Regulators Urge Deutsche Bank To Merge With European Rival (To Spread The Pain)

Throwing a monkey wrench in rumored plans to merge Germany's two biggest banks, Bloomberg reports that Germany's financial regulators would prefer for Deutsche Bank to merge with a European rival rather than local, and just as troubled, competitor Commerzbank, setting them apart from forces in the government keen on an all-German deal.

According to Bloomberg, the ECB is favoring a cross-border combination to drive integration in the region’s financial markets, while analysis by German regulator BaFin suggests a preference for a European deal because the two domestic banks - surprise - are currently too weak to benefit sufficiently from a merger.

In other words, merging one Too Big To Fail bank with another would only result in a teetering behemoth that will need an even greater bailout when the next financial crisis hits. And by "sharing" the combined liabilities of the combined entity - which would likely inherit Deutsche Bank's tens of trillions in gross notional derivatives - with another sovereign, would at least ensure that German taxpayers would enjoy some dilution of the upcoming bailout pain with another European nation at some point in the coming years.

This cross-border merger strategy is also more aligned with the position of Deutsche Bank CEO Christian Sewing, who has asked for patience with his turnaround plan before embarking on any deal. The European preference, meanwhile, is at odds with some German government officials who patriotically want a "national banking champion." Both banks are key partners of the companies that make up Germany’s export-oriented economy.

Following the report, DBK shares, which have plunged 48% over the past 12 months, jumped as much as 8.2% and were up 6.6% at 7.98 euros at 4:48 p.m. in Frankfurt trading. Commerzbank, inexplicably, also climbed as much as 6.7% even though the news was decidedly negative for it as it would mean it wouldn't be "even bigger to fail."

Some more details from Bloomberg:

Late last year, the Finance Ministry asked BaFin for its data on how different merger scenarios could play out for the German banks, said people familiar with the matter.

During a strategy retreat in September, Deutsche Bank executives concluded that a merger with Swiss competitor UBS Group AG was the most favorable option among potential European partners, though they determined that the time isn’t right due to the German lender’s weak share price, people familiar with the matter have said. BaFin’s analysis came to a similar conclusion, the people said.

Meanwhile, the German regulator BaFin has insisted that it would prefer to see both German banking titans improve profitability if they are to pursue a combination. Still, some at the banking watchdog are concerned that mergers could end up working against efforts to ensure banks are no longer too big to fail, which of course is the whole point: with both banks teetering on the verge of collapse, at least according to their stock price, the whole point of the exercise is to make sure someone picks up the tabs when both eventually keel over.

Now if only someone in Europe will volunteer to be on the hook for hundreds of billions when Deutsche Bank's time finally comes...