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Thursday, 15 September 2016 12:47

Revisiting the Run on Deutsche Bank: Making the Hypothetical Frighteningly Realistic - You've Been Warned! Featured

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Following up on "What Happens to Banks When the Real Funding Rate Appears?", we will take a look at could happen to Deustche Bank when LIBOR does this...

... and depositors realize Deutsche Bank as Ground Zero?, thus contemplate Deustche Bank and the Anatomy Of A European Bank Run: Look at the Situation BEFORE The Run Occurs, from which they may learn this...

... and this...

... consequently doing this...

As explained in "What Happens to Banks When the Real Funding Rate Appears?", bank funding and derivative benchmark costs are going up. In the past, banks have manipulated these numbers to increase their perception of creditworthiness and to synthesize profits from their derivative positions. Reference Wikipedia's description of the LIBOR scandal:

WSJ Libor study

Libor manipulation to lower rate

Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the lib or fixing at 5.39 for the next few days. It would really help. We do not want it to fix any higher than that. Tks a lot.

Barclays Bank trader in New York to submitter,
13 September 2006[25]

On 16 April 2008, The Wall Street Journal released a controversial article, and later study, suggesting that some banks might have understated borrowing costs they reported for the Libor during the 2008 credit crunch that may have misled others about the financial position of these banks.[26][27] In response, the BBA claimed that the Libor continued to be reliable even in times of financial crisis. Other authorities contradicted The Wall Street Journal article saying there was no evidence of manipulation. In its March 2008 Quarterly Review, the Bank for International Settlements stated that "available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings."[28] Further, in October 2008, the International Monetary Fund published its regular Global Financial Stability Review which also found that "Although the integrity of the U.S. dollar Libor-fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar Libor remains an accurate measure of a typical creditworthy bank's marginal cost of unsecured U.S. dollar term funding."[29]

A study by economists, Snider and Youle, in April 2010, however, corroborated the results of the earlierWall Street Journal study that the Libor submissions by some member banks were being understated.[30]Unlike the earlier study, Snider and Youle suggested that the reason for understatement by member banks was not that the banks were trying to appear strong, especially during the financial crisis period of 2007 to 2008, but rather that the banks sought to make substantial profits on their large Libor interest-linked portfolios.[31] For example, in the first quarter of 2009,Citigroup had interest rate swaps of notional value of $14.2 trillion, Bank of America had interest rate swaps of notional value of $49.7 trillion and JPMorgan Chase had interest rate swaps of notional value of $49.3 trillion.[32] Given the large notional values, a small unhedged exposure to the Libor could generate large incentives to alter the overall Libor. In the first quarter of 2009, Citigroup for example reported that it would make that quarter $936 million in net interest revenue if interest rates would fall by .25 percentage points a quarter, and $1,935 million if they were to fall by 1 percentage point instantaneously.[33]

Central banks aware of Libor flaws

The Governor of the Bank of EnglandMervyn King, by the end of 2008, described the Libor to the UK Parliament saying "It is in many ways the rate at which banks do not lend to each other, ...it is not a rate at which anyone is actually borrowing."[34][35]

The New York Federal Reserve chose to take no action against them at that time.[36][37] Minutes by the Bank of England similarly indicated that the bank and its deputy governor Paul Tucker were also aware as early as November 2007 of industry concerns that the Libor rate was being under-reported.[38][39] In one 2008 document, a Barclays employee told a New York Fed analyst, "We know that we're not posting an honest Libor, and yet we are doing it, because if we didn't do it, it draws unwanted attention on ourselves."[37]

The documents show that in early 2008, a memo written by then New York Fed President Tim Geithner to Bank of England chief Mervyn King looked into ways to "fix" Libor.[40][41] While the released memos suggest that the New York Fed helped to identify problems related to Libor and press the relevant authorities in the UK to reform, there is no documentation that shows any evidence that Geithner's recommendations were acted upon or that the Fed tried to make sure that they were. In October 2008, several months after Geithner's memo to King, a Barclays employee told a New York Fed representative that Libor rates were still "absolute rubbish."[37]

Alas, as you see in the first graphic of this article, LiBOR is going up, and it's going up for real this time. Banks are paying practically nothing to depositors who are now forced to take the brunt of the risk that banks entail, while others taking the exact same risks are offered considerably higer rewards and payouts. We're talking the EU bail-in laws that put unsecured creditors on equal footing - that includes depositors. So, using our favorite healthy bank, DB, how would this play out of the smarter of our constituency decided to either be properly compensated for this risk or opted not to take it at all?

DB balance sheet liquidity

Assets with maturity within 1 year or less held the major part of total financial assets of Deutsche bank. In 2014 & in 2015 it constituted more than 75% of total financial assets of Deutsche Bank. And assets on demand comprises more than 60% of total financial assets of Deutsche Bank.

The total financial assets of Deutsche bank decreased by almost 90 billion euros from 2014 to 2015. Deutsche Bank’s financial assets designated at fair value through profit & loss reduced by almost 122 billion euros during the same period. Deutsche Bank’s Derivative assets also reduced by almost 115 billion euros.

Among the total financial liabilities, on demand liabilities constituted almost 70% in both 2014 and 2015. And liabilities with maturity within 1 year or less comprises more than 90% of total liabilities.

Deutsche Bank’s total financial liabilities increased by almost 75 billion euros from 2014 to 2015. Out of the total on demand liabilities dues to bank and customers both increased by almost 50 billion euros in aggregate during this period. Financial liabilities designated at fair value through profit & loss also increased from 2.6 billion euros in 2014 to 18.42 billion euros in 2015. This increase was mostly driven by increase of 16.2 billion euros in securities sold by Deutsche bank under repurchasing agreement.

There's an imablance of about 3.5:1 of truly liquid, stable liabilities to truly liquid, stable assets. This means, if depositors really started withdrawing overnight and on demand deposits from DB, DB goes bye-bye! Why would this happen? Ask the ECB, the Fed and their Z/NIRP propensities.

banks charging for deposits

I'll close out with a video from everone's favorite old school investor, Warren Buffet.

We have posted a deep dive analysis of:

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VE DB short 2x leverage

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