The twin tower skyscraper headquarter offices of Deutsche Bank AG stand at dusk in Frankfurt, Germany. Image Credit: Bloomberg

Abu Dhabi: While investors and analysts around the world fret about Italy’s banking crisis, there is an even bigger problem hiding in plain sight that just might trigger the next financial collapse; Deutsche Bank.

Last week, Deutsche Bank reported €256 million (Dh1.04 billion) in net profit for the first half of 2016, marking an 81 per cent decline from the €1.38 billion reported in the same half of 2015. Profits for the second quarter alone were €20 million — down 98 per cent from the €818 million recorded in the second quarter of 2015.

For a bank of its size (Deutsche Bank’s investment arm represents one of Europe’s biggest investment banks), this spells trouble, if not the beginning of a long domino effect comparable to the one Lehman Brothers started.

The Lehman Brothers analogy might be misleading, though, because Deutsche’s assets dwarf Lehman’s — the former has €1.8 trillion in assets whereas Lehman, for all the damage it started, had $600 billion (€537 billion) in assets.

Christopher Dembik, head of macro analysis at Saxo Bank, said that Deutsche faces two main challenges; high dependence on investment banking activities at the expense of retail banking, and a huge derivatives exposure of circa $60 trillion.

“[The derivatives exposure] represents almost 24 times the German GDP (Gross domestic Product) and is almost equivalent to the global GDP. If a loss of 0.1 per cent on its gross derivatives exposure happens, Deutsche Bank may be forced to ask for financial aid from the German state.

The direct consequence of this rescue plan would be an increase by at least 10 basis points of the German public debt,” he said.

Enough deposits

As for the bank’s other hurdle (dependence on investment banking), while investment banking offers higher revenues, it has led to Deutsche Bank not having enough deposits today.

The bank’s second quarter of 2016 financial report shows it has around €566 billion in deposits. By comparison, Bank of America, whose assets (at $2.19 trillion) are quite on par with Deutsche’s, has $1.2 trillion in deposits.

Deposits are considered a cushion against volatility and macroeconomic challenges, meaning Deutsche, which is already facing trouble, is too fragile to face any new fluctuations in financial markets.

In 2015, Deutsche Bank reported €6.8 billion in net losses for the full year, marking a significant plunge from the €1.7 billion in net profit reported in 2014.

The losses in 2015 are even larger than those the bank recorded in the midst of the global financial crisis. In 2008, Deutsche reported €3.9 billion in net losses. At the peak of the global financial crisis back in 2008-2009, Deutsche Bank’s share prices fell to a low of nearly €15 per share. Today, they’re trading at around €11.

While most analysts do agree that Deutsche represents massive risk to the European banking industry, they also agree that the bank is unlikely to ever go bankrupt as the German government will probably keep injecting it with liquidity.

“Deutsche Bank needs a lot more capital, and it’s going to find it very difficult to go to shareholders for that because the outlook for its earnings is so weak … Eventually, something will have to be done with it. Nobody wants to buy it because its balance sheet is so weak and it’s probably got lots of bad loans on its books, so I don’t see any immediate way that that situation can be reversed,” said Tom Elliot, International Investment strategist at deVere Group, a financial consultancy.

Spread too thin

Elliot described Deutsche as a “zombie bank” that expanded too much too quickly and didn’t crash when it should have.

He also told Gulf News the bank has “spread itself too thinly” as it doesn’t have a dominant role in any one branch of banking even in Germany where it is based.

He doesn’t think, however, that Deutsche will be the beginning of another financial crisis simply because “there is no way the Bundesbank in the German government will refuse to save Deutsche” the way the US government refused to save Lehman Brothers in 2008.

“You might ask why any bank should get continued support from taxpayers when the German government wouldn’t support a small [manufacturer]. Well, the banking system needs for banks not to fail suddenly or fail at all, and in that way, banks are part of a social structure,” Elliot said.