Deutsche Loss Underlines European Economy’s Dependence on Banks

With its surprise report of a billion-euro fourth-quarter loss, Deutsche Bank has provided another reminder that the financial crisis has never really ended for European banks â€" raising questions about whether the Continental economy can recover before they do.

The bank announced the loss, bigger than expected and earlier than it had planned to report, on Sunday night.

Anshu Jain, the co-chief executive of Deutsche Bank, argued during a conference call on Monday that, despite the loss, “2014 will represent the turning point” in dealing with lingering problems of the financial crisis, which include a long list of legal woes and pressure from regulators to reduce risk.

If so, and if Deutsche Bank were part of a turnaround among European banks, it would be good news for the euro zone economy, which is barely growing, in part because credit is scarce.

But it may be more likely that any revival of Deutsche Bank and its big competitors, like Barclays and HSBC, will be based on growth in Asia or the United States and pass Europe by, said Kern Alexander, a professor of law and finance at the University of Zurich. The midsize banks that do much of the business and consumer lending in Europe will continue to struggle, Mr. Alexander said.

“The big global banks that are more multinational and more diverse are able to weather the storm,” he said. “The big question is, Will the banks be able to make loans and help the economy turn the corner?”

Deutsche Bank, based in Frankfurt, is one of the few European banks able to compete globally with United States giants like JPMorgan Chase or Goldman Sachs. Its currency trading business is the largest in the world. As a so-called universal bank, Deutsche Bank also has a large network of consumer banking branches and lends to businesses and consumers.

But investment banking, based largely in London and New York, still accounted for half of Deutsche Bank’s pretax profit last year, and for much of the 965 million euro, or $1.3 billion, quarterly net loss the bank reported late Sunday. Deutsche Bank attributed the loss in part to a decline in bond trading that helped reduce revenue by 16 percent, to €6.6 billion.

As investors worldwide shifted out of bonds and into booming stock markets in the last quarter, Deutsche Bank was hit particularly hard because of its focus on bonds and other fixed-income securities.

The bank also booked additional losses from lawsuits and official inquiries related to suspicions of misconduct in past years, also linked primarily to the investment bank. Deutsche Bank has been accused of being part of a group of banks that colluded to manipulate benchmark interest rates. Litigation charges subtracted €528 million from profit in the fourth quarter.

The Deutsche Bank loss showed how difficult it has been for European banks to keep pace with their American rivals, whose profits have increased sharply. Mr. Jain acknowledged in the conference call that the bank’s greater exposure to Europe, with its barely growing economy, had been a problem.

Like many banks in Europe, Deutsche Bank is also struggling with tougher regulations, which have led it to unload riskier assets and contributed to the drop in revenue.

“The trends of 2013 will likely continue,” Mr. Jain said. “We don’t see a materially better revenue picture at this point.” But he said that the company had cut costs, by simplifying its information technology systems, for example, and that the stage was set for a turnaround in 2015.

The state of banks in Europe is crucial for the economy because European companies are more dependent on bank credit than American businesses. Unlike the United States, Europe lacks a vibrant market for corporate bonds issued by smaller, riskier companies.

In a sign of Deutsche Bank’s importance as a bellwether, the earnings report weighed on other European banks. Deutsche Bank shares fell more than 5 percent on Monday in Frankfurt, and in London, shares of Barclays slid 2 percent and HSBC was down 0.7 percent.

While some of Deutsche Bank’s problems are fairly limited to the bank, others are widespread among European lenders. In particular, almost all banks in Europe are struggling to meet new capital requirements being imposed by the European Union in line with guidelines established by the Basel Committee on Banking Supervision. The rules will place stricter limits on the amount of borrowed money banks may use to do business.

The new rules have prompted banks to shed assets â€" in Deutsche Bank’s case by 29 percent since the peak in 2006, to a total still valued at about €1 trillion. The pressure for banks to cut their holdings has intensified in recent months as the European Central Bank prepares for a thorough review of bank assets, with an eye to requiring banks to confront hidden problems.

While the reduction in assets should make the banks less prone to crises, it also reduces revenue and profit.

Signs suggest that regulators have concluded that the new rules were in danger of becoming too onerous, and contributing to a credit squeeze that is particularly acute in countries like Italy and Spain.

This month, central bank chiefs and top regulators from around the world that oversee the Basel Committee endorsed changes to proposed rules that would effectively reduce the amount of banks’ own money, as opposed to borrowed funds, that they use to maintain huge stockpiles of derivative securities that they issue and trade on behalf of clients.

Because of its huge derivatives portfolio, Deutsche Bank was seen as a prime beneficiary of the revision by the Basel Committee, which sets benchmarks used by the United States, the European Union, Japan and most large countries.

But Mr. Alexander of the University of Zurich questioned whether the revision would simply allow European banks to further postpone a reckoning with damaged assets and other problems. European regulators have been much less aggressive than United States regulators in requiring banks to clean up bad loans or soured investments, and compelling them to raise more capital.

“It’s an example of the Basel Committee going light-touch,” Mr. Alexander said. “The question is, Will the banks make adjustments with the lighter touch? Or are they just putting off the inevitable where they will have to deal with these bad assets at some point?”

With regards to Deutsche Bank, some analysts were willing to give Mr. Jain and Jürgen Fitschen, the other co-chief executive, the benefit of the doubt.

“DB management deserves credit for moving ahead with resolving some outstanding litigations and running ahead of schedule” in reducing risk, analysts at JPMorgan wrote in a note to clients Monday.

In many ways, Deutsche Bank is better off than many of its European peers because of its base in Germany, where the economy is solid. Banks in countries like Spain and Italy have had to cope with soaring numbers of loans in or near default, a consequence of high unemployment and recession.

One area where Deutsche Bank has not had trouble competing with American rivals is in the scale of accusations of misbehavior, in most cases dating from before the financial crisis began in 2008.

Deutsche Bank agreed to pay $1.9 billion in December to settle claims that it had defrauded the government-controlled companies Fannie Mae and Freddie Mac in the sale of mortgage-backed securities before the American real estate market collapsed. In addition, the European Union antitrust authorities fined the bank €725 million for its role in helping to rig benchmark interest rates.

Last week, Deutsche Bank suspended several traders amid investigations into potential manipulation of the $5-trillion-a-day foreign exchange market, according to a person briefed on the matter. The traders who were placed on leave worked in the German bank’s offices in New York.

Mr. Jain said on Monday that the bank had reformed the way it paid executives and begun a campaign to instill a stronger sense of ethics among employees. He said the bank was “utterly committed to a culture which ensures we don’t wind up with new problems.”

Chad Bray contributed reporting.