Deutsche Bank Loss Creates Worldwide Ripples

When Deutsche Bank, Germany’s biggest bank and one of the biggest banks in the world, reported its first annual loss since it was cobbled back together after World War II, the reverberations were felt globally. Global banks are now so interlinked through credit swaps and other instruments that a loss anywhere along the chain can cause problems.

While the $5 billion loss for the year seems almost manageable compared to the write-offs at some of the U.S. banks, it was still huge. Worse, it involved big trading losses in the fourth quarter, at a time when CEO Josef Ackermann has staked Deutsche’s future on investment banking activities.

What adds to the concern is that Deutsche, like most European banks, is much more thinly capitalized than U.S. banks. There are bewildering array of capital ratio measures, but on a simple asset-to-equity comparison, Deutsche is at a leverage ratio of about 60, compared to 30 for Citigroup and other U.S. banks.

There are a number of historical reasons for this disparity. For most of the postwar era, the German banks counted on vast “silent reserves” in the form of unrealized capital gains on huge equity positions in the big German companies. Deutsche, for instance, for decades owned more than one-fourth of Daimler-Benz, the diversified auto maker that is one of Germany’s biggest companies, carried at book value from the time it acquired the holding in the early 20^th century. But as part of the recent efforts to streamline the bank and also to make German stocks more liquid, Deutsche has divested itself of most of these holdings and no longer has that extra capital cushion.

The other two “Grossbanken” of Germany’s postwar heyday — Commerzbank and Dresdner Bank — have already required government aid to keep them afloat. Deutsche is far too proud an institution to ever seek government aid, and Ackerman continues to express confidence in the success of the bank’s strategy. Germany’s universal banks have always combined commercial and investment banking, but the focus was squarely on the humdrum profit of retail banking and corporate lending. Only in the past couple of decades, as they sought to become global players, have the German banks strained to emulate U.S. and British investment banks in the scope of their trading and corporate finance activities. (Ditto for the Swiss banks, by the way, which are also in trouble now.)

The market isn’t fully accepting Ackermann’s assurances, and everything that has happened to banks in the past year should make people skeptical. There may well be more bad news from Deutsche before this is all over.