Deutsche Bank And Commerzbank May Become EU’s “Too Big To Fail” Bank

Germany Makes Its Big Bank Problem Even Bigger

EU and ECB Need To Be Ready For The Consequences If This Doesn’t End Well

Courtesy of Bloomberg Editorial Board

Germany has come up with a solution to the deep troubles at one of the world’s largest banks: make it part of an even bigger one.

The people who oversee Europe’s financial system had better be ready for the consequences if this doesn’t end well.

The Frankfurt-based Deutsche Bank is in talks to merge with crosstown rival Commerzbank — a move that Germany’s finance ministry has favored for months. The result would be a behemoth with assets of about 1.8 trillion euros, equivalent to more than half of Germany’s annual economic output; the merged bank would be Europe’s third biggest after the U.K.’s HSBC and France’s BNP Paribas.

The deal is a short-term answer to a politically fraught question — what to do about a struggling and systemically important institution. After a series of unsuccessful turnaround efforts, Deutsche Bank has been in what its own chief financial officer described as “a vicious circle of declining revenues, sticky expenses, lowered ratings and rising funding costs,” exacerbated by numerous international money-laundering probes.

The proposed merger will provide a brief respite, but is unlikely to solve the underlying problems.

The combined bank will be able to reduce costs by cutting staff. However, the deal won’t lessen competition from hundreds of regional public-sector banks for relatively inexpensive deposit funding. It won’t help Deutsche figure out how to handle its legal issues, or revive or dispose of its investment banking unit. In fact, the complications of merging have the potential to distract attention from the real issues that both institutions and Germany’s entire banking industry need to address.

The crucial question is what happens if the combined bank remains financially fragile — or if another crisis hits before it finds its footing. Under Europe’s new banking union, supranational supervisors led by the European Central Bank can deem an institution unviable, take it over and dismantle it before the damage spreads. But they’ve never tried this with an institution remotely as big as Deutsche, let alone Deutsche-Commerzbank, and one doubts they have the necessary resources to undertake such a challenge.

To guard against this risk, Europe’s regulators should require the combined institution to have ample equity capital to absorb any losses. (As things stand, a loss of a few percent of assets could leave it distressed.)

They should also press the bank to simplify its operations and lay out a realistic crisis plan — a process that has only just begun. Beyond that, Europe’s governments need to give the Single Resolution Board better access to financing, so it can keep critical operations up and running if a big institution fails.

One hopes Deutsche-Commerzbank will find a business model that benefits the economy and works for shareholders. But in case it doesn’t, Europe should be prepared with a plan to wind it down. The alternative would be embarrassing as well as expensive: Germany, which has always insisted on strict rules against bailouts in the banking union, may find itself keeping the bank afloat at taxpayers’ expense.

via Bloomberg

********