered systemic.
ECB President Christine Lagarde and all European governments are competing in affirming the solidity of the European banking system, “aided by the banking regulatory reforms initiated in the wake of the global financial crisis.” Perhaps these reforms are lacking.
DB’s 2022 financial statements reveal one of these serious shortcomings: the total notional value of financial derivatives is 42,500 billion euros, almost all of the very risky type, over the counter (OTC). An increase of 6% in one year. They are a little less than the peak of 48 trillion in 2018, but the situation has not really changed. Almost 80% are derivatives entered into on interest rate trends.
Not only the DB but all the too big to fail banks are involved in these speculative operations on interest rates. It is precisely the volatile behavior of central banks that makes them highly “flammable”.
Even if one admits that DB has tried to reduce its exposure to riskier OTC derivatives, it must be recognized that it is a difficult process on its own. Just as it is for an addict who would like to free himself from addiction, but continues to frequent drug dealing environments.
The problem of financial speculation is global, but if true reform is not tackled at an international level, banking crises will become more frequent and intense. We expect the European authorities and governments to make the first move: eliminate speculation to defend the real interests of citizens, starting with economic stability and social welfare.
