Deutsche Bank's risk hedging instruments, or so-called CDSs, have doubled in value. What could this mean for the European banking system and is there anything to fear?
A short history of Deutsche Bank's problems
Deutsche Bank is a German global bank that offers a wide range of financial products and services, such as corporate and investment banking, private banking, insurance, as well as securities trading and asset management.
Deutsche Bank has had many problems in the past. In 2016, it was fined $14 billion by US authorities for selling poor-quality mortgage products before the 2008 financial crisis. In 2019, it announced a restructuring that involved downsizing and closing some branches to cut costs and improve its financial position.
Deutsche Bank has also been accused of violating money laundering laws, and in 2020. The bank paid a $130 million fine in relation to breaches of corruption and money laundering laws.
What do rising CDS prices mean for Deutsche Bank's situation?
Deutsche Bank's shares have now fallen after last week's credit default swap price spike. This could mean that the probability of the collapse of one of Europe's largest banks is increasing. Derivatives that hedge against a bank's insolvency, so-called credit default swaps (CDS), have doubled in value in just the past two weeks. A CDS is an insurance contract listed on the interbank market that hedges against credit events such as the insolvency, bankruptcy or debt restructuring of a company. The increase in uncertainty appears to have led to a fall of more than 20 per cent in share prices.
However, it should be noted that the CDS values for Deutsche Bank have already been quoted at similar or even higher levels on several occasions because, as we mentioned earlier, the bank has been struggling with recurring problems for a long time. Despite this, the European Central Bank and the German government have come out with a helping hand practically every time. A similar situation occurred with the problems of Switzerland's Credit Suisse, which might be taken over by its largest domestic competitor UBS. Will Deutsche Bank be rescued again?
Today, it seems difficult to determine unequivocally. It should also be borne in mind that CDS are quoted on the illiquid interbank market. This means that only financial institutions have access to this type of instrument, which may influence possible manipulation of their price or not necessarily reflect the real situation of the company.
What is the current financial situation of the company?
Deutsche Bank's asset value is melting year-on-year. Research firm Rebellion Research, examining the level of banks' unrealised losses on securities, highlights that DB is not on the distressed list. The report also discusses Deutsche Bank's performance, noting increasing loan loss provisions in 2022, but positively at the same time looking at a strong Tier 1, or current liabilities coverage ratio. This may mean that we should not face a situation analogous to the one that led to the collapse of US banks. The case of Deutsche Bank may be more akin to Credit Suisse's problems in the cumulative deterioration of customer confidence. This could lead to government intervention to support the bank's liquidity by providing a non-recourse loan.
Source: Conotoxia MT5, DeutschBank, Daily
This scenario seems possible after the liquidity agreement between the six largest central banks signed just on 19 March. Rhys Williams, chief strategist at asset management firm Spouting Rock Asset Management, mentions that protecting the banking system should be the first order of business for regulators, and that at the moment there is a liquidity problem rather than high borrowing costs. He also believes that fear in the banking sector is nevertheless exaggerated.
Grzegorz Dróżdż, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
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