The outcome of a possible merger between two German ailing banks – Deutsche Bank and Commerzbank – is not necessarily one healthy bank

Deutsche Bank managers used to boast that theirs was one of the few global investment banks to survive the financial crisis without a government bailout. That was before the scandals, the multibillion-dollar fines and the plummeting stock price. Now, a decade after the global meltdown, it looks as if Berlin may intervene after all. The market chatter is that the government will strong-arm Deutsche Bank into a merger with its Frankfurt crosstown rival Commerzbank, which also has major problems. The two banks are Germany’s largest, and the government’s most likely aim is to ensure that the country has at least one big-league lender.

In our opinion, Germany needs at least one bank that can stand up to competitors from the United States and China. Analysts and investors already warn that the sum of two ailing Frankfurt banks is not necessarily one healthy bank. But a merger in our opinion may be the least-bad option for Deutsche Bank, which lost money in the fourth quarter of 2018 and faces accusations that it facilitated money laundering. The question is if a merger of Deutsche Bank and Commerzbank would make any sense?

Here’s our look at some of the main issues.

Why are German banks currently in such bad shape?

The underlying problem is that the German banking market is overcrowded, and consumer and small-business lending is dominated by quasi-public savings banks. That makes it hard for commercial lenders like Deutsche Bank and Commerzbank to make money, even though they reside in one of the world’s most formidable economies. But the two banks are also suffering the consequences of years of management mistakes.

Commerzbank for example lent heavily to the shipping industry just before it ran into a deep recession caused by a worldwide oversupply of freighters. The bank required a government bailout in 2009 after it acquired Dresdner Bank, which turned out to have billions of Euros in toxic assets. The government still owns about 15% of Commerzbank.

Deutsche Bank, in its zeal to compete with the likes of Goldman Sachs and JP Morgan Chase, got caught in many of the big scandals of the early 2005: rigging interest rates, selling toxic mortgages, laundering money, violating sanctions, It paid billions of dollars in fines.

The bank’s reputation continues to suffer. In November 2018, German prosecutors and police officers raided Deutsche Bank’s headquarters in Frankfurt as part of an investigation into whether some bank employees had helped criminals launder money in offshore tax havens. The bank’s own inquiry uncovered no wrongdoing by employees, Karl Von Rohr, the bank’s chief administrative officer, said in February. Still, he acknowledged that the allegations drove away customers and hurt the bottom line. Accusations of money laundering “were not helpful in the fourth quarter of 2018”, Mr. Von Rohr said at a news conference. Deutsche Bank reported a net loss of 409 million Euros for the quarter, or 464 million USD. Commerzbank did far better, reporting a profit of 113 million Euro on revenue of 2.1 billion Euro. Investors, however, remain skeptical. Shares of both banks are trading near 10-year lows.

What’s the point of combining two weak banks?

German and European political leaders fear domination by the big American investment banks, which emerged from the financial crisis more powerful than ever. In times of economic stress, the argument goes; Germany will need a big bank with an international presence to ensure that German corporations still have access to credit.

But political leaders risk creating a monster that could ultimately prove costly for taxpayers. In a crisis, the government would have little choice but bail out the country’s biggest bank. The government in our opinion would be better off encouraging German companies to reduce their dependence on bank loans by issuing bonds, a common practice in the United States.

Why is the German Government getting involved?

By orchestrating a merger, Olaf Scholz, the German finance minister, may hope to raise the fortunes of his Social Democratic party, whose poll numbers have gone in the same direction as Deutsche Bank shares. Mr. Scholz has been a frequent visitor to Frankfurt recently, fueling media speculation that he is trying to act as marriage broker.

Government meddling in the economy went out of fashion in the 1990s. But it’s making a comeback as political parties try to regain electoral clout and beat back populist challengers by positioning themselves as defenders of jobs and creators of national champions. Even Angela Merkel’s conservative Christian Democrats are talking about “industrial policy”, a term that implies government involvement in company decisions.

How hard would it be to combine the two banks?

The history of German bank mergers is not encouraging. Commerzbank took years to absorb Dresdner Bank. Deutsche Bank continues to wrestle with its acquisition in 2010 of majority in Postbank, which has a large branch network in Germany. We see from Deutsche Bank and Postbank how long it takes to actually integrate information technology. This in our opinion is a major burden. Both banks have large, overlapping branch networks, which would have to be trimmed. That would not be easy. Job cuts are costly in Germany because of labor laws, and the union represents bank workers have already signaled its opposition to a merger.

There are a few areas in our opinion where the banks complement each other. Commerzbank is strong in lending to midsize German exporters. Deutsche Bank is more international and could help those companies handle foreign transactions. But the large amount of duplication would inevitably lead to turf battles. We at Calvin • Farel don’t see an economic rationale for such a merger.

Why not a merger with a foreign bank?

It might make sense for Deutsche Bank to team up with a strong foreign bank, but there don’t seem to be any takers. Deutsche Bank is currently valued by the stock market at about 16 billion Euro, half what it was worth at the end of 2017. That’s very cheap for a big bank. JP Morgan Chase generates more revenue than that in a single quarter. The lack of takeover bids suggests that potential buyers think fixing Deutsche Bank would be more trouble than it would be worth.

Can these banks make it on their own?

There have been signs of progress. Commerzbank’s fourth-quarter profit was a 50% improvement over the same period a year earlier. The bank has largely disposed of its shipping portfolio and the bad assets it acquired from Dresdner Bank.

Though Deutsche Bank reported a loss for the fourth quarter, it reported a net profit for the full year, its first since 2014. Under Christian Sewing, who became chief executive in April 2018, Deutsche Bank exceeded forgets for cutting its costs, which are too high for the bank’s revenue. So far, they have shown the cost discipline they promised – so it would be in our opinion too early to give up hope. But it would probably take years for Deutsche Bank to regain its former stature.

What would a possible new bank be called?

So far, no word on that. Deutsche Bank might signal a new, scandal-free beginning by agreeing to a name change, something like “Deutsche Commerz”. But the Deutsche Bank brand, though tarnished, still connotes more than a century of tradition and has cachet. Commerzbank is just as old and just as proud; both banks were founded in 1870.

Figuring out what to name the new beast, if it comes into existence, could be one of the toughest points of negotiation.