Could Deutsche Bank trigger GFC II?

Global equity markets have been rocking on the back of the growing troubles of what is probably Europe’s most important bank in Deutsche Bank. Its shares lost more than 7% overnight to approach a 30-year low amidst news reports that some hedge funds have been reducing their exposure to the investment bank’s prime brokerage operations.

Hedge funds commonly use the prime brokerage operations of investment banks to borrow securities to sell short and clear derivatives or physical securities intermediated with the likes of Deutsche Bank as operational counterparties.

The hedge funds’ nervousness is due to their nightmarish memories of the sudden collapse of investment bank and prime broker Lehman Brothers in 2008.

Almost no one expected Lehman’s to actually fold on the morning of September 15 2008, and I remember working at the Bank of New York Mellon as entire trading floors watched Lehman’s stock price plunge over just a short hour’s trade before being placed into a trading halt followed by permanent extinction.

The lightening speed of the collapse shocked everyone including hedge funds and other counterparties left high and dry with large amounts of capital deposited at Lehman’s prime brokerage in the form of collateral or margin against which derivatives or other assets could be borrowed and physically or synthetically traded.

Lehman’s implosion triggered the mass deleveraging (reduced borrowing) of financial markets as global banks were forced to accept taxpayer bailouts to avoid bankruptcy as confidence evaporated overnight and credit markets seized up.

Today it’s commonly accepted wisdom that the main cause of the GFC was the wild over-leverage of the banks in particular and legislative reform was enacted (to supposedly prevent this happening again) via the Dodd Franks Act in the US and Banking Reform Acts in the UK for example.

While the global banking regulator, The Basel Banking Supervisory Committee, is also still imposing tougher risk management requirements under renewed inter-governmental political pressure transmitted via central bank policymakers and their lunch-buddies in the political classes.

No wonder the German government is denying it’s talking to the bankers about a potential bailout as this would be the ultimate humiliation given it was supposed to be responsible for reigning in the bank’s well-deserved reputation for excess bonuses, hubris, egregious behaviour, rule breaking and a lack of risk management.

However, letting Deutsche Bank collapse is not an option as there’s no doubt it remains a systemically important bank to the world’s financial system. For investors though its problems could keep rattling markets with banks like Macquarie Group Ltd (ASX: MQG) and European focused fund managers like Henderson Group plc (ASX: HGG) especially vulnerable to any shockwaves from another European banking meltdown.

The other important takeaway for ASX investors from the problems of the European banks is the potential for tougher capital adequacy regulations to filter through to Australian banks like Commonwealth Bank of Australia (ASX: CBA) and Australia and New Zealand Banking Group (ASX: ANZ).

If Deutsche or other European banks are forced to ask for a bailout there’s little doubt that tougher capital adequacy requirements will once again be imposed on global banks via the Basel Banking Supervisory Committee. This could mean further share price lowering capital raisings for all the major Australian banks.

If you don't like the banks, you could consider this ASX-listed top dividend share instead. A strong yield and potential share price gains make this an alternative investment idea in my opinion.

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Motley Fool contributor Tom Richardson owns shares of Macquarie Group Limited.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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