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What the Failure of Deutsche Bank Says About Central Banks

0 | By Shah Gilani

No, Deutsche Bank, Germany’s largest bank, hasn’t failed, as in going out of business and being shut down.

But it has failed in every other sense of the word.

What happened to Deutsche Bank is a warning.

It’s not a warning for how greedy bankers blow themselves up, though it is about that.

It’s not a warning against how easily compliance can be circumvented, though it is about that.

It’s not a warning of what one giant bank’s “failures” can do to banking across a country or Union, though it is about that.

Ultimately, Deutsche Bank’s failures are a warning about how central banks cover up failure and how dangerous they are…

Deutsche Bank Wanted to Rule the World

And it almost did.

It had most of the big industrial loan business in Germany. It had most of the investment banking business in Germany.

But that wasn’t enough.

The big bank wanted to be a global player of the first order. And it set out to accomplish that.

For all intents and purposes, the bank made it to the top of the class.

By the late 1980s Deutsche had become a huge lender everywhere.

It built its investment banking business into one of the biggest and most profitable in the world.

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It had global trading of everything: bonds, stocks, currencies, and derivatives in size, as they say on Wall Street.

By the time of the financial crisis, Deutsche Bank was “a player” and a force to be reckoned with.

But there was rot everywhere.

The crisis exposed it and then some.

The short version of what happened to Deutsche is that it grew too quickly, paid too much for bankers and traders, gave them all too much leeway, made excessively large bets across the board, got in over its head in too many areas where it wanted to jump out in front of competitors, especially big American competitors Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, JPMorgan Chase, and the cowboys running roughshod over Wall Street and Main Streets.

So many of Deutsche’s systems – its compliance systems, its technology systems, its management systems – were all flawed. Critics say they were patched together and never up to date given the bank’s size and scope.

The monster came out during the financial crisis.

In the end, and there were to be many ends, including a new end just started, Deutsche Bank’s failures led to a spiral of declining revenue, out-of-control expenses, decimated credit ratings, and constantly rising funding costs.

Leadership changes and management shake-ups couldn’t reverse the bank’s slide.

On top of increased spending on outdated technology and an immense and debilitating talent drain post crisis, Deutsche had to pony up $17 billion in fines over the last ten years.

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While that was happening, adverse market conditions compounded unrelenting homemade difficulties.

Just last week Deutsche Bank put forward another plan to right itself.

In a prepared statement for the world, CEO Christian Sewing said, “Today we have announced the most fundamental transformation of Deutsche Bank in decades. We are tackling what is necessary to unleash our true potential: our business model, costs, capital and the management team. We are building on our strengths. This is a restart for Deutsche Bank – for the long-term benefit of our clients, employees, investors and society.”

He went on to say…

The Exit of Global Equities and a Significant Reduction in Corporate and Investment Banking Risk Weighted Assets

Deutsche Bank will exit its Equities Sales & Trading business, while retaining a focused equity capital markets operation. In addition, the bank plans to resize its Fixed Income operations in particular its Rates business and will accelerate the wind-down of its existing non-strategic portfolio. In aggregate, Deutsche Bank will reduce risk-weighted assets currently allocated to these businesses by approximately 40%.

The bank will create a new Capital Release Unit to manage the efficient wind-down of the assets related to business activities, which are being exited or reduced. These assets and businesses represented EUR 74 billion of risk-weighted assets and EUR 288 billion of leverage exposure, as of 31 December 2018.

A Significant Restructuring of Businesses and Infrastructure

Deutsche Bank will implement a cost reduction program designed to reduce adjusted costs to EUR 17 billion in 2022 and is targeting a cost income ratio of 70% in that year.

To facilitate its restructuring, Deutsche Bank expects to take approximately EUR 3 billion of aggregate charges in the second quarter of 2019, of which approximately EUR 0.2 billion would impact Common Equity Tier 1 capital. These charges include a Deferred Tax Asset write-down of approximately EUR 2 billion and impairments of approximately EUR 0.9 billion. Additional restructuring charges are expected in the second half of 2019 and subsequent years. In aggregate, Deutsche Bank currently expects cumulative charges of EUR 7.4 billion by the end of 2022.

Managing the Transformation Through Existing Resources

Deutsche Bank management intends to fund its transformation from its existing resources without requiring additional capital. This reflects the bank’s current strong capital position as well as management’s confidence in the high quality and low risk nature of the assets, which it is exiting. In connection with these decisions, the Management Board intends to recommend no common equity dividend be paid for the financial years 2019 and 2020. The bank expects to have capacity for payments on additional tier 1 securities throughout the transformation phase.

Updated Capital and Leverage Targets

The Management Board believes that the future business mix is consistent with a lower capital requirement. After consultation with the bank’s regulators, the bank now intends to operate with a minimum CET1 ratio of 12.5% going forward. As a result of the significant deleveraging actions, the bank targets a fully-loaded leverage ratio of 4.5% by the end of 2020 rising to approximately 5% by 2022.

Improving Broken Internal Controls

Deutsche Bank is committed to investing a further 4 billion euros in improving controls by 2022. The bank will combine its Risk, Compliance and Anti-Financial Crime functions to strengthen processes and controls while also increasing efficiency. To reshape and improve its long-term competitive position, the bank will undertake a restructuring of its infrastructure functions, which include back office systems and processes that support all business divisions. These functions will become leaner, more innovative and more digital.

A separate Technology function will be created which will have responsibility to further optimize Deutsche Bank’s IT infrastructure. It will also drive the digitalization of all businesses. This is set to boost innovation as well as further strengthen the internal control environment. The bank will make targeted investments in technology and innovation, utilising a budget of 13 billion euros by 2022.

“In refocusing the bank around our clients, we are returning to our roots and to what once made us one of the leading banks in the world. We remain committed to our global network and will help companies to grow and provide private and institutional clients with the best solutions and advice for their respective needs – in Germany, Europe and around the globe. We are determined to generate long-term, sustainable returns for shareholders and restore the reputation of Deutsche Bank.”

The bank’s “radical overhaul” to refocus on clients includes closing most of its trading unit and splitting off €74 billion of its “assets” as the struggling lender calls them into a “bad bank.”

“These actions are designed to allow Deutsche Bank to focus on and invest in its core, market leading businesses of Corporate Banking, Financing, Foreign Exchange, Origination & Advisory, Private Banking, and Asset Management”, the bank said in a Sunday statement.

The “radical transformation” as published by the bank includes:

  • Creating a fourth business division called the Corporate Bank which will be comprised of the Global Transaction Bank and the German commercial banking business.
  • Exiting the Equities Sales & Trading business and reducing the amount of capital used by the Fixed-Income Sales & Trading business, in particular Rates.
  • Returning 5 billion euros of capital to shareholders starting in 2022, facilitated by a new Capital Release Unit (CRU) to which the bank plans initially to transfer approximately 288 billion euros, or about 20% of Deutsche Bank’s leverage exposure, and 74 billion euros of risk weighted assets (RWA) for wind-down or disposal.
  • Funding the transformation through existing resources including maintaining a minimum Common Equity Tier 1 ratio of 12.5%. The bank expects to execute its restructuring without the need to raise additional capital.
  • As a result, the bank’s leverage ratio is expected increase to 4.5% in 2020 and approximately 5% from 2022.
  • Reducing adjusted costs by 2022 by approximately 6 billion euros to 17 billion euros, a reduction by a quarter of the current cost base.
  • Targeting a Return on Tangible Equity of 8% by 2022.
  • Investing 13 billion euros in technology by 2022, to drive efficiency and further improve products and services.
  • Investing 13 billion euros in technology by 2022, to drive efficiency and further improve products and services.

For more on the specifics of the bank’s transformation, see the side bar…

At the end of 2017 Deutsche had 94,400 employees worldwide.

It’s already down to about 91,000 and announced 18,000 plus more layoffs as part of its resizing.

Cutting head count isn’t going to help Deutsche Bank face the mounting legal woes its facing.

Besides the more than $17 billion in fines that Deutsche Bank’s paid over the past decade, it faces Justice Department investigations into charges of money laundering, foreign corruption, and its role in the $6.5 billion 1MDB Malaysian scandal, where $4.5 billion was siphoned off with help from crooks at Goldman Sachs and possibly Deutsche Bank.

As bad as Deutsche Bank has been, as poorly managed as its been, as criminal as its been, as much money as the bank’s lost, it’s been protected and backed all along by German politicians, German regulators, and most importantly, the European Central Bank.

All the issues facing Deutsche Bank affect almost every other European bank.

The European Central Bank is expected to hold interest rates near zero into 2020, precisely because European banks are such a mess. They all need the lifelines that the European Central Bank can give.

None of the banks a decade after the financial crisis should be on life support.

If there was no European Central Bank, the weak links would have been broken off (of course with lots of pain), but mergers and new capital requirements and safeguards would have been put in place.

European banks would be in much better shape and the Eurozone would have better access to capital form its banks.

None of that’s been allowed to happen. That’s because the false god of bankers (their central bank) shepherds them through crises after crises without ever letting free markets clear the dead wood from the dying forest that’s supposed to underpin economic growth across the European Union.

That’s what Deutsche Bank’s failures says about central banking.

It’s a failure.

Sincerely,

Shah

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