Is Deutsche Bank a Canary in the Economic Coal Mine?

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Deutsche Bank has recently announced its $8.3 billion restructuring plan to decrease its costs by 25% until 2022. The bank has already begun slashing jobs and scrapped the dividends for the next two years. 18,000 people will lose their jobs, in particular those working in the bank’s investment branch. The news on this European bank comes amidst the discussions about the expected interest rate cut by the US Federal Reserve (Fed). The bank’s dramatic downsizing should be seen in light of the rock bottom interest rates fixed by the Fed’s euro counterpart, the European Central Bank (ECB). It is a sign of the long-term disadvantages of such policies.

Expansionary Monetary Policies as Root Cause

Since the 2008 financial crisis, the ECB has continuously decreased the interest rates while aiming for an inflation of slightly below 2 percent. Meanwhile, the stock price of Deutsche Bank decreased over the same time (Figure 1). This is not a coincidence. It decreased especially as the interest rates approached and finally hit zero percent. Since then, the share price moved only between 8 to 30 percent of its maximum value in 2009.

Figure 1: Time series of ECB Main Refinancing Operations interest and Deutsche Bank share price at closing (NYSE).

Sources: ECB, Deutsche Bank.

But why is this happening?

Low interest rates make credit for private banks — and in turn, for consumers — cheaper. But at the same time, the low return on government bonds makes investment in these long-term options unattractive. Inflation and low return on investment options discourage people from saving and investing capital but encourage spending. Moreover, the low interest rates result in a low return for banks on the credit they grant to consumers. High consumption, low investment, and low profit on all banking activities strongly affects the ability of European banks to compete. Consequently, Markets Insider reports

The bank has struggled financially amid rock-bottom interest rates in Europe and fierce competition in the German banking industry, limiting its ability to invest and expand in line with US rivals.

The extremely low interest rates in the Eurozone hit the bank’s investment branch hard, and the ECB has recently announced that it expects to maintain the current level of interest rates until the middle of 2020. (The Deposit Facility Rate is even below zero.)

The Deutsche Bank: Weakened by Proximate Causes

The Deutsche Bank did not fail only and directly because of low interest rates in the Eurozone, however. The bank was financially already stricken by lawsuits and tough competition, both in Germany and in the global investment sector. The market had substantial doubts on the feasibility of the already low return expectation of 4 percent on tangible equity. In addition to that, an attempt to merge with the German Commerzbank failed this year despite being politically backed by the German government. The bank desperately needed to reduce its costs. The merger with the Commerzbank would have been an option to do so although it was expected to cost jobs as well. The merger failed, however, and the bank had to resort to restructuring, making cuts in their traditional investment branch.

The example of the Deutsche Bank shows the failure of the ECB policies: the bank’s value has decreased substantially, and the bank will cut jobs, although they are expected to hit the US in particular. The pressure on the bank due to lawsuits, etc., was only a trigger. The bank’s value has been decreasing for a decade, but its strategy for recovery was ultimately foiled by low-interest-rate policy. 

International Context

The ECB will maintain its current interest rate level for another year. The bank’s new prospective president, Christine Lagarde, will inherit these policies and is likely to support them, given her history with the International Monetary Fund. The US Federal Reserve is expected to cut interest rates in the summer. Politicians in various countries support such policies as well.

Deutsche Bank’s intention to reduce its global presence is a bad sign. The negative consequences of expansionary monetary policies take a while to show up, but they do eventually surface. Deutsche Bank was already weakened and thus the effects of current policies have become visible there first.  But in the longer run, we are likely to see additional effects throughout the larger economy.

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