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Are Deutsche Bank's Troubles Overblown?

· Banks,Banking

Are Deutsche Bank's Troubles Overblown?

Worried U.S. investors drove Deutsche Bank share price down in the second quarter of 2019, continuing a decade long decline for the German bank in direct contrast to one of the greatest bull-market runs for the general market. Deutsche announced last week that the company would cut 18,000 jobs as a part of a firm-wide restructuring plan, which exacerbated concerns surrounding the bank's heavily leveraged portfolio and profitability issues.

Many analysts have cited the potential systemic risk of Deutsche Bank's derivative portfolio, whose notional value exceeds nearly €43 trillion according to its 2018 annual report. The FCIC comments on the role of derivatives in great recession by saying, "the existence of millions of derivatives contracts of all types between systemically important financial institutions added to [market] uncertainty and escalated panic" (The Financial Crisis Inquiry Commission).

Many banks and non-banks own short-term commercial paper and long-term bonds issued by Deutsche Bank or have granted loans or credit facilities to Deutsche Bank in addition to the many financial derivatives that the bank owns. For example, JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, and Bank of America, as well as other significant banks across Europe, are financially linked to Deutsche Bank. This level of interconnectivity among many of the world's largest banks has made experts believe that Deutsche Bank poses the greatest threat to global financial stability.

The company's massive market capitalization combined with its risky equity positions has lead journalists to preemptively labeled Deutsche Bank as the next Lehman Brothers. Germany and the European Union's GDP equate to about €3.03 trillion and €14.6 trillion respectively - both of which are significantly less than Deutsche's notional derivative exposure. Derivatives are relatively illiquid assets, which makes them challenging to appraise during a period of rapid selling pressure.

Deutsche Bank's net derivative portfolio is €41 billion, which more accurately measure of counterparty credit risk than its notional value. As a result, many of the analysts quoting the bank's notional exposure are inflating the magnitude of the bank's instability. Christian Sewing, the new company's CEO, promises to revive the company and decrease the company's counterparty risk. Unless Sewing's risk management strategy exposes €61.3bn of capital to €43.5tn of unhedged derivative positions, it is unlikely that Deutsche Bank will trigger the next economic crisis.

Written by James Mueller, Edited by Willie Turchetta & Alexander Fleiss

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