Deutsche Bank’s travails concerning the US Department of Justice and a settlement due to the mis-selling of mortgage backed-securities are grabbing the headlines, but, says Brian Caplen, the cause behind the bank's predicament goes much deeper.
As Deutsche Bank’s recent share price weakness is linked to a US authority's settlement demands over the past mis-selling of mortgage backed-securities, it would be easy to conclude that this is another case of a bank struggling due to past misdeeds.
But this would be the wrong conclusion. Deutsche Bank’s troubles reflect rather the poor banking environment in Europe in general and the industry-wide search for a viable business model, which is a challenge for Deutsche in particular.
While there has been open discussion about whether the bank might need – and whether it would receive – German government support, an analysis of the balance sheet shows that on the basis of capital and liquidity – the two critical issues for sustaining a bank – Deutsche has few concerns. Core Tier 1 is at 10.8% and it has €215bn in liquidity reserves. This core Tier 1 ratio is many times higher than those of banks that got into difficulties during the financial crisis.
The problem for Deutsche, along with many other banks, is profitability and this will remain the case regardless of whether the settlement with the US Department of Justice is $14bn or a more realistic $5bn. Second-quarter pre-tax profits, for example, were down 67%, prompting CEO John Cryan to promise to be even more ambitious in the speed and intensity of current restructuring.
The headwinds are negative interest rates in the eurozone, which hurt bank margins, slow economic growth and the impact of regulation. On top of this, Deutsche has to find a new path in a world where being a top investment banking player is becoming more challenging and the bank does not have a strong domestic retail business to fall back on.
Deutsche does have a strong payments and transaction banking business, although negative rates impact on this too. It is busy offloading non-core assets such as the insurance business Abbey Life and a stake in Chinese lender Huaxia. It wants to sell domestic operation Postbank too.
But that still leaves the question of how best to position the investment bank. Deutsche needs an investment banking model that is simple and easy to understand and based on the needs of European corporates. This should probably be its focus, more than globally, where it is falling behind. It fell out of the Coalition table of top five investment banks in September. At a time when European companies are being encouraged to use capital markets rather than bank borrowing this should be doable but in the current environment Deutsche does not have time on its side.
Brian Caplen is the editor of The Banker.
