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ESSA

Deutsche Bank and the Global Financial Crisis


Michelle Hall & Alina Förster

By

May 20th, 2017


This article first appeared in Short Supply 2017 – check out the full magazine via the Short Supply tab at the top of this page!


Deutsche Bank has been scrutinised and surrounded by controversy in relation to its conduct leading up to the Global Financial Crisis. However, when the facts are distilled from the myths and stigma, what is revealed is an admirable recovery by the institution, despite tumultuous economic times and the bad publicity.

When the Global Financial Crisis hit, Deutsche Bank Group posted its first annual loss in over 50 years. Deutsche’s net income fell from €6.5bn in 2007 to -€3.9bn in 2008. [1] The primary source of these losses was the Corporate & Investment Banking Division, suffering losses before taxes of €7.4bn. [2] Losses from this division were primarily attributable to trading of financial derivatives linked to the value of housing markets across the globe; namely Collateral Debt Obligations (CDOs) and Residential Mortgage Backed Securities (RMBS).

In order to understand the extent to which Deutsche Bank’s assets were at risk of fluctuations to housing price values, it is helpful to examine the bank’s net exposure to CDOs and RMBSs. This measures the value of the bank’s bets on the financial derivatives that are not hedged (i.e. insured) against any risk of market downturn. Deutsche Bank’s net exposures to CDOs and RMBSs, as of 2007 and 2008, are displayed in the diagrams below, with residential mortgage business exposure (both US and Europe) accounting for 80% of the bank’s total net exposure of €7.215 billion in 2007.

Following the crash of Lehman Brothers, the bank quickly started mitigating its losses and managing its risk through dumping billions in risky loans and dismissing employees. Due to its decisive action, Deutsche was able to recover quickly and even made a profit of approximately €5bn by 2009, largely attributable to its investment banking sector’s performance.

An advantage Deutsche Bank had over rivals was their comparatively low proprietary trading volume; in comparison to other firms, the bank did not risk much of its own money during this period to trade for its own profit. Furthermore, the trading positions Deutsche Bank did take were well hedged against the risk of any market fluctuations, as seen by the difference between the bank’s gross exposure and net exposure (see Figure 3).

Many of its CDOs were insured against credit default by the American International Group (AIG) to the nominal value of €7.8bn. [3] After AIG faced financial troubles during the peak of the GFC in 2008, Deutsche Bank received roughly US$11.8bn from AIG as a result of a bailout package provided by the U.S. government. In 2008, Deutsche Bank started acquiring Deutsche Postbank, a German retail bank, adding 14 million customers to Deutsche Bank’s domestic retail business. By diversifying away from their risky investment banking business, the acquisition was aimed at further strengthening Deutsche’s retail banking profits.

Deutsche Bank has proved over the years to be a leading financial institution, excelling since its establishment. Despite these achievements, the bank, along with its competitors, clearly suffered tremendous setbacks after both the Global Financial Crisis and the European Debt Crisis. These crises have affected Deutsche Bank’s profitability as well as the underlying structure of the bank. However, regardless of what the future holds, there is no doubt that Deutsche Bank, through bold and purposeful strategies, has managed to come out stronger after what was a catastrophic economic event.

 

Michelle is a Master of Business Economics student. She is passionate about applying economic theory to solve real world problems.

Alina is in the final year of her Master of Business Economics degree. She enjoys economics because it finds its application in every part of life.

 

[1] Deutsche Bank. (2009). Deutsche Bank Annual Report 2008. Retrieved from https://annualreport.deutsche-bank.com/2008/ar/servicepages/downloads/files/dbfy2008_entire.pdf

[2] Ibid

[3] Ibid

Image: ‘Frankfurt Deutsche Bank Headquarters’ by Epizentrum, http://bit.ly/2tZN2Ww. Licence at https://creativecommons.org/licenses/by-sa/3.0 

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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