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Germany’s Banks Downgraded Due to Risk Concerns.

01 Dec 2019 - Market News

Accounting for approximately 28% of Europe's economy, Germany's economy can be described as a developed social bank economy and is reportedly the fifth-largest by GDP and fourth by nominal GDP worldwide. As one of the founding members of the Eurozone and European Union (EU) and the World Bank's third-largest shareholder, there is no disputing its worth in Europe's and the global economy.

Playing a critical role in influencing Germany's economy and finance, German banks have been reported to provide a wide array of services at both individual and national levels, including but not limited to account management, advising on asset placement, banking, saving, and investment services, brokering securities, foreign exchange, national investment capital, and underwriting of equity issues. This is promulgated by the fact that most German citizens favor the use of banks over investing in bonds or stocks. With banks controlling approximately 28% of all seats on the national supervisory boards and a quarter of the national voting capital in 25% of Germany's largest corporations, there is no disputing the role the banks play in influencing the overall standard of living. It is for this reason that issues such as the downgrading of these banks are a significant concern, even if they are merely threats. Unfortunately, this is not just a threat.

With a significant drop in global trade, it is no wonder that Germany's export-led economy has been affected. In the past decade alone, several banks, including the three most prominent German universal banks, Commerzbank, Deutsche Bank, and the Dresdner Bank, have experienced significant drops in their high cost-to-income ratios. While these banks have been able to resist shutting their doors thus far, several smaller banks have not been as lucky, and have had to resort to alternative measures to keep afloat, including engaging in the fast-growing domestic real estate market, and offering loans to "relatively high-risk businesses" while reducing their funds against losses on lending. In spite of these measures, more losses will still be incurred if the global economy, and more precisely, Germany's economic decline persists. This risk is only worsened by the significantly low interest rates that simultaneously nurture the growth of the financial vulnerabilities while masking the real deteriorating state of the economy, and can be explained by the fact that while good for its customers, low interest rates limit banks from making profit while higher and rising interests enable them to lend out more money at profitable interest rates.

 In a bid to improve the deteriorating creditworthiness and profitability of its lenders, several German banks are considering charging negative rates to large retail depositors, then passing on the cost of these negative interest rates to their new retail customers with smaller deposits. This is, however, risky as it is posited that instead of paying for depositing their funds and or savings, customers will instead put their money elsewhere their money out and put it elsewhere, thus exacerbating the already slow economy. To mitigate these risks, the German government has threatened to prohibit negative deposit rates.

 All of these low interest rate-promoting factors, coupled with negative interest rates and investors shunning equity investments, have minimized the growth of German banks' interest margins. Based on this, although it is forecasted that Germany's GDP will experience a slight growth from 0.6% in 2019 to 1.0 % in 2020, German banks are yet at the risk of being downgraded in the absence of a significant economic turnabout. Thus far, on account of losing about 80% and 90% of their market value in the past decade alone, Germany’s two largest bank, Deutsche Bank and Commerzbank, have been downgraded for their inability to improve their profitability and stabilize their business models. The question now is “if this could happen to Deutsche Bank and Commerzbank, what is the fate of other banks?"

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