Why Deutsche Bank Is No Lehman Brothers

Deutsche Bank
A statue next to the logo of Germany's Deutsche Bank, Frankfurt, Germany, January 26. The bank is facing a tough time with investors. Kai Pfaffenbach/Reuters

In Deutsche Bank (DB), Europe has a bank that was once the biggest in the world according to the size of its balance sheet. A source of pride for many, DB is also an institution that has bankrolled a significant degree of European development over recent decades. However, just as the eurozone is finding itself fighting one crisis after another, we are seeing questions asked of a firm that was historically a beacon for European corporate strength. With investors in the dark over the future of the bank, perhaps the bigger question is what this will mean for Europe and banking as a whole.

The decision from the U.S. Department of Justice to fine DB $14 billion has led to widespread panic among investors, dragging shares over 18 percent lower in the space of two weeks. However, this crisis is by no means the beginning of DB's decline, with its shares having fallen 91 percent since the 2007 peak. The firm has never been the same. It is not alone in this, with the wider Euro Stoxx Banks index losing 44 percent in the past 17 months.

Back in June, the IMF cited the bank as the greatest contributor to systemic risk amongst the world's biggest lenders. This sent shockwaves through the markets and dented one of the most important things in banking; confidence. Without the confidence that a bank will still be there in a year's time, where is the incentive to utilise their services? The withdrawal of funds by institutions and hedge funds is yet another body blow, which will certainly make many other investors think about whether they want to follow suit. European confidence is already at a low and the argument goes that if we see DB in the dock, we could see a greater unwillingness to trust institutions and in turn avoid taking out loans to fund investing.

European banking, much like its US counterpart, has been suffering under the weight of rock bottom interest rates with no end in sight. The core role of a bank is to lend money to businesses and individuals, yet in a climate of lowering costs amongst the less profitable business units, could we see banks give up on the role of lender?

The fact is that European banks have been in decline and the most obvious route to profitability is cost cutting. Deutsche has been cutting costs for years, offloading and restructuring to squeeze greater profitability out of its operations. However, the time has come for the bank to begin downsizing, highlighted by the decision to sell its Abbey Life business for €1 billion ($1.1 billion). Perhaps this is the beginning of a consolidation, where banks focus on their core and most profitable business units at the detriment of their less crucial operations.

This is no Lehman Brothers, for there are a number of options available to Deutsche, be it equity issuance, further sales, withdrawing bonus offers, or letting the German government take a stake in the firm.

However, what is certain is that whatever the fine, we will see it paid and the sooner these negotiations occur, the better as we need to restore confidence as soon as possible. Angela Merkel may be disillusioned with the bailouts that have been a feature of her tenure, yet this is one of her own and there is no way she will let Germany's biggest bank fail given the implications it would have for businesses and individuals.

European banks are not about to collapse, yet some form of diversification could make sense as each firm focuses on their own strengths. The problem is that while these fines will be paid in time, they are also detrimental to bank balance sheets, with the capital buffers likely to suffer.

Joshua Mahony is a Market Analyst at IG