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Deutsche (DB) under the ECB’s scanner on leveraged transactions

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The problems have been piling up since Deutsche Bank AG DB, the latest blow being an increase in the capital requirements of its main regulator, the European Central Bank (ECB), if it fails to moderate the company’s leveraged lending to heavily indebted clients.

According to people knowledgeable on the matter, the ECB has warned Deutsche Bank that the company will likely need to hold a larger amount of equity to account for the risks associated with its leveraged loans. The regulator further noted that the German banking giant could escape the higher capital bar if it modifies those risks before the ECB sets 2022 requirements by the end of this year. .

Leverage financing is part of the investment bank’s debt origination business, which generated $ 300 million in revenue in 2020, according to data compiled by Bloomberg. According to the data, Deutsche Bank ranks seventh in leveraged loans in the United States, up from 10th last year. In Europe, Middle East and Africa, he is ranked third after gaining a level. The bank said leveraged financing activity was the main driver behind the 5% increase in debt origination income in the first quarter of 2020.

Responding to the ECB’s concerns, a Deutsche Bank spokesperson said: “We have a strong track record in the industry and take a prudent approach to managing risk in accordance with regulatory requirements.

According to people familiar with the matter, if Bank CEO Christian Sewing does not respect the ECB’s caution, the latter could authorize Deutsche Bank to apply an additional capital charge individually linked to the leveraged credit unit or impose a higher total capital limit on business risk considerations.

Final result

In recent years, the ECB has become increasingly anxious and aware of the risks associated with leveraged finance transactions, as stiff competition among banks leads to a relaxation of underwriting standards and the accumulation of capital. indebtedness.

As for Deutsche Bank, the company’s leveraged lending activity was previously the responsibility of regulators. Last year, the ECB warned that Deutsche Bank’s internal risk management framework for highly leveraged transactions was “incomplete”, and warned the lender to correct the flaws.
The regulator had also “encouraged” Deutsche Bank to suspend high-risk transactions until the ECB clears its new risk framework. However, the bank tightened its internal approval process but did not follow up on the regulator’s request to suspend high-risk transactions until the case was resolved.

Indeed, in June 2019, the sale of two risky corporate loans taken out by the bank resulted in losses of several million dollars in its American investment banking branch after the unloading of two loans taken out for private equity clients.

While Deutsche Bank’s cost containment efforts and strategic initiatives are likely to support finance in the quarters to come, litigation issues due to the bank’s past malpractice are a major concern. These could lead to higher legal costs in the future, thus hurting its bottom line.

Deutsche Bank currently holds a Zacks Rank # 2 (Buy). The company’s shares have gained around 19.5% in the past six months, outperforming the 18.4% rally in the industry.

Image source: Zacks Investment Research

Other banks facing meetings with regulators

Several banks continue to be the subject of judicial inquiries and have been charged with huge sums of money for malpractice. This can, Bank of America LAC agreed to pay a fine of $ 75 million in order to settle an investigation into the excessive fees.

Last December, Mr. Cooper Group Inc. COOP was fined $ 28.6 million to settle legal inquiries with the Consumer Financial Protection Bureau regarding certain inappropriate loan service practices committed between 2010 and 2015.

In November 2020, the major of Wall Street JP Morgan JPM was fined $ 250 million for poor risk management and internal controls over fiduciary activity.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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