February 10, 2016 7:54 am JST
Financial shock

Touchy derivatives market spreading Deutsche Bank waves

YOICHI NAGAI, NQN senior staff writer

TOKYO -- Doubts about Deutsche Bank's creditworthiness are rocking financial markets, amplified by investor insecurities about the massive global derivatives industry.

     Shares in the German bank plummeted Monday as analysts signaled doubts about its ability to make coupon payments in 2017 on debts issued to shore up its capital ratio. The shock stirred up turbulence in the U.S. stock market the same day and made waves in Tokyo on Tuesday as well.

     Deutsche Bank had announced Jan. 28 a net loss of 6.8 billion euros ($7.68 billion) for the year ended December as prolonged low interest rates sapped revenue. Costs for paring down the investment banking department also weighed on the bank's balance sheet.

     The bank's considerable holdings of derivatives have long left markets leery. Deutsche Bank had begun taking on complicated positions in the high-risk, high-reward instruments to cover enormous litigation costs incurred amid accusations of helping clients avoid taxes.

     Yet negative interest rates in Europe and now Japan, as well as stricter financial regulations worldwide, have raised headwinds to earnings by these operations. Deutsche Bank renewed efforts to shift away from the derivatives business after co-CEO John Cryan took office last year. But its holdings of the instruments remained above 1.4 trillion euros at the end of December.

Sore spot

Financial institutions must maintain large amounts of collateral when trading in derivatives. The requirements are typically met with government bonds. Yet banks begin to incur higher costs when bond yields drop below zero, with write-downs to collateral slowly eating away at capital ratios.

     The global balance of derivative instruments traded outside exchanges came to $550 trillion at the end of June 2015, the Bank of International Settlements estimates. Interest rate derivatives accounted for $434 trillion of this, foreign exchange derivatives $75 trillion and equities derivatives $8 trillion. The total is 20% below its peak at the end of 2013 but still amounts to seven times global gross domestic product. Investors are thus extremely sensitive to bad news connected to the market.

     "Stock markets are overreacting" to the Deutsche Bank news, as "the downturn in the global economy has already been mostly priced in," said Kenichi Hirayama of Tokio Marine Asset Management. Investors will soon start to consider "buying primarily blue chips on the dip," he predicted.

     Yet the effects of negative interest rates now appear to be spreading beyond pressure on banks' core operations through slimmer loan-deposit margins. An end to market turbulence remains far out of sight.

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