First Silicon Valley Bank, then Credit Suisse, now Deutsche Bank? Shares in Germany’s biggest lender fell by 14% at one point during Friday’s trading session before rebounding later in the day and trimming losses to around 3%. With the bank losing a fifth of its value since the beginning of March, its troubles set up a nervy atmosphere heading into this weekend after both SVB and Credit Suisse disappeared earlier this month after turbulent Friday trading. Some observers have pointed to a sudden surge in the cost of insuring Deutsche Bank’s debt against a possible default as a reason for the plunge, but most onlookers say the dip may be best explained by a pervading sense of fear in the industry. For its part, Citibank fears animal spirits at work.
“We view this as an irrational market,” Citibank analysts led by Andrew Coombs, director of equity research for European banks, wrote in a Friday note. Last week's downfall of Switzerland’s Credit Suisse and its subsequent takeover by domestic rival UBS in a deal brokered by the government, following the second-biggest ever U.S. banking failure in the form of SVB, has left European banks on red alert over whether banking contagion will continue spreading while exacerbating a climate of fear that could be much ado about nothing.
Citi pinpointed exactly this kind of self-feeding public fear in its note. “[T]he risk is if there is a knock-on impact from various media headlines on depositors psychologically, regardless of whether the initial reasoning behind this was correct or not,” the analysts wrote. They echoed the Nobel-winning work of economists Douglas Diamond and Philip Dybvig, about how bank runs are self-fulfilling phenomena.
This Friday, a surge in the value of Deutsche Bank’s credit default swaps, the cost of insuring asset-holders against a default, coincided with the sell-off, bringing the company’s shares to their lowest point in five months. Ominously, the value of Credit Suisse’s credit default swaps also surged in the days before it failed.
But Credit Suisse was not only marred by a series of scandals and poor management long before higher interest rates began cooling economic activity, it had issues right up to the end. On March 14, days before its stock started tanking, Credit Suisse responded to a prompt from U.S. regulators about its financial reporting that its accountant had found “material weaknesses.” It added that its statements for 2022 and 2021 “fairly present[ed]” its financial condition, but stopped short of expressing full confidence in them.
Deutsche Bank is another matter, with Citi analysts saying its fundamentals are robust, given current banking woes. The bank has been profitable for 10 consecutive quarters, while Citi also cited its strong liquidity and capital flows. It's not free from scandal, though.
As recently as four years ago, Deutsche Bank’s stock hit a record low as it weathered a storm of controversies, including accusations of laundering Russian money, violating U.S. sanctions, and spying on journalists and shareholders the bank considered threatening. But Christian Sewing, its CEO since 2018, has successfully slashed unnecessary costs and improved the bank’s capital flows, boosted by an investment banking boom during the pandemic.
A Friday effect?While progress at Deutsche Bank may be slowing due to its ongoing need to cut costs amid higher interest rates, the Financial Times’ Alphaville blog echoed Citi’s findings that it was fundamentally sound and suggested this was a modern twist on the “Friday Effect,” where bad news is disclosed at the end of the workweek, in hopes that it draws less attention. But in this climate, Deutsche Bank’s apparently minimal bad news on Friday, that it had bought back a tier 2 bond that was trading under par, freaked out the market instead.
In addition to the multiple bank failures this month, investors have not been soothed by central banks’ willingness to continue raising interest rates to reduce inflation in both the U.S. and Europe. The Federal Reserve approved a ninth consecutive rate hike earlier this week, while the European Central Bank announced a larger increase.
Critics of further monetary tightening on both sides of the Atlantic have slammed central banks for their willingness to risk a financial crisis in their bid to reduce inflation, although officials in both the U.S. and Europe have said their respective banking systems are sound and pledged to provide support to troubled banks if needed.
European officials tried to soothe nerves on Friday, with German Chancellor Olaf Scholz telling reporters: “Deutsche Bank has fundamentally modernized and reorganized its business model. It is a very profitable bank, and there is no reason for concern.”
It may just be another example of how SVB’s collapse earlier this month has spooked investors worldwide, and a sign that the extent of the damage is still unclear.
“The Silicon Valley Bank problem brought more attention on banks,” Larry McDonald, founder of the investment newsletter “The Bear Traps Report,” told CNBC Friday. “Banks like Credit Suisse and Deutsche Bank that have been horribly, horribly managed for decades … all of a sudden, investors around the planet, focus on that.”
This story was originally featured on Fortune.com
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