The bank itself reckons that, were it to apply the new Basel 3 rules in full next year, instead of when legally required to do so by 2019, it would have a core Tier-1 capital ratio of 7.2%. That looks skimpy. The bank says it would have plenty of time to build up capital through earnings or that it could take steps to free up capital through asset sales. Still, the risk on many investors’ minds is that the new team may be pushed into issuing shares at a deep discount to its book value.
Regulators are also getting tougher on liquidity. Deutsche’s home regulator is BaFin, the German financial watchdog, but its biggest and riskiest trading operations happen in its London branch. Those close to the issue say that Britain’s Financial Services Authority (FSA) frets that it does not have enough direct control over Deutsche’s London operations because of European Union branching rules. BaFin approves Deutsche’s internal risk models, of which it has little other experience since Deutsche is the only complex bank it supervises. Regular trilateral sessions with the New York Federal Reserve and the FSA are supposed to give comfort on this score, but the FSA is haunted by the collapse of Lehman Brothers in September 2008, during which $8 billion of liquidity flew to America under the nose of supervisors. The FSA and Bank of England are trying to exert greater control by using their power to set requirements for branch liquidity.
Fitschen for purpose?
As well as convincing regulators on capital, the new team will have to convince shareholders about its business model. Investment banking has been the engine of profits in recent years, but this is the bit of banking where new rules bear down particularly hard (and may bite even harder if Germany were to consider a separation of retail and wholesale activities).
In their defence, Messrs Fitschen and Jain can point to two strengths. First, Deutsche was quick to appreciate that many areas, such as foreign-exchange and interest-rate swaps, were becoming volume (or “flow”) businesses where scale and low costs were paramount. By investing in IT systems to reduce transaction costs, the bank has been able to gain market share. Yet the process of consolidation is well under way; further gains will be harder.
A second strength has been the bank’s domicile in Germany, which has the lowest borrowing costs of any of the big economies within Europe: on May 23rd Germany auctioned a two-year bond with a coupon of precisely zero. Partly as a result of being in Germany and partly because it is viewed as too big to fail, Deutsche Bank is seen as having a lower risk of default than its peers. That translates into lower funding costs for its investment bank. “Can you hold it against us that we’re in Europe’s safest economy?” quips one executive.
Despite these strengths, Deutsche’s new bosses will need to rebalance the bank’s earnings towards less racy areas such as retail and commercial banking. The bank has a long-standing ambition to earn more than half of its profits from divisions other than investment banking, yet these units have struggled to grow quickly enough to keep pace with Mr Jain’s empire.
The full acquisition of Deutsche Postbank, which gives the bank a far larger retail presence in Germany, will help shift the balance. It provides the scale for Deutsche to invest in computers and processing systems that, in theory at least, would allow it to build out a cost-competitive retail bank in neighbouring countries. The bank is also investing in its global-transactions service, which helps firms process payments and manage their finances abroad. This is a growing business, particularly in Asia, and one in which only a few big banks have the necessary scale to serve big multinational firms. A third area of focus needs to be on asset and wealth management. Both are lines of business that promise relatively stable income, but which Deutsche has yet to master.
New chief executives usually have a honeymoon period in which they can reveal problems and blame them on the old management before having to prove their own worth. Mr Jain and Mr Fitschen may not have this luxury, given the acrimony surrounding their appointment, the impact of the euro crisis on confidence and familiar shareholder complaints over pay. They will be under immediate pressure to outline their plans to expand the divisions outside investment banking, while offering reassurance about levels of capital. Bankers on both sides of the Atlantic reckon that Deutsche is Europe’s most credible competitor to America’s universal-banking behemoths. But the new team is in a tougher position than that suggests.