To Bail In Or To Bail Out?

Europe’s most systemically important bank, Deutsche Bank has been in the news lately and if hearing phrases like “too big too fail” or “derivative trades” gives you flashbacks of the Lehman Brothers or the global financial crisis of 2008 then you are not alone. However, it’s not that cut and dry. Here are some facts:  Deutsche Bank is said to be the World’s largest derivatives trader. Derivatives happen to be one of three main categories of financial instruments, the other two being Debts (bonds, mortgages etc. and Stocks (equities, shares, etc.). Investopedia defines a financial derivative as

“a security with a price that is dependent upon or derived from one or more underlying assets. The derivative itself is a contract between two or more parties based upon the asset or assets. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes.”

The DB is said to have an exposure of close $47 trillion worth of derivates on its books. This amount is alarming; mainly because if derivatives are really just “bets” on the movement of assorted prices, then this exposure would be the total amount the DB would have to pay if it lost all it’s “bets.”

It’s important to note that DB is not Europe’s only problem child. Europe is facing an issue with the emergence of negative interest rates, leading bond yields to fall as prices rise.  Also, unlike it’s North American counter parts many banks in Europe have been late to restructure in the wake of the 2008-2009 financial crisis. Banks in Italy are also reported to being saddled with billions of bad loans and are a potential threat to the Euro-zone economy. On top of all this, the fines that are being imposed on many European banks including the DB, related to the fallout of selling dicey mortgage-related securities, may cripple the capital cushions of these banks.

 

DB Investors became worried after news hit that the United States department of Justice wanted the Bank to cough up $14 billion to settle misconduct charges from the 2008-2009 financial crisis. As a result the bank is reported to have lost half its market value this year affecting their profits. In June of this year, the International Monetary Fund reportedly referred to the DB as the “single source of risk in the global banking system”

Leading to the speculation that the DB was in need of a Bail out or a Bail-in. A Bail out would mean a rescue by external parties including the government using tax payer money while a Bail-in would mean that the DB creditors and depositors take a loss on their holdings. Both options have their own unique consequences. The most recent news to come out was that CEO John Cryan had failed to secure a deal with the US to lower the $14 billion fine. There are other international players that are said to be in a position to bail out Germany. Most recently China has been in the forefront. Financially, it would make great sense for the Chinese to bail out DB as they are reported to have roughly $600 billion in Euro Foreign reserves earning negative interest. An added bonus is that China has been trying to enter the European Market and this looks like Deutsche Bank’s best if not only feasible option. However, it is important to note that a Chinese bail out does not mean we avoid an upset in the global financial markets; it just happens to be a better option than what’s on the table now.

 

Politically, this crisis has weakened Angela Merkel’s leadership both at home and her European Leadership abroad, impacting her ability to secure a fourth term during next September’s elections.  At the center of Merkel’s political problems is her mishandling of the DB crisis. Time and again she refused to bail out DB. Her decisions will not only have a negative impact of Germany economic performance but it ultimately it will impede on the euro-zone’s efforts to move towards integration.

So what does this mean for the Canadian economy? Well, the DB is linked to insurance companies and other publicly traded banks therefore if the situation deteriorates it will most likely trigger a chain reaction that would lead to a global banking crisis. At this time Canada is not among the four countries that are directly exposed to a failure of the DB.

By,

Kaha Haji-Mohamed

Works Cited

Picture titled, "deutsche bank", taken by samchills on March 24, 2005, obtained through Creative Commons (https://flic.kr/p/a6A9HC)