Deutsche Bank: How negative interest rates helped make Germany's largest bank a disaster
But Deutsche Bank's struggle has also been amplified by something the 149-year-old lender had never imagined, mostly because it had never happened before in modern history: negative interest rates.
In 2014, the European Central Bank wanted to boost the weak economy, but interest rates were already at zero. The unconventional decision to take them into negative territory was aimed at encouraging growth and avoiding deflation, but that meant that banks were charged a fee to park their reserves in the central bank.
"Negative interest rates have been another nail in the coffin," said Claus Vistesen, head of the eurozone at Pantheon Macroeconomics.
Although all banks in the eurozone have been subject to the ECB's extreme policies, Deutsche Bank's business model and uncertain balance made it particularly vulnerable to this pressure.
Negative rates did not cause Deutsche Bank problems, Vistesen said, but they "certainly" magnified them.
& # 39; Very Destructive & # 39;
It's no secret that negative rates are a direct tax on banks.
During normal times, lenders earn interest when holding surplus reserves in the central bank. But under negative interest rates, the opposite is true: the central bank charges the banks interest for holding on those cash. The goal is to encourage lending – but in practice it has pushed the loan's profitability, also known as net interest income.
"The business model of running a bank with negative interest rates is very devastating," said Jeffrey Sherman, co-portfolio manager for the DoubleLine Core Fixed Income Fund.
Recently, Deutsche Bank's share price had almost collapsed with bond yields, which have recently fallen even deeper into negative territory.
There has been a strong correlation of 0.85 between Deutsche Bank's stock and German 10-year return over the past year, according to Sherman.
Goldman Sachs analysts said in a recent report that sharp fall in interest rates from 2014 corresponded to a "significant" decline in net interest income of euro area banks, relative to where projections were in 2014.
Mass job cuts, falling stock price
Deutsche Bank has made an annual profit since 2014. The bank announced plans earlier this month to eliminate 18,000 jobs as part of a new effort to curb red ink.
Deutsche Bank's NYSE-listed shares topped $ 124 in May 2007, tomorrow for the global financial crisis. Although some major banks have failed to return to all-time highs, many have at least come close. Deutsche Bank, on the other hand, trades for $ 8, or more than 90% below its pre-crisis highs.
Deutsche Bank's shares have plunged 77% since the ECB announced negative interest rates.
"You basically kick a wounded animal while it's down. Negative interest rates have simply wiped out European banks," said Danielle DiMartino Booth, CEO and chief strategist of Quill Intelligence and a vocal critic of modern central bank policy.
"Counter-productive" policy?
The Euro Stoxx Banks Index, a basket of lenders in the eurozone, is down more than 40% since the ECB ventured into negative interest rates.
While the eurozone gained growth in 2017, the economy has slowed down significantly in late, partly due to global trade tensions and demographic challenges. Draghi, the defiant ECB chief, warned last week that the eurozone's economic outlook is getting "worse and worse."
"Monetary policy in Europe has been wonderfully unsuccessful," said David Kelly, head of global strategy at JPMorgan Funds. "These negative rates are counterproductive. They slow down the European economy."
Kelly noted that Europe's economy is more dependent on bank lending than the US because European capital markets are not as deep.
"The banking industry cannot flourish at negative prices," he said. "And it acts as a drag on the entire European economy."
Would things be even worse without negative prices?
To be sure, there have been benefits from the ECB's policies. Negative interest rates, along with massive asset purchases, have helped lift the stock market and made it easier for companies to borrow. This has probably helped boost confidence among households and businesses to go out and use.
Vistesen also said that negative interest rates have boosted credit growth among European households. He pointed to cheap mortgage rates in Spain and Italy and improved house prices.
And advocates of the ECB's extreme attitude to prices argue that the European economy would be in even worse shape without negative rates. Higher unemployment and loan losses will certainly be a negative issue for the euro area, including Deutsche Bank.
But it is impossible to prove. No one knows for sure how the economy would have behaved in a different environment.
Some argue that it can be healthy to let the economy fall into a recession, even if it is painful. This is what happens in the business cycle. Downturns are shaking out the weaker companies and leaving more room for the healthier. Negative prices do just the opposite, keeping alive so-called "zombie" companies.
"What's wrong with a recession?" Sherman asked. "Capitalism says that things that are not recommended should go to zero."
Deutsche Bank is particularly vulnerable to further interest rate cuts
The banks are now supporting the ECB to go even deeper into negative territory.
Last week, Draghi said that "plenty of monetary accommodation" is still needed to boost inflation and "soften" global growth.
The German banking union issued a statement warning that the ECB's plan to "intensify its ultra-loose" stance is a "repetitive and heavy burden for banks , financial stability, savers and companies. "
Deutsche Bank is particularly vulnerable.
An interest rate cut of just 0.2 percentage points would wipe out 42% of Deutsche Bank's estimated earnings from 2019, according to Goldman Sachs. Without a doubt, most of any eurozone bank is in the company's coverage universe.
Goldman Sachs said that the banks most exposed to negative interest rates are those with a significant balance of retail accounts and a low level of recurring profitability. Deutsche Bank checks both boxes.
ECB seeks to soften blows
Deutsche Bank's CFO James von Moltke told analysts last week that the bank is "strongly aware of headwinds" from further interest rate cuts.
Legal restrictions limit banks' ability to pass on negative interest rates to private customers, even though they have provided some of the costs through fees.
"We have deposited deposit and account fees now for some time," said von Moltke. "It's just a process that must continue for us and the industry."
When it comes to business customers, Deutsche Bank said it works hard to "make sure we have given negative prices where we can."
Although banks rarely require negative interest rates for customers, Deutsche Bank signaled that this had to change.
The good news is that the ECB has signaled a willingness to try to "curb" the fallout from negative interest rates. The central bank's employees prepare a stratified system for reserves that will exempt any deposits from the most punitive rates. The Bank of Japan has a system where most deposits up to a certain level avoid the lowest interest rates. The Swiss National Bank, another central bank with negative interest rates, also has a tiered system to ease the pain on banks.
Goldman Sachs said that a tiered system would be a "critical" part of further interest rate cuts by the ECB.
"Without it, an extremely challenging operating environment gets worse," it states.
