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On Monday, July 26, a memorable exercise in market power and the power of persuasion of those who favor financial market transparency took place. It came in the form of the last 7 remaining EU banks out of the total of 91 participating in the stress test reluctantly releasing their individual exposures to European sovereign debts. The "Shamed Seven" included 6 German banks—Deutsche Bank, Landesbank Berlin, Hypo Real Estate (failed the stress tests), DZ Bank, WGZ Bank, and Deutsche Postbank—as well as one Greek bank that had also failed the stress tests: ATEBank.
Why these 7 banks did not immediately follow the 84 other banks is an open question. It was especially strange for Deutsche Bank to stigmatize itself over a lack of transparency, especially since the newly published data shows that—quite unlike other banks—Deutsche Bank had most of its European sovereign debt exposure in its "trading book," which means that it has been marked to market anyway. Appropriately, Deutsche Bank was punished at the opening of the markets on July 26 with a multipercent percent decline in its stock price, while the price of its more transparent German peers rose.1 Justice done!
It should be noted though, as discussed during the Deutsche Bank Q2 results analysts' conference call, Deutsche Bank's total sovereign exposure to Greece is volatile. According to the Deutsche Bank CFO, by June 2010 it had declined to just €500 million, from the higher number reported according to the Committee of European Banking Supervisors (CEBS) definition for March 31, 2010. Similarly, an earlier June 10, 2010, presentation from the Deutsche Bank Chief Risk officer2 included some data on their Greek exposures, though it is not clear what definition was used and to what degree it is consistent with the CEBS disclosure requirements. Still—why didn't Deutsche Bank simply do what everyone else did on July 23?
So what information was initially withheld—and were there any skeletons to be found here? With the new information, we now have the location on EU bank balance sheets of about €107 billion of Greek sovereign debt, of which just over €94 billion (88 percent) is allocated in the banking books of the 91 participating banks.3 Forty-five billion euros—or 42 percent of the €107 billion—resides on the balance sheets of the six participating Greek banks.
Starting the skeleton hunt with the Greek ATEBank, the answer is "no." It predictably had only Greek sovereign debt and a little bit of Romanian sovereign debt. Deutsche Bank had (mostly on the trading book, as noted) an immaterial €1.7 billion in gross exposure and just over €1 billion in net exposure to Greek debt.
One bombshell, however, was the almost €8 billion in total exposure to Greek sovereign debt in the already failed Hypo Real Estate (HRE). With these new data, it is clear that HRE is the winner of the sovereign debt crisis' "Bigger Fool Contest"—no doubt much to the regret of German taxpayers, who have already had to bail it out.
Among the other German banks, there was about €600 million in exposure at WGZ Bank, which in a 100 percent Greek default scenario, as modeled here on RealTime earlier this week, would be enough to lower its Tier 1 capital level to just 6.4 percent. The roughly €400 million exposure of Landesbank Berlin would not, in a Greek default scenario, have had a noteworthy effect in its Tier 1 ratio, something also true about the approximately €1.1 billion exposure of DZ Bank to Greek sovereign debt.
Indeed, apart from the already failed HRE, only Deutsche Postbank's €1.3 billion exposure to Greece would, in a 100 percent Greek default scenario, push it below the 6 percent Tier 1 threshold. Accordingly, Deutsche Postbank, as a weakly capitalized bank with a large exposure to Greek debt, had a clear reason to try to hide its exposure to Greek debts from publication.
It is possible that Deutsche Bank's controlling shareholding in Deutsche Postbank (up to 30 percent) made Deutsche Bank itself unwilling to publish its own sovereign debt exposure out of sympathy with its weak "subsidiary." Fortunately, transparency prevailed.
With these new data, transparency on sovereign debt exposures in the European banking system is far more complete than before. We now know that indeed the "biggest fools" are to be found among Germany government-linked banks (e.g., HRE). But we also know that they after all were not as big fools as many had expected and that their foolishness is no real threat to the solvency of Germany.
A complete list of the sovereign debt exposures of the 91 participating EU banks and the effects of a 100 percent Greek default on their Tier 1 capital ratio can be found here [xlsx].
Notes
1. Deutsche Bank's lack of disclosure furthermore made the front page of the Financial Times (US edition) on Tuesday, July 27, 2010. As a communications strategy that must count as abject failure!
2. These data show Deutsche Bank total gross exposure to Greece at €2.6 billion and €500 million in net sovereign exposure.
3. Note that most of the sovereign debt exposures are dated March 31, 2010, while some of the German banks report later.
