Deutsche Bank Liquidity Problems Grow

It looks like Deutsche Bank (DB) could be in the early stages of a death spiral and the implications for the world's financial system are, once again, enormous. The stock, which was already at 30-year lows, dropped 6.7% yesterday and at one point earlier this morning had fallen another 9% as concern about the bank's health grows. The reason for the most recent sell-off has to do with the concern that the company has too little cash on hand as well as the fact that customers have begun cutting back their exposure to the bank. At least one client has admitted he had stopped doing business with DB in anything but the most liquid securities because of concern about their liquidity and the company admitted that 10 hedge funds had removed their cash from the bank. If this trickle of counterparties and hedge funds starts growing, the lack of confidence in the bank will simply feed on itself, resulting in the loss of liquidity that has brought down banks in the past (see MF Global).

Another sign that the bank is feeling under pressure is that on Wednesday it agreed to sell its Abbey Life insurance business for $1 billion. Although the banks said the sale would simplify structure and improve returns, it also provides additional liquidity and capital to the bank.

The bank's stock has admittedly been effected by speculating short sellers who do not believe the bank will be allowed to fail. Despite Angela Merkel's insistence that the German government will not bail the bank out, it is hard to imagine that she would let the bank go bankrupt - it is just too important to the German economy and the ramifications as its failure rippled through the financial system is too enormous. There are a number of options that Merkel could employ before she has to decide on a bailout, should it come to that. She could force the bank to merge with another big German bank that the government does own a stake in, Commerzbank, or it could force DB to sell its prized asset management division in order to raise capital and increase liquidity.

In any case, regulators around the world must be getting a bit nervous as they see this unfold. If the bank is subject to a liquidity run, it will really be the first test of all the new rules put in place after the financial crash in order to deal with the collapse of a bank that is really too big to fail.