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Weekend reports that German Chancellor Angela Merkel had ruled out the prospect of any form of state aid in the event that Deutsche Bank’s problems become more acute have hit the share price hard this morning.

Germany’s largest bank is currently embroiled with the US Department of Justice over the mis-selling of mortgage backed securities with the latter insisting that the bank pays a $14bn fine.

While the eventual fine may not be anywhere near that much, the litany of legal problems has raised concerns about the health of one of Europe’s largest lenders and any contagion effect to the rest of Europe’s sickly banking sector.

Since its peaks last October Deutsche Bank’s share price has fallen over 60% reflecting increasing investor disquiet about its ability to deal with its problems at a time of negative rates, shrinking profitability, no dividend and the prospect of tighter capital rules. These problems have contrived to send the bank’s current market capitalisation under €15bn, and there is a concern that further declines in the share price will mean increased pressure to raise additional capital.

While one can understand the reticence of German politicians to bailout yet another bank, particularly in the lead up to an election next year, one has to question the wisdom of articulating that reluctance out loud when markets are already nervous about Deutsche Bank’s capital position.

It’s akin to a red rag to a bull or a bear given that due to its size Deutsche Bank is arguably too big to fail and markets could well look to test the German government’s resolve on that as we head into next year, with further falls in the share price below €10 looking increasingly possible, which will increase the pressure on regulators and politicians to step in, and shore up confidence.

We already know from 2008 here in the UK how quickly sentiment about the health of an important financial institution can shift and the willingness of politicians to react to shore up market concerns about a “systemically important” financial institution.

It’s been a long hard road for the Royal Bank of Scotland here in the UK, and there is an increasing risk that unless politicians in Europe are able to react quickly to a further deterioration in sentiment that some banks in Europe could well go the same way.

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