Hunting Depositor Risk In The Eurozone

“In the future, German Chancellor Angela Merkel said, ‘banks must save themselves.’
---Der Spiegel, April 1, 2013

“We strive to be the most respected Investor Relations team by delivering financial transparency and outstanding communication.”
--Deutsche Bank Investor Relations

Europe has solved the problem of failing banks dragging down their governments with the cost of bailouts. Henceforth, the costs of bank resolution will be borne by bank bondholders and depositors, instead of by German taxpayers.

This is a very clean solution to a complex problem. If the eurozone’s banking system were viewed as a contingent liability of Germany, Germany would no longer be rated AAA, since the potential ongoing bailout costs are enormous.

By severing the link between governments and their banks, the size of Germany’s contingent liability (and hence the cost of defending the euro) becomes manageable. It is clear that the ongoing bills for maintaining the solvency of the eurozone banking system will continue to be large. These bills must be paid upon presentation because the ECB won’t lend to “insolvent” banks (an incredibly stupid policy). Hence there is a limit to the degree that such bills can be postponed. (Remember that the Cyprus bailout was precipitated by an ECB ultimatum.)

German finance minister Wolfgang Schaeuble and prime minister Angela Merkel have been particularly vocal in welcoming this new paradigm. It solves their biggest problem: how to hold the eurozone together without bankrupting Germany. And, in addition, the Germans like the new policy because it hands the bill to the guilty parties. As Schaeuble said: “We decided to have the owners and creditors take part in the costs of the rescue - in other words those who helped cause the crisis." (I will observe that, in all known cases of bank insolvency, the guilty parties are defaulting borrowers, not bondholders and uninsured depositors, but that's a quibble.)

The World’s Opinion Page

Help support Project Syndicate’s mission

subscribe now

Now that European bank resolution policy has changed from “Too Big To Fail” to “Too Expensive To Rescue”, a bank analyst must turn his gaze towards those eurozone banks likely to need assistance, who are now candidates for defaulting on their liabilities (sorry, for bailing-in their creditors). One might start by asking if there are any solvent banks in the eurozone, given the combination of the banks’ large exposures to troubled sovereigns/banks, plus their rotten real estate portfolios. The short answer, of course, is that there is no way of knowing which eurozone banks are insolvent because of the uselessness of European financial reporting.

Take Deutsche Bank, the avatar of German banking excellence. At year-end, it had “core capital” ratio of 8% on the basis of Tier One Capital to Risk Weighted Assets. But its ratio of equity to book assets was 2.3%, with EUR 57B in equity supporting EUR 2.2 trillion in book assets . This puzzling anomoly results from the fact that Deutsche's risk-weighted assets are EUR 334B, or 15% of book assets. Potential depositors should pay no attention to the EUR 2.2 trillion in book assets, which have no analytic information value!! Deutsche Bank must have a really high-quality balance sheet to be so riskless. Or does it?

The rather obvious analytic schedules that a diligent uninsured depositor might desire are:
1. A schedule of eurozone government bond and bank exposure by country, showing face, MTM, and carrying values.
2. A schedule of loan and problem loan books by industry and country, showing face, MTM (where available) and book values.

I couldn’t find these on DB’s financial reporting, and I looked. I'm not saying they're not disclosed somewhere; I'm saying I couldn't find them and I'm not a layman. Maybe they're not translated into foreign; I wouldn't know.

My understanding is that under European accounting rules, eurozone government bonds are carried at face value until legally impaired (as in the case of Greece). If this is correct, this would mean that Deutsche is carrying all Club Med government bonds (except Greece, but including Cyprus) at full value, rather than at market or at impaired value. In other words, under eurozone bank accounting, all eurozone government debt is AAA until it defaults; no impairment or MTM is permitted. This renders regulatory capital useless. It also means, if it is the case, that Deutsche's risk asset calculation doesn't include any of the PIIGSC except Greece. I would be happy to be corrected on this supposition. You would think that, if I am wrong, Deutsche's IR department would make a point of saying how it carries eurozone government bonds. If it does, I didn't see it.

How well is DB’s massive global real estate portfolio provisioned or marked? Unless there is a schedule that I couldn’t find, no one knows. In fact, I couldn’t even find out the size of DB’s RE portfolio, although I am not saying it isn’t disclosed somewhere in all that fabulous transparency.

Can a bondholder or uninsured depositor really be confident that Deutsche Bank’s EUR 57B of equity is sufficient to absorb the entire expected loss of a EUR 2.2 trillion balance sheet, especially given the opacity of that balance sheet?
If it were your money, would you keep an uninsured deposit at risk there?

An old rule of thumb in analyzing capital adequacy and leverage is: does the bank have sufficient free funding (equity) to be consistently profitable throughout the entire credit cycle? If the bank was always profitable, you could conclude that its capital was adequate for the kinds of risks that it took. It was a backward-looking but very effective way to assess capital adequacy. Has Deutsche been profitable throughout the entire credit cycle? No, it lost EUR 3.9B in 2008. That was after reporting a 6.5B profit in 2007. FY 2012 wasn't great either.

Despite my intellectual defects, I am an experienced bank analyst relying on Deutsche Bank’s public disclosure in order to render a risk assessment for potential uninsured depositors. I can only say that, in the absence of TBTF, I would have my money elsewhere. Now we all know that Deutsche is TBTF because of its systemic importance in Germany. This goes for Germany’s other problem children such as HSN Nordbanken and DEPFA, issuer of those amazing risk-free pfandbriefe. All German banks are solvent by virtue of their address. I don't doubt this, no matter what Merkel and Schaeuble might say on any given day. German banks don't default on their senior dent or on their uninsured deposits (maybe because this is good public policy?).

But do we know this about the other problem banks in the eurozone, such as Banca Monte dei Paschi or Bankia? Both are disaster areas that will require ongoing bailouts from someone. Are Spain and Italy inside the TBTF zone, or are they outside it, in the dreaded "Cyprus zone"? That we will find out, when Spain or Italy ask Germany for bailouts.;
  1. Television sets showing a news report on Xi Jinping's speech Anthony Wallace/Getty Images

    Empowering China’s New Miracle Workers

    China’s success in the next five years will depend largely on how well the government manages the tensions underlying its complex agenda. In particular, China’s leaders will need to balance a muscular Communist Party, setting standards and protecting the public interest, with an empowered market, driving the economy into the future.

  2. United States Supreme Court Hisham Ibrahim/Getty Images

    The Sovereignty that Really Matters

    The preference of some countries to isolate themselves within their borders is anachronistic and self-defeating, but it would be a serious mistake for others, fearing contagion, to respond by imposing strict isolation. Even in states that have succumbed to reductionist discourses, much of the population has not.

  3.  The price of Euro and US dollars Daniel Leal Olivas/Getty Images

    Resurrecting Creditor Adjustment

    When the Bretton Woods Agreement was hashed out in 1944, it was agreed that countries with current-account deficits should be able to limit temporarily purchases of goods from countries running surpluses. In the ensuing 73 years, the so-called "scarce-currency clause" has been largely forgotten; but it may be time to bring it back.

  4. Leaders of the Russian Revolution in Red Square Keystone France/Getty Images

    Trump’s Republican Collaborators

    Republican leaders have a choice: they can either continue to collaborate with President Donald Trump, thereby courting disaster, or they can renounce him, finally putting their country’s democracy ahead of loyalty to their party tribe. They are hardly the first politicians to face such a decision.

  5. Angela Merkel, Theresa May and Emmanuel Macron John Thys/Getty Images

    How Money Could Unblock the Brexit Talks

    With talks on the UK's withdrawal from the EU stalled, negotiators should shift to the temporary “transition” Prime Minister Theresa May officially requested last month. Above all, the negotiators should focus immediately on the British budget contributions that will be required to make an orderly transition possible.

  6. Ksenia Sobchak Mladlen Antonov/Getty Images

    Is Vladimir Putin Losing His Grip?

    In recent decades, as President Vladimir Putin has entrenched his authority, Russia has seemed to be moving backward socially and economically. But while the Kremlin knows that it must reverse this trajectory, genuine reform would be incompatible with the kleptocratic character of Putin’s regime.

  7. Right-wing parties hold conference Thomas Lohnes/Getty Images

    Rage Against the Elites

    • With the advantage of hindsight, four recent books bring to bear diverse perspectives on the West’s current populist moment. 
    • Taken together, they help us to understand what that moment is and how it arrived, while reminding us that history is contingent, not inevitable

    Global Bookmark

    Distinguished thinkers review the world’s most important new books on politics, economics, and international affairs.

  8. Treasury Secretary Steven Mnuchin Bill Clark/Getty Images

    Don’t Bank on Bankruptcy for Banks

    As a part of their efforts to roll back the 2010 Dodd-Frank Act, congressional Republicans have approved a measure that would have courts, rather than regulators, oversee megabank bankruptcies. It is now up to the Trump administration to decide if it wants to set the stage for a repeat of the Lehman Brothers collapse in 2008.