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How France scrapping the euro could go beyond a ‘Lehman moment’

Past performance is no guide to future returns, as investors are so often told, but the French electorate runs the risk of creating a crisis worse than the fall of Lehman Brothers if it follows the U.K. in instigating a referendum on EU membership, according to analysts at Deutsche Bank.

As the French presidential race heats up ahead of the first round of voting in April, the German bank has warned of the pitfalls of using the U.K.'s Brexit vote as a model for a potential "Frexit", as touted by nationalist candidate Marine Le Pen.

Le Pen, who is currently leading the race according to the latest BVA-Salesforce opinion poll, has vowed to hold a French referendum on EU membership if she is successful in winning France's two-round leadership race. Pointing to the U.K., which has – so far – felt a relatively benign impact from its Brexit vote, Le Pen has relied on it as a basis for rallying support during her campaigning, saying: "They told us that Brexit would be a catastrophe, that the stock markets would crash … The reality is that none of that happened."

However, Deutsche Bank has warned of the inconsistencies of likening the two votes. An EU referendum in France, one of the founding members of the economic bloc, runs the risk of undermining the euro, the currency shared by 19 of the EU's 28 member states.

"Make no mistake, there is the world of difference between tearing up bilateral and multilateral trade agreements, and, unwinding a monetary union as far reaching in scope as the EMU (economic and monetary union) project," Deutsche Bank said in a note Tuesday.

"It is the difference between a benign global risk event and something that has the potential to go beyond a 'Lehman's moment'."

Chesnot | Getty Images

Turning into a 'nightmare'

The frictionless interaction enjoyed by countries within the European Monetary Union would turn into it a "nightmare", says Deutsche Bank, as a lack of a currency hedge would make all EMU members vulnerable to currency weakness.

The bank estimates that assets shared between the economic bloc plus liabilities totaled 46 trillion euros ($48.5 trillion) at the end of the third quarter 2016. This it describes as an "upper bound estimate of EMU exposure that would have no hedge, and be exposed to currency risk in the event of an EMU break-up."

In addition, foreign exchange balances, held by corporations, financials and households, while only a fraction of this figure, have the capacity to "cascade through the financial system, with unprecedented implications for global risk," according to the bank.

Investment bank Lehman Brothers is responsible for the U.S.'s largest ever bankruptcy filing, triggering the start of the 2008 financial crisis. It held assets of $600 billion – a fraction of the estimated $46 trillion at risk under a break-up of the EMU.

While central banks could be expected to step in to secure the system, as they did during the 2008 crash, the long lead times and multiple legal obstacles of an EMU break-up would do little to manage the immediate aftermath of such a wide-reaching crash, said Deutsche Bank.

"It would be tough to squeeze the toothpaste back into the tube," it said.

September 15, 2008, the day the 150-year-old Lehman Brothers declared bankruptcy.
Keith Lew | Flickr Vision | Getty Images
September 15, 2008, the day the 150-year-old Lehman Brothers declared bankruptcy.

Europe 'looking at its core again'

The likelihood of a French referendum on its membership of the EU was called further into question Wednesday when independent candidate Emmanuel Macron, who is currently seen in second place to Le Pen in first round opinion polls, formed an alliance with Democratic Movement leader Francois Bayrou.

It is thought that together the duo could achieve a lead on Le Pen, especially in the second round, which Le Pen currently has a 20 percent chance of winning, according to Teneo Intelligence figures released Wednesday.

Meanwhile, the chief executive of French multinational insurance firm AXA, Thomas Buberl, told CNBC Thursday that he was mindful of the shock Brexit vote last June, but believes the risk of a "Frexit" remains low.

"After Brexit, Europe is looking at its core again, which is the German-Franco couple. I do believe that there is a very high chance that Europe has a chance for revival so my personal view on 'Frexit' is that it is a scenario with low probability today," he said.