Germany: The Ebb and Flow of an Economic Powerhouse II - Deutsche Bank’s Past Might Come Back to Haunt its Recent Success

Deutsche Bank in Hamburg, Germany (Photo: Tony Webster, CC BY 2.0, via Wikimedia Commons)

The past two and a half years have represented a tumultuous period for Europe’s economic powerhouse, which began with the outbreak of the COVID-19 pandemic. With countries halting economic activity and imposing restrictions to quell the spread of the virus, many German companies were hit hard as their revenues collapsed before them. Just as markets were rebounding off the back of a successful vaccination programme, Germany received another shock owing to Russia’s invasion of Ukraine in February 2022. With the West waging economic warfare on Russia, which has weaponised energy supplies in retaliation, Germany is on the brink of a financial crisis. How are German businesses coping in such turbulent conditions? What other issues might they have to contend with? All this, and more, shall be explored in my column.

By all accounts, the past three months have seen a resurgence in the financial performance of Europe’s largest banks. Arguably, Deutsche Bank has stood out above the rest, with its pre-tax profit more than doubling to €1.6bn in the third quarter, significantly exceeding the expectations of analysts. For Germany’s largest lender, all this seems like a far cry away from last July, when it was abandoning plans to cut costs and issuing warnings about a challenging second half to the year. However, whether Christian Sewing, Deutsche’s CEO, and the rest of the management board will be resting easy off the back of such positive figures, is another matter. In truth, as 2022 draws to a close, there might yet be a few more bumps in the road for Deutsche in the new year, with its involvement in several scandals lurking in the background.

On the face of it, Deutsche looks to be in a stable position. Primarily, the bank’s profits have benefited from the interest rate hikes introduced by the European Central Bank (ECB) this year to temper inflation. Having raised rates in July and September, the ECB acted again last week by adding 75 more basis points to the benchmark deposit rate, which now stands at its highest point since 2009. This increases the cost of borrowing, meaning lenders such as Deutsche make more of a return on the loans that they issue. At the same time, the interest that you or I might receive from a savings account increases at a slower rate, thereby widening profit margins. To be sure, rate rises are not the only reason for Deutsche’s improved fortunes of late; revenues within its investment banking division, which earns commission by helping clients buy and sell fixed-income securities (bonds), grew as trading in this asset class jumped by 38% in the third quarter. In short, Deutsche is reaping the rewards of hawkish central banks and volatile markets, but this could attract attention from the German government who might demand a slice of the cake via a windfall tax on lenders.

Such a tax, however, might be the least of Deutsche’s worries, following the raid of its Frankfurt headquarters by German authorities two weeks ago, who were searching for more information concerning the bank’s involvement in ‘cum-ex’ tax fraud. The scandal first emerged in the media in 2017 and has since sprawled across Europe, implicating huge names like Barclays and Macquarie along the way. Without delving too deeply into the complex legal details, a ‘loophole’ allowed investors to claim tax refunds from European governments on a stock’s dividend payment, even though no tax had been paid to begin with – almost like tricking someone into giving you £5 by saying you gave them the same amount last week. The Federal Ministry of Finance estimates that, between 2001 and 2011, the German government lost around €3.9bn through such fraudulent tax refunds, and last year the Bundesgerichtshof, Germany’s highest court, ruled that such transactions have always been illegal. Now, Deutsche’s involvement in the scandal is somewhat murky; in 2015, an internal report found that the bank actively disregarded its regulatory policy and advised clients that specialised in cum-ex trading, earning itself generous fees as a result. Perhaps worse, Deutsche reportedly held a 5% stake in cum-ex focused Luxembourg Financial Group Holding between 2008 and 2011, meaning it potentially funded these illicit deals directly. While Deutsche has consistently tried to put the matter to bed, agreeing to contribute to the €60mn sum offered by BNY Mellon and Warburg Group to German tax authorities, the recent raid highlights that the cum-ex story has not reached its conclusion just yet. What the public prosecutors will find is anyone’s guess – Deutsche can only hope its reputation as one of Europe’s leading banks will not be irreparably tarnished.

And to think, that was not the first raid connected to Deutsche this year. On top of cum-ex, the bank’s independent asset management arm, DWS, was raided in May by public prosecutors and BaFin, Germany’s financial regulator, as part of an ongoing investigation into its use of ‘greenwashing’. This is a broad term which relates to deliberately misrepresenting certain investments so that they seem more sustainable, or ‘greener’. The raid came in response to allegations made by Desiree Fixler, former head of sustainability at DWS who lost her job in 2021. She claims that the asset manager knowingly overstated the ESG (environmental, social and governance) credentials of some portfolio companies. For example, Fixler recounts how Wirecard, the German payment processor which forged client details to secure €900mn, was awarded the second highest rating for sustainable governance. While DWS denies any wrongdoing, the optics of the raid were so damaging that its CEO, Asoka Wöhrmann, was forced to resign just hours after German officials had left the firm’s premises in Frankfurt. Wöhrmann had come under scrutiny earlier this year for his alleged use of a third-party platform, WhatsApp, to communicate with clients without being monitored, but the greenwashing accusations proved to be the final straw. As the majority owner of DWS, Deutsche will be concerned as companies seeking compensation continue to come forward, with a German consumer group announcing last week that it is suing DWS on the grounds of misrepresenting green marketing materials. Clearly, the issue will not go away, and could cause Deutsche further embarrassment, if not worse.

Of course, it is difficult to judge how the cum-ex and greenwashing scandals will affect Deutsche as we head into the new year, or whether the German government will turn to a windfall tax on lenders to help fund its costly energy package. It shall be a nervous waiting game for Sewing and Co, who will hope that Deutsche’s recent strong performance signals the start of a new chapter after the turmoil of 2022. However, despite the positivity surrounding European banks right now, there might still be some skeletons in Deutsche’s closet that it does not want exposed.