Germany’s DZ Bank takes €100 million-plus swaps hit

DZ Bank, the largest central co-operative bank in Germany, has made significant trading losses from its zero-coupon interest rate swaps positions.

The bank will book trading losses of €40 million due to its interest rate swaps positions for 2002, and will write down exceptional losses expected at more than €100 million in last year’s account, also associated with the swaps.

The losses are related to zero-coupon swaps entered into by DG Bank in 1997, before the bank merged with GZ Bank in 2001. When DG Bank upgraded its trading and risk systems in 1999 to a service provided by Summit Systems, a unit of UK systems provider Mysis, swaps data was incorrectly keyed into Summit. This created a mismatch between the bank’s active and passive swaps positions.

In effect, DZ Bank has posted artificially inflated profits for the past four years with regard to its trading book. Once one of these zero-coupon swaps reached maturity a few weeks ago, DZ Bank’s internal controls identified the error. Zero-coupon swaps are off-market swaps, where either or both the counterparties makes only one payment at maturity. This means they can effectively lie dormant in the trading book until maturity triggers payment.

A DZ Bank spokesman said an internal investigation was ongoing at the bank, but to date there was no indication of malicious behaviour or any problems associated with Summit technology.

DZ Bank acts as a ‘central bank’ to around 1,350 co-operative banks in Germany that typically cater to about 15% of the retail and small to medium-sized enterprise segment of the market.

Stefan Best, a bank analyst at credit rating agency Standard & Poor’s (S&P) in Frankfurt, said the losses were unlikely to affect DZ Bank’s A-/A2 rating with outlook negative. S&P takes the robustness of the entire co-operative banking system into consideration when assessing DZ Bank’s credit rating.