Shares
of Deutsche Bank and Credit Suisse have been dropped from the
prestigious Stoxx Europe 50 share index. Is European banking in
decline? And if so, what are the factors that led to its current
parlous state?
Remember the
days when bankers were bankers, not "investment bankers,"
and thought of as sober-suited, cautious accountant types,
risk-averse to the point of being thought rather dull and
unimaginative?
Back in
those days, business was still based on long-term relationships, not
just on quarterly results. A handshake was worth as much as a written
contract. In terms of public prestige, senior bankers were on a par
with leading university professors, or the sort of senior physicians
who head up medical clinics. In Germany, during the years of the
Wirtschaftswunder (post-war economic miracle), Deutsche Bank in
particular was a deeply respected, almost sacred institution.
But that was
before the events which an article in "Zeit Online," a
leading German news website, called the "inside-job robbery"
of Deutsche Bank. That started 27 years ago, in 1989, as Deutsche's
executive team under then-CEO Alfred Herrhausen bought British
investment bank Morgan Grenfell and made it a unit of Deutsche.
Suddenly, hundreds of financial markets experts and securities
dealers flooded into Germany's biggest private bank. This ended up
fundamentally changing its culture and character.
What had
once been a staid, solid institution that made its money by extending
credit to industrial companies looking to expand their production
lines increasingly became a casino more and more focused on making
bets in the financial markets on its own account.
Ten years
later, in 1999, Deutsche Bank also bought up the big American
investment bank Bankers Trust. As a result, Deutsche temporarily
achieved a new status as the largest bank in the world, measured by
the size of its balance sheet. More importantly, the takeover of
Bankers Trust completed the transformation of Deutsche. The
investment bankers dominated the fused entity.
Bank
robbery from inside
In contrast
to the bank's directors, Deutsche's investment bankers weren't
legally liable for their deals. They took - and still take - far
higher risks than the Deutsche Bank of the pre-Morgan Grenfell,
pre-Bankers Trust days, and they rake in huge bonuses - estimated to
have amounted to a total of 40 to 50 billion euros ($44 to $55
billion) within a span of just 15 years.
That's
despite the fact that Deutsche's investment banking arm may not have
actually booked any profits, on a net basis, over that time frame. By
the end of the period, Deutsche had dropped from number one to
somewhere in the 40s in terms of balance-sheet size. Its share price
crashed by two-thirds within the past year, from 33 euros a share to
11, and valuable, long-held shareholdings of major industrial
companies were sold in an effort to shore up the bottom line. Those
measures were ultimately the price Deutsche paid for the 40 or 50
billion euros in bonus payouts. That's what critics mean by "bank
robbery from the inside."
The
investment bankers changed the corporate culture of Frankfurt's
biggest banking house into one that seemed to scorn ethical and legal
norms. Worldwide, more than 7,000 lawsuits are underway against
Deutsche, alleging a long list of financial crimes, including
large-scale money laundering, interest rate manipulation, and tax
evasion. Deutsche presently has 5.4 billion euros set aside in a
special fund to pay for litigation costs. Last year, fines,
settlements and litigation costs weighed on the bank's bottom line to
such an extent that it reported a record loss of 6.8 billion euros.
Provisional
nadir
The low
point in the bank's reputation - to date, at any rate - came this
spring, when CEO John Cryan and CFO Marcus Schenck felt compelled to
reassure investors that Deutsche would continue to be able to pay
interest on its bonds, now seen as high-risk. When a corporate CEO
comes out saying that sort of thing, it's often because his company
is at the brink of insolvency.
Even if that
appears not to be the case with Deutsche, it's not a reassuring
signal. Investors such as pension funds, which are mandated to put
their money into safe, long-term investments, have been pulling their
money out of Deutsche Bank shares. Moody's, the US-based ratings
agency, has adjusted Deutsche's rating accordingly; it's now just two
notches above "junk" status. That, in turn, is driving up
the bank's refinancing costs.
Meanwhile,
things don't seem to be going much better for other European banks.
On the Tuesday afternoon a couple of business days after the European
Banking Authority's stress-test results of the 51 biggest European
banks were released, bank shares all over Europe took a dive. Italy's
Unicredit, which owns the German bank Hypo-Vereinsbank as a
subsidiary, lost 7.2 percent, followed by Spain's Santander, down 5.3
percent, and BBVA, down 4.9 percent. The Netherlands' ING Group,
parent of Germany's ING Diba bank, lost 4.6 percent.
The long
descent
The balance
sheets of many European banks are still weighed down from the fallout
of the global financial crisis of 2007-8. Hundreds of billions of
euros in nonperforming loans are still on their books. The most
recent stress-tests show that some big banks - including Germany's
two biggest private banks, Deutsche Bank and Commerzbank - still have
a rather thin core capital ratio, the cushion of paid-in
shareholders' money and retained earnings that's meant to absorb any
losses during a downturn. And all the banks are suffering from a
sustained reduction in profitability resulting from very low interest
rates, which are now all the more likely to stay low in the wake of
Brexit.
The
weakening of the big European banks is now making itself evident in
one of the continent's most important stock indices, the Stoxx Europe
50. Deutsche Bank and the Swiss giant Credit Suisse were dropped from
the Europe Stoxx50 index, which includes Europe's most important
companies, as of today. If the two banks were football teams, this
would be like dropping from the Premier League down into the second
division.
The future
doesn't look particularly rosy. Thomas Mayer, formerly chief
economist of Deutsche Bank and today a professor at the University of
Witten-Herdeke, a year ago prophesied the "downfall of the
traditional banks." His prognosis suggested that their business
model could become obsolete as a result of several developments:
technical developments in finance, or "fintech," allowing
new players to enter the market, more stringent new regulations, and
the near-zero interest rate policy imposed by central banks will
combine to squeeze banks' margins.
Future
dangers
Central
banks' low-interest rate policy, Mayer argues, will hit profit
margins of banks in the traditional business of granting credit to
borrowers, "and the longer the low-interest-rate phase lasts,
the more will banks have to give up on this core business."
Increasing
government regulation tends to squeeze margins, according to Mayer,
who has argued that "the supplemental equity capital
requirements for systemically important banks, and the obligation to
be able to wind up a bank that enters insolvency without any recourse
to taxpayers' money, will make the business model of global universal
banks obsolete."
But the
banks' biggest enemy, Mayer says, is technological progress - because
it could lead to banks' losing their core payments and
credit-brokerage businesses to 'fintech' companies. Payments "could
in future increasingly be made via novel electronic payments systems,
in which information technology companies have technical advantages."
Classic
credit brokerage activities could also be threatened by new
competitors, Mayer warns: "The rise of crowd funding shows that
social enterprises can bring together savers and investors with
borrowers."
The
traditional banks are responding, however, by monitoring the fintech
startups closely and in some cases teaming up with them or investing
in them.
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