Deutsche Bank’s Q4 2018 results were not reassuring. In the main, a merger would present some inherent – but not unsurmountable – difficulties and would be fraught with uncertainties. But with some wise and patient steering, it would have a decent chance of being successful. Europe’s strongest economy is entitled to at least one bank with reassuring business and financial characteristics.

In a hypothetical merger, and certainly in a change from earlier periods, the fundamentally less challenged partner appears to be Commerzbank (rated A with Stable outlook by Scope) rather than Deutsche Bank (rated BBB+ with Negative outlook). Deutsche would have much more to gain from such a transaction than Commerzbank, not least via a more effective anchor in the German economy. There would be advantages to Commerzbank as well, especially in franchise diversification and securing in-house expertise and products, but to a lesser extent.

Business-model complementarities

The key rationale of a potential merger should be related to the relative complementarity of the two banks’ business models, rather than merely being a cost-reduction play. A merger would provide Deutsche with the possibility to enhance its position in Germany’s economic landscape – primarily in the Mittelstand (SME sector) which is one of the country’s economic backbones. Commerzbank has a significant market position in this sector already, and a merged group would be able to provide a broader array of products and services – primarily in wholesale and investment banking – to German SMEs. Deutsche has a broader and deeper client offering in these areas.

For Deutsche, a potential merger would ideally mean a de-emphasis of its less-than-healthy reliance on global trading revenue (where the bank in the past was a “flow monster”) and a re-focus on primary market activities in Germany and other European markets). The enhanced group would be in a prime position to become a champion in bringing a wide array of German businesses to the capital markets and providing advisory services to them. In this, it would be at the forefront of the ongoing credit disintermediation trend in Germany and elsewhere in Europe.

A potential combination would also allow Deutsche to be less dependent on the success of Postbank (a large retail-bank subsidiary which is struggling to be profitable) in strengthening its retail franchise in Germany. Commerzbank is already well advanced on the digital path, having invested heavily in this respect.

If well executed, the merger would see the birth of a national champion in Germany – a development that would be welcomed by the German government – with a proportionately less significant exposure to global trading markets where Deutsche is no longer as meaningful as it used to be and where it stands little chance of restoring its earlier position.

To be sure, boosting profitability would remain a top challenge, especially in the stubbornly difficult German market. But the new group, once the merger effects kick in, would at least no longer be an outlier to large European peers with similar business models.

Alternatives are not encouraging

One alternative to a merger with another bank is Deutsche continuing on its own. As convincing as the current top management team may be in business re-focus and cost-cutting, it is unlikely that it will be able to steer the bank towards the stronger market position and more reassuring financial fundamentals – notably heightened sustainable profitability – investors are hoping for or expecting it can one day secure.

As for a potential cross-border merger of Deutsche Bank, that would be problematic. And in any event, it is unlikely that a large non-German banking group would be up for the challenge. If anything, large European banks such as ING, Santander, BNP Paribas and others have already made inroads into the German market in a cheaper and less risky way, even if profitability in some cases remains underwhelming.

Senior ECB supervisors mention the desirability of Deutsche partnering in a cross-border merger rather than a domestic one, but their view may be influenced by their aim of seeing a wider network of cross-border banking groups across the euro area, further enhancing the rationale for strengthening the hand of cross-border bank supervisors.