DEUTSCHE BANK is one of the financial industry’s hardest problems. It is not a viable business when judged by any sensible yardstick, because it is unable to make enough profits to generate a remotely adequate return. Its existence does not seem to be in the public interest, since it is dominated by an investment bank that has paid its lucky staff a colossal €40bn ($49bn) over the past decade. The bank’s governance has misfired for ages. On April 8th Deutsche fired John Cryan, its chief executive, in the third regime change in seven years. If the rules of capitalism apply to banks, Deutsche should be wound down. Is that possible?
Deutsche was founded in 1870 to help German companies go abroad. In 1999 it bought Bankers Trust, a Wall Street firm, and went on a long expansion in the investment-banking business. Today it has four elements. A decent asset-management operation called DWS; a profitable payments business that ships money around the world for companies; a mediocre German retail bank that uses the Postbank and Deutsche brands; and a faltering global investment bank that soaks up half of the bank’s capital.
The bank’s profitability has been dismal. Over the past decade its average return on equity (ROE) has been 5%; it was 2% last year. These figures exclude the cost of fines and goodwill write-downs and assume that today’s capital levels were always in place. Shareholders have almost lost hope, valuing the bank at 0.4 times its book value, roughly where American banks were during the 2007-08 crisis. Creditors have not panicked, but have got gloomier this year. They think that Deutsche is riskier than other banks, judged by the cost of insuring its debt against default.
The bank’s troubles reflect weak businesses but also weak governance. Paul Achleitner, the chairman since 2012, has presided over chaos. As a German company, half of the supervisory board are staff representatives, who may have opposed deeper cost cuts. As Deutsche has drifted, its shareholder register has become bizarre. Its largest investors include HNA, a Chinese tourism conglomerate loaded with debt, and funds linked to Qatar’s royal family that lack an established record of stewardship.
Deutsche offers two defences. First, that it has a plan to restore profitability. Not really. To make a passable ROE it needs to generate pre-tax profits of €7bn a year, compared with the €1.5bn it managed last year. Planned cost cuts are not nearly deep enough to close the gap. Deutsche’s weakness is structural. The German retail operation is badly run and has to compete with state- and mutually owned banks that do not care much about profits. The investment bank, meanwhile, has decent market shares in some activities such as currency dealing, but is unable to cover its massive overheads. One way to demonstrate this is to compare it with its big four rivals, Goldman Sachs, and the investment-banking units of JPMorgan Chase, Citigroup and Bank of America. Deutsche’s division is less than half their size in terms of its revenue. Yet it spends a similar sum—$9bn—on non-compensation expenses such as fees and IT.
Deutsche’s second defence is that it is indispensable to Germany. That is debatable. The investment bank books only 5% of its revenue in Germany. Deutsche’s corporate-loan book in the country is only about €40bn, equivalent to 5% of the total debt of all the country’s listed firms, and only twice as big as JPMorgan Chase’s German book. The payments business has a better case, with a quarter of its business from German customers.
Any benefit that Deutsche brings to Germany should be weighed against the potential cost to the government of hosting a barely profitable bank that relies on wholesale funding. During the subprime and euro-zone crises, the benefit to Deutsche of having an implicit government guarantee was worth billions of euros a year. Germany has a new “bail-in regime” that is meant to protect taxpayers and eliminate subsidies by imposing losses on bank bondholders. But it has never been tested in an emergency.
No one would recreate Deutsche. Breaking it up would take several steps. DWS could be spun off or sold. The retail bank could be merged with Commerzbank, another German lender, in a government-blessed deal. The payments business could be sold to the likes of BNP Paribas, a solid euro-zone bank that took on the global payments arm of Royal Bank of Scotland in 2015.
Its investment bank would need to be wound down responsibly over ten years, reflecting the long life of some of its positions. For example, 16% of its €42trn of notional derivatives have a maturity of over five years. Revenues might fall faster than costs, resulting in losses. There would be redundancy costs for 30,000 staff. And regulators would allow the capital trapped in the business to be released only gradually. It would be messy. But the net present value that shareholders would recover from the investment-banking division could be roughly €15bn. While that is only half of its book value, it is more than investors attribute to it today.
The hardest job in finance
The new boss is Christian Sewing, a lifetime employee who has worked across the bank. It is unlikely that he will dissolve the institution he owes his career to. But he should, at a minimum, halve the size of the investment bank, push the authorities for a new supervisory board and attempt to merge the retail operation with Commerzbank. He should find new shareholders—one option would be to persuade a good bank, such as BNP, to buy a stake, in order to provide a credible force on Deutsche’s board.
The danger is that Deutsche just staggers on, cloaked in patriotism and paying only lip service to making an adequate ROE. Germany’s politicians protest that they will never bail out Deutsche but they probably want one big German bank that is active abroad, just as they did back in 1870. That is a slippery slope. The world’s best-run lenders, such as JPMorgan Chase, are safe because they are disciplined enough to crank out high and stable profits. A bank that cannot pay its way is no champion at all.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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