Banking crisis lingers as contagion fears take aim at Deutsche Bank

Shares in Deutsche Bank fell sharply on Friday, as fears about vulnerabilities in Germany's largest lender sent investors for the exits.

Deutsche Bank shares closed down 9 per cent on the German stock exchange, and have now lost one-fifth of their value since the start of March.

The drop in the share price on Friday comes amid a steep rise in the cost of financial derivatives pegged to the bank, known as credit default swaps.

Credit default swaps (CDS) are essentially insurance, which pay off if a company defaults on its loans. The higher the price of the insurance, the more likely the market thinks the underlying company is to default.

The price of a five-year Deutsche Bank CDS touched 220 basis points at one point on Friday, up from 142 just two days ago, according to S&P Global Intelligence. That's the highest level for a Deutsche Bank CDS since 2018, although by the close of trading it had settled at about 193.

That's well below the price that swaps reached at other teetering banks recently. Prior to Credit Suisse being bailed out by UBS, the price of its swaps went as high as 1,194, S&P says.

Like Credit Suisse, Deutsche Bank is one of 30 banks considered globally significant financial institutions under international rules, so it is required to hold higher levels of capital reserves because its failure could cause widespread losses.

Fears about Deutsche Bank come despite the lender's financial results showing capital reserves well in excess of regulatory requirements and 10 straight quarters of profitability. In 2022, the bank made 5.7 billion euros ($8.45 billion Cdn) in after-tax profit.

'"It's a very profitable bank," German Chancellor Olaf Scholz told reporters on Friday. "There's no reason to worry."

U.S. investment bank JPMorgan told clients in a research note that it was "not concerned" and said Deutsche's fundamentals were "solid."

But the ongoing crisis underway in the global banking system is partly being driven by emotion, and not always fundamentals. 

Paul van der Westhuizen, a strategist with Dutch lender Rabobank, says the concern over Deutsche Bank is likely overdone, but he doubts it will be the last bank in the crosshairs.

"There is a fundamental difference in that Deutsche has returned to profitability over the last few quarters, whereas Credit Suisse did not have a profitable outlook for 2023 at all," he said. "Investors don't want to hold on to positions that have any concern around them over the weekend, so getting out of such positions is probably what we're seeing with Deutsche Bank."

Banks around the world have been gripped by fears after the sudden and unexpected collapse of several U.S. banks.

Although the details are different in each case, a common thread to all their problems is sharply higher interest rates, which are a double-edged sword for lenders because they increase the returns from their loans, but sharply reduce the value of their government bond holdings if they are forced to sell them in a hurry to raise capital.

Shares in other European banks were also lower on Friday, but not by as much as Deutsche Bank. Germany's Commerzbank was down 6 per cent, France's Société Generale was down by about the same amount, while Austria's Raiffaisen was off by almost 8 per cent.

"This is a global issue right now and nobody knows where it will end. So people are acting with their feet and continuing to sell bank stocks," said Peter Tuz, president of Chase Investment Counsel.

Deutsche Bank declined to comment but it's clear that concerns about the company didn't get put to rest when the stock market closed on Friday.

"In our view, the tail risk has not entirely gone," said Frédérique Carrier, head of investment strategy with RBC Wealth Management. "Scars heal slowly and concerns about the sector are likely to linger. The banking system is based on confidence so we have to monitor future developments very closely."