Deutsche Bank – the name in the latest headlines for all the wrong reasons. The Bank survived the Global Financial Crisis (GFC) and then the European Financial Crisis, however, was riddled with fraudulent activities and has been the subject of several criminal investigations, with fines to the tune of billions of dollars paid over the past decade. The new CEO, Christian Sewing, is tasked with ensuring the Bank’s survival – and his plan seems to be the most aggressive compared to previous CEOs. Sewing’s restructuring proposal involves watering down its investment banking operations and getting rid of a fifth of its global workforce, meaning 18,000 employees will lose their jobs in the near future. Will this restructuring effort truly save the Bank?
For decades, Deutsche Bank has worked in close proximity with the important sectors of the Germany economy. However, due to the growth of the global finance capital, this business model was rendered redundant in the 1980s. Adapting – Deutsche Bank restructured themselves into a global investment bank and sought to increase their competitiveness in the global context by targeting their rivals, in particular its American counterparts. In this process, Deutsche Bank also allegedly began mirroring some criminal activities of their competitors; and this laid the foundation of its bleak future.
In 2007, Deutsche Bank’s share price used to be more than $120. However, the company has been struggling to profit post the GFC, with the share price dropping to below $20 in 2009. To date, the Bank has spent around $18.3 billion in fines and legal settlements. According to Bloomberg, it is the largest bill for any European bank after Royal Bank of Scotland Group Plc. ($18.5 billion). $7.2 billion of the total amount was due to its involvement in the GFC. Exchange rate manipulation, precious metals’ price manipulation, and laundering billions of dollars out of Russia, are some of the illegal activities which the bank was involved in, and they were a direct contributor to the GFC.
Post GFC, Deutsche Bank has been led by 5 different CEOs. In 2015, previous CEOs John Cryan and Anshu Jain announced ‘strategy 2020’, a plan which included cost reduction strategies and a capital strength improvement that aimed to result in a post-tax return on tangible equity greater than 10% by 2018. However, in 2017, the Bank’s promise to recover its lost market share looked very unrealistic in spite of cutting bonuses and raising additional capital; which then led the Bank to appoint its new CEO, Christian Sewing.
A detailed look at the scandals and controversies
Deutsche Bank’s recent history is riddled with controversy and unethical practices. The first of those is closely related to the GFC. After the crisis of 2007, the global financial industry was left crippled. Global earnings of all investment banks fell by 40 per cent between 2007 and 2009 and their profits were halved. Global cross-border capital flows fell by 60 per cent driven by the collapse in international lending. A strict monetary policy and increased demand pushed down the yields on safer bonds caused a dip in earnings. Several years later it was unearthed that the only reason that Deutsche Bank withstood the GFC turbulence was through the concealment of a $12 billion USD loss which helped to avoid a government bail-out.
It is believed that the LIBOR (London Inter-bank Offer Rate – the interest rate at which global banks lend to one another in the short-term) scandal is potentially the instigator to Deutsche Bank’s downfall. The incident involved Deutsche Bank employees – traders, managing directors and a vice-presidents- across Europe, North America and Asia – who were charged with manipulating the LIBOR between 2004 and 2015. Even the bank was fined $2.5 billion USD in April of 2015. Since the LIBOR is a ‘trimmed average’ of inter-bank lending rates ‘submitted’ by major banks and financial institutions, many of the world’s largest banks including Deutsche Bank were colluding to report artificially low rates for almost 11 years before the scandal was uncovered. With a lower discount rate, Deutsche Bank employees were able to inflate the value of their trading books, investments and projects. To make matters worse, the German bank faced financial penalties for financing terrorism. Deutsche Bank helped execute more than 27,000 transactions worth $10.86 billion USD and was punished by the US authorities for it.
Earlier this year, it was reported by the New York Times that suspicious activity was flagged in relation to the financial transactions of the US President Donald Trump and his son-in-law Jared Kushner in 2016 and 2017. This investigation is still ongoing and a group of U.S. Senate Democrats has urged the Federal Reserve to investigate Deutsche Bank’s relationship with Trump and Kushner. In 2017, Deutsche bank was fined another $700 million USD in relation to allowing money-laundering from Russia which allowed illegal money transfers across the US, the EU and Asia.
Another significant recent event is the end of the merger talk between Germany’s two largest commercial banks (Deutsche Bank and Commerzbank) Excessive risks and costs, such as job losses and concerns among investors were cited as the reasons for the deal to have fallen through. The time and resources spent on six weeks of high level, unsuccessful negotiations have raised questions about the future direction of these two banks.
The Restructuring Plan
In July 2019 Deutsche Bank announced its plans to enact transformative change. With this announcement, it seems that the bank is reaffirming its commitment to stability. It is reorganising its strategic goals, focusing on core Corporate and Retail operations and moving away from high-risk instruments in its Investment Banking division. It has announced plans to shut down the Equity Sales and Trading divisions and establish a new Capital Release Unit, ensuring risk factors are at a sustainable level.
With the goal of reducing operational risk, Deutsche Bank’s controversial decision to eliminate its Equity Sales and Trading divisions is rather understandable. With equities and commodities being among the most volatile financial instruments, divestment in these divisions is consistent with their goals. This move comes after UBS and Credit Suisse also restructured in 2012 and 2015 respectively to alleviate the pressure of uncertainty. However, the human sacrifice as a result of these decisions will be tragic. Over 3 years, Deutsche Bank will cut 18,000 jobs, sacking entire teams in their Hong Kong and Sydney offices, totaling to one-fifth of its global workforce.
Another key aspect of the restructure is the establishment of a Capital Releases division, that is corporate-speak for what’s known as a ‘bad bank’ – a division created specifically to lose money. The Bank plans to transfer 74 billion EUR in risk-weighted assets, with the aim of reducing this number to less than 10 billion EUR by 2021. It is important to note that ‘risk-weighted assets’ is a creative accounting metric by which the value of assets is multiplied by its risk (probability of generating a return). For example, cash and risk-free securities may have a zero weighting while assets with exposure to capital markets (e.g. options) may have a 1.25 weighting. Using this metric ensures that the intangible value of assets is being expressed in some form. By placing all undesirable assets into a single division, Deutsche Bank is effectively recognising on their books that the assets are impaired and positioning itself to record an impairment loss. The task for the Capital Releases division will be to balance the trade-off between minimising losses and quick sale.
The way ahead
The restructuring efforts of Deutsche Bank seem feasible on paper, but only time will tell if the Bank can make a return to generating a net profit. After UBS, Deutsche Bank is the second European bank that has decided to shrink its global investment banking operations. On the other hand, American investment banks have been growing from strength to strength in the past decade. Australia may soon lose some investment banking jobs, but these banks perform a crucial role of purposefully directing and distributing credit in the economy. For this reason, Deutsche Bank’s restructuring does not signal trouble for investment banks all over the world. However, it does signal once again to the world that when your house is not in order, even global giants like Deutsche Bank can find themselves fighting for survival.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
