Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

As market-moving updates go, the Fitch Ratings downgrade of Deutsche Bank AG debt had little new to tell long-suffering investors in Germany's No. 1 lender. Shares and bonds fell only slightly, a reflection of how cheap central bank funding and better finances have masked investor fears about euro zone banks.

Nevertheless, it's a stark reminder to politicians and regulators trying to fix Germany's over-banked economy that all is not well.

Deutsche is struggling with a business model overwhelmingly exposed to balance sheet-heavy fixed income trading and investment banking, which isn't the money-spinner it was after a decade of cheap money and tight regulation. CEO John Cryan has bolstered finances and promised a leaner, more diversified bank. It will be a slog getting there with no revenue rebound in sight, as record low interest rates squeeze lending margins.

Fitch has correctly flagged these challenges, which have taken their toll on Deutsche's market valuation. While it has the third-biggest balance sheet among its peers, with about $1.8 trillion in total assets, the shares trade at one of the sector's steepest discounts to book value, at 60 percent.

Bottom of the Pack
Big German lenders have the lowest price-to-book ratios in their peer group
Source: Bloomberg Intelligence

Not everything is within Cryan's control. His strategy is right, namely to strike a better balance between investment banking and retail and asset management. Yet the tough domestic market is a sore point. Despite Germany's economic power, its 1,800 banks are fragmented and weak. If the country fails to overcome the political and business obstacles to more bank mergers -- and the signs aren't good -- that will force Deutsche to keep cutting cost. Finding a partner for Commerzbank, or other banks, would be a good step.

Ultra-low interest rates and loose central bank policy are acutely painful for Cryan too, as Fitch has flagged. While the ECB's 2 trillion-euro bond-buying program and rate cuts have eased worries about a euro zone breakup, they've dampened volatility and caused suffering for deposit-rich banks. Cryan has called for Europe's cheap money era to "come to an end." If the economic recovery falters, delaying the path to tighter monetary policy, his job will get harder still.

Sure, there's little sign of imminent crisis. Deutsche's woes are understood and it has replenished the capital base. But markets have a tendency to lose confidence at unpredictable times. Analysts at Autonomous Research recently labeled Deutsche "beyond repair."

A Small Negative
Deutsche Bank shares have held up despite a credit-rating cut from Fitch Ratings
Source: Bloomberg
Intraday times are displayed in ET.

So Fitch's warning should show politicians and regulators that there's a job left to do. Europe's banking union rules have tried to break the link between governments and lenders to try to avoid future taxpayer bailouts, but it's hard to see Germany's biggest bank as anything other than systemically important if things get shaky again. 

As such, Angela Merkel can't ignore Cryan's predicament. The best help from the politicos would be proper pro-growth policies and to clear out of the way of mergers. Unless they want Deutsche to end up being taken over.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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