When it comes to speculation about German government support for Deutsche Bank, Chancellor Angela Merkel has no good answer.

After years spent leading the push for new European Union rules to contain banking crises without putting taxpayers on the hook, you might expect Ms Merkel to rule out state aid for Deutsche Bank. She hasn’t, even though that would be politically expedient with an election looming next year.

Confronted with ailing banks, Ms Merkel and other EU leaders face a quandary. Markets assume they won’t deploy their biggest weapon – bail-in, or imposing losses on private investors – when it comes to a giant such as Deutsche Bank because of the risk of contagion. Yet policy makers are also increasingly ambivalent about the bloc’s solution for too-big-to-fail banks, largely for the same reason.

“There’s a good chance if Deutsche Bank was to go under there would be a series of bail-ins that would affect not just the German economy and the German financial system, but the entire European financial system as well,” said Megan Greene, chief economist at Manulife Asset Management. As a result, “you could end up seeing leaders decide they’re not going to comply with bail-in rules”, she said.

Ms Merkel’s dilemma concerning Deutsche Bank, whose shares have fallen almost 50 per cent this year, can be seen in the government’s reticence to put the issue of state aid to bed.

Speculation about Deutsche Bank’s health was stoked last month when it received a $14bn (£11bn) claim from the US Justice Department to settle an investigation into the firm’s sale of residential mortgage-backed securities. Analysts said the bank might need to raise capital even if the amount of the fine came down.

In Berlin, lawmakers became concerned and talk of government intervention swelled. A response of sorts followed when Focus, a popular weekly news magazine, reported – citing unidentified officials – that Ms Merkel had ruled out state assistance. Deutsche Bank’s shares took another tumble.

Asked about the Focus report at a press conference, however, government spokesman Steffen Seibert neither confirmed nor denied it: “There are no grounds for such speculation,” he said. A day later, Merkel also sidestepped the question, saying only that the government wants companies having “temporary difficulties” to “develop well”.

John Cryan, Deutsche Bank’s chief executive officer, told the Bild newspaper that raising capital “is currently not an issue”, and accepting government support is “out of the question for us”. The bank had liquidity reserves of €223bn (£196bn) as of 30 June, of which 56 per cent was in cash, according to CreditSights.

There are a lot of good reasons for Ms Merkel to keep quiet on the issue, of course. Politically she would gain nothing by promising to prop up Deutsche Bank. As her ally Hans Michelbach made clear, a bailout would “lead to a public outcry”. A firm indication in either direction from the Chancellor would also prompt a strong market response.

But the growing debate over EU bank-crisis rules also complicates Ms Merkel’s task. In the past, she has stood firm in defence of the Bank Recovery and Resolution Directive (BRRD), the cornerstone of Europe’s efforts to tackle too-big-to-fail banks. When Italian Prime Minister Matteo Renzi was hunting in the summer for a way to prop up banks, Ms Merkel insisted that he play by the rules. “We can’t do everything all over again every other year,” she said.

Now the shoe is on the other foot.

The aim of BRRD, which entered fully into force at the start of this year, was to ensure that “from now on, it will be the banks’ shareholders and their creditors who will bear the related costs and losses of a failure rather than the taxpayer”, as Michel Barnier, then the EU’s financial services chief, said at the end of 2014.

The law is intended to ensure the continuity of critical functions such as deposits and lending as the bank is restructured, recapitalised and relaunched on to the market. To do that, shareholders and creditors – all the way to senior bondholders if necessary – would be forced to take losses before rescue funds could be tapped.

For an institution of Deutsche Bank’s size, politicians would have to decide if bail-in would hurt more than a bailout.

“Somebody’s got to be hurt because there’s a loss that has to be borne,” said Charles Goodhart, director of the financial regulation research programme at the London School of Economics and a former Bank of England policy maker. “It’s a question of which is likely to be the least damaging procedure politically.”

Critics of bail-in say the risk of contagion may outweigh other concerns. “It doesn’t look good to say that we have bail-in in place when everyone knows that it can’t be used because of these systemic and contagion risks,” Bank of Italy Governor Ignazio Visco said in April.

Contagion from a bail-in at Deutsche Bank, whose stock and bonds are widely held by retail investors in Germany as well as by institutional investors across Europe, would be keenly felt.

“If you divide the loss by, say, 50 million people, it amounts to a relatively tiny amount,” Goodhart said. “If you divide the loss by 10,000 retail investors, some of whom would lose all their savings, some of whom would commit suicide rather publicly, as happened in Italy, it’s a loss that is concentrated very publicly.”

Given all the debate, leaders may have little choice but to avoid the question of whether they’ll step in to bolster struggling banks.

“Is the financial system strong enough to withstand the failure of Deutsche Bank in its current guise? I don’t think so,” said Robert Jenkins, a senior fellow at Better Markets, a Washington-based non-profit group that advocates for the public interest in finance, and former member of the Bank of England’s financial policy committee. “Would the German government bail them out if Deutsche Bank threatened a domino effect? Yes, they would. But they will not go there unless it’s absolutely necessary.”

Bloomberg