Have investors become immune to bad news from Deutsche Bank? Shares in Germany’s largest bank surged more than 3 percent in Frankfurt trading Friday morning. You would be forgiven for thinking that shareholders hadn’t done their homework: After all, the US Federal Reserve late Thursday announced that Deutsche was the only bank to fail its latest “stress test” of 34 US financial institutions.
Why the shrug from shareholders? Part of it is unrelated to Deutsche’s woes. Investors were in a buoyant mood thanks to an EU summit deal over refugees — a deal that just might save German Chancellor Angela Merkel’s job back home. The blue-chip DAX index rose more than 1.5 percent in morning trading in Frankfurt, after four straight days of losses.
Deutsche is likely profiting from that overall optimism. The bank’s shares also hit a record low earlier this week, falling below €9, and have long been underperforming the benchmark DAX index (see graphic). With such bargain basement prices, it seems shareholders on Friday were willing to let the bank rebound along with the rest of Germany’s stocks.
It also helps that the Fed’s latest fail grade has been expected for weeks. Deutsche Bank has long had problems with US authorities and already failed earlier versions of the US stress test in 2015 and 2016. Last year it was put on a list of problem banks by the FDIC. So, Friday was partly a case of “sell the rumor, buy the news” for financial markets.
US authorities are not saying the bank is in an acute crisis. A “stress test” is designed to evaluate whether a bank could withstand a future financial crisis, not whether it’s currently in one. Moreover, Deutsche passed a first stress-test round last week, which looked at whether the bank has enough capital or liquidity on its books. It failed the second round because of “serious weaknesses” in its internal control processes. In other words, the Fed fears that Deutsche’s systems and management might not be able to spot or react to a financial crisis if another one were to come along.
One other silver lining: The Fed made clear that it was evaluating only the bank’s US operations – not the entire global bank. Since Deutsche has already made clear that it plans to cut back on business in the United States, the Fed’s fail grade wouldn’t seem to be the bank’s biggest problem at the moment.
So, everything’s fine?
That explains the shrug from markets, but it doesn’t make the news any less troubling. The Fed’s latest round of stress tests were introduced in 2013 as a means of preventing a future financial crisis. In the first couple years, larger US banks failed, too, as they struggled to adjust to the Fed’s new stringent requirements. But adjust, they did. Even European banks Barclays and Credit Suisse, which were examined by the Fed for the first time this year, passed the test. Only Deutsche keeps failing.
The fact that Deutsche has poor systems is well known. Former CEO John Cryan, who was fired earlier this year, called them “lousy.” Kim Hammonds, the former executive in charge of technology, was let go soon after she complained that the bank’s systems were the worst she had ever worked with. In a statement Thursday night, the bank said it has been making major investments in upgrading its systems and would continue to work with authorities.
The inability to get on the Fed’s good side could force Christian Sewing, the bank’s new CEO, to cut US operations even faster than already planned. It also poses other, bigger challenges, because it falls into a far more troubling broader narrative. It gives Deutsche’s already-skittish clients one more reason to feel uncertain about doing business with the bank.
The lack of trust, coupled with a continuing erosion of its revenue sources, is already the biggest risk that Deutsche Bank is having to deal with, and is what sent shares to a record low earlier this week – before the US stress test results were even announced. Time is running out for Mr. Sewing to clean up Deutsche’s operations.
Michael Maisch is a senior financial correspondent for Handelsblatt in Frankfurt. Astrid Dörner covers finance for Handelsblatt in New York. Christopher Cermak is an editor for Handelsblatt Global and adapted this article. To contact the authors: email@example.com, firstname.lastname@example.org and email@example.com