C2 Deutsche Bank
C2 Deutsche Bank
C2 Deutsche Bank
On July 31, 2012, Deutsche Bank Group (Deutsche Bank) reported its 2nd quarter 2012
financial results. What made this earnings report different from the company’s past earnings
announcements was that it marked the first time after former CEO Joseph Ackermann stepped
down that co-CEOs Jürgen Fitschen and Anshu Jain would publicly address investment analysts
and shareholders on Deutsche Bank’s quarterly conference call since assuming their roles on
June 1, 2012.
The biggest question on the minds of analysts and investors was whether or not Deutsche
Bank would be able to meet the capital requirements imposed under a revised global banking
regulatory framework—Basel III. In response to the global financial crisis, the Basel Committee
on Bank Supervision, consisting of senior representatives of the G20 central banks, began
formulating the new framework in an effort to raise “the quality, consistency, and transparency
of the capital base” of financial institutions worldwide. Although approved in December 2010,
the new requirements would not take effect immediately. Rather, the various requirements would
be phased in gradually, beginning in 2013 and becoming fully implemented by January 1, 2019.
For banks, Basel III meant clearing a series of regulatory hurdles starting in 2013 that
would fundamentally change the banking industry landscape. Investors were concerned that
Deutsche Bank would need to raise fresh equity capital to meet the requirements, thereby
diluting the equity value of existing shares. In addition, profitability in the banking sector had
been in steady decline since the global financial crisis of 2008, and investors worried that stricter
capital requirements would further reduce profitability at Deutsche Bank going forward. And the
sovereign debt issues plaguing many European Union countries added more insecurity.
The uncertainty in Deutsche Bank’s future prospects was reflected in its share price. At
the close of trading on the day before the earnings announcement, Deutsche Bank shares traded
at (euros) EUR24.95, a discount of 40% from its tangible book value per share and roughly
8 times Deutsche Bank’s trailing 12-month earnings. Investors were anxious to know whether
the new co-CEOs would shed some light on how Deutsche Bank planned to meet the new
regulatory requirements, what effect Basel III would have on the company’s profitability, and
This public-sourced case was prepared by Matthew Dougherty (MBA ’12), Gerry Yemen, Senior Researcher,
Yiorgos Allayannis, Professor of Business Administration and Associate Dean for Global MBA for Executives, and
Andrew C. Wicks, Ruffin Professor of Business Administration. It was written as a basis for class discussion rather
than to illustrate effective or ineffective handling of an administrative situation. Copyright 2013 by the University
of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to
sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system,
used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying,
recording, or otherwise—without the permission of the Darden School Foundation.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-2- UV6662
what lines of business it would focus on going forward in a new banking environment. No doubt
investors would also want to know more about Fitschen and Jain’s plans for the 2010 majority
stake in Postbank, a German commercial and retail bank that was formerly a major competitor to
Deutsche Bank’s domestic commercial and retail business lines. Was that purchase an indication
of a complete return to a more conservative way of doing business and a departure from
investment banking? The earnings call was bound to be lively.
Founded at the forefront of the economic crisis of the 1870s, Deutsche Bank made its
entrance with global flair due, in large part, to Adelbert Delbruck’s actions. He had wanted to
exploit economic interdependencies between countries and circumvent the supremacy of British
banks that had dominated international foreign trade. The bank’s statute stated: “The object of
this company is to transact banking business of all kinds, in particular to promote and facilitate
trade relations between Germany, other European countries, and overseas markets.”1 Almost
from the start, Deutsche Bank diversified its banking and established international trade
financing and cross-border commercial investment banking services all in the same house—
indeed it was one of the first banks to adopt universal banking.2 In so doing, Deutsche Bank
deepened its economic links to the rest of the world.
Deutsche Bank’s global reach did not preclude its rise to prominence at its home base. As
German business activity grew, so too did Deutsche Bank as it gobbled up smaller banks that
couldn’t make ends meet during and after the 1870s economic crisis. Deutsche Bank handled
international transactions for German companies, which expanded the bank’s international reach
(most famously financing the Baghdad Railway). It was the only German bank with that
capability. And Deutsche Bank became favored for handling government-issued securities and
for government control of capital markets.3 Some of the bank’s greatest successes and failures
would take place in Germany.
Following World War I, Germany plunged into economic and political chaos and was in
frantic need of capital—Germans were seen as the enemy by many. The Treaty of Versailles (a
peace treaty) demanded that Germans pay reparations. Inflation spread through the country, and
Deutsche Bank lost many of its foreign assets. Borrowers failed to pay back debts, Deutsche
Bank had to sell holdings, and for the most part, the bank just focused on survival, which
diminished its global reach. By 1929, a series of consolidation efforts among German banks saw
Deutsche Bank merged with a longtime rival, Disconto-Gesellschaft, to become the largest bank
in the country. Yet before Deutsche Bank could regain its title as a global player, inflation hit,
and the 1930s depression followed, which devastated the banking industry—a shortage of
liquidity paralyzed banks.
1
Deutsche Bank History, “Under the Empire: 1870–1918,”
https://www.db.com/en/media/DB_geschichte_meilensteine_120dpi_en.pdf (accessed May 8, 2012).
2
Christopher Kobrak, Banking on Global Markets (New York: Cambridge University Press, 2007), 5.
3
Kobrak, 6.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-3- UV6662
During the depression, the rise of the National Socialists (Nazis) coincided with the
economic and moral fall of Deutsche Bank. As German armies invaded countries, the bank was
not far behind, expanding its holdings and opening new branches. By the end of World War II,
Deutsche Bank had transferred monies and holdings from nearly all its Jewish customers to the
German government.4
Following World War II, Allied forces occupied Germany and, depending on whether
German banks were in West or East Germany, they were broken down into smaller regional
banks, or they were nationalized. After almost 75 years of operation, Deutsche Bank was split
into 10 different banks, and the Deutsche Bank name was outlawed. Nearly 10 years later,
former parts of Deutsche Bank in Düsseldorf, Frankfurt, Munich, and Hamburg were merged and
allowed to operate under the old name, but it was a much smaller entity with regional status.
By 1958, Germany was starting to recover financially and gain a foothold as a creditor
nation again. Deutsche Bank issued its first foreign-currency bond in 44 years on the German
capital market, thereby reopening the market to international firms. Deutsche Bank’s global bank
history repeated itself as it opened branches and acquired major banks in Italy, Spain, the United
Kingdom, and the United States. Thirty years later, Deutsche Bank had expanded into 12
countries located in the Asia-Pacific region and into Canada, Brazil, Portugal, and the
Netherlands. By the 1990s, the political changes in Eastern Europe helped Deutsche Bank
establish numerous subsidiaries worldwide, and by 2001, it had acquired its way into 70
countries—it was even listed on the NYSE.
In addition to becoming a global bank again, Deutsche Bank had shifted its business
focus from traditional retail banking toward global investment banking. Beginning in the late
1990s and onward through 2000, many commercial banks began to focus on providing
investment banking services in addition to traditional commercial banking services. The goal of
adding those services was to make a bank a “one-stop shop” for any financial need a customer
might have (see Appendix 1 for a summary of activities). This concept left some asking what the
role of a bank really was—to hold deposits and lend money or to sell investments and take on a
higher risk tolerance in its activities, or both. Jain said publicly that the “universal banking model
is likely to prevail over ‘pure play’ investment banking”5 and was in the “best interests of
Germany.”6
By the end of 2002, Deutsche Bank derived a significant portion of its revenues from
investment banking activities, peaking in 2007 (Table 1). Revenues from sales and trading
increased from 30% to 42% of total revenues between 2002 and 2007, while revenues from
4
The Deutsche Bank website provides a detailed history of the bank’s activities during World War II at
https://www.db.com/en/media/DB_geschichte_meilensteine_120dpi_en.pdf.
5
James Wilson,” Deutsche Bank Wins Control of Postbank,” Financial Times, November 26, 2010,
http://www.ft.com/intl/cms/s/0/601c6480-f94b-11df-a4a5-00144feab49a.html#axzz2MD8CJYkq (accessed
February 27, 2013).
6
James Wilson, “Jain Warns Against Forced Bank Break-Ups,” Financial Times, January 22, 2013.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-4- UV6662
traditional commercial and retail banking decreased from 22% to 19%. Between 2007 and 2011,
Deutsche Bank’s revenue composition had varied significantly (Figure 1).
As of June 30, 2011, Deutsche Bank employed 100,654 people in 72 countries and
operated 3,064 branches worldwide—2,036 of which were in Germany (Figure 2).8 In the prior
10 years, Deutsche Bank significantly increased its assets dedicated to investment banking
activities from EUR640 billion at year-end 2002 to EUR1,860 billion by June 30, 2012
(Figure 3). But starting in 2010, commercial and retail bank assets had grown substantially on an
absolute and relative basis. By the time Fitschen and Jain took over Deutsche Bank’s leadership
7
Deutsche Bank’s Corporate Investments Segment related to its industrial participations in German and other
European companies.
8
“Deutsche Bank Facts and Figures,” https://www.db.com/en/content/company/facts_and_figures.htm
(accessed September 6, 2012).
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-5- UV6662
in 2012, the bank was still headquartered in Frankfurt and was one of the largest banks in
Germany—indeed one of the largest financial institutions in Europe and the world.
3,000
2,500
2,000
1,500
1,000
500
‐
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
German Branches Non‐German Branches
2,000,000
1,500,000
1,000,000
500,000
‐
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
With commercial banks already focused on providing investment banking activities and
being a one-stop shop for financial service needs, the world economy experienced an accelerated
trend in globalization. One major reason was the proliferation of the Internet in the late 1990s,
which made global communication and cross-border transactions easier to facilitate. In addition,
many corporations and investors in developed economies were pouring funds into emerging
markets in response to staggering projections for GDP growth in countries including Brazil,
India, and China.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-6- UV6662
For banks, globalization meant they had to provide a full range of commercial and
investment banking services to clients, and they had to do so in all the places their customers
were doing business. Increasingly, their customers were conducting business outside their home
countries. Additionally, most investment banking activities, especially sales and trading and asset
management, benefited from economies of scale,9 meaning they became more profitable as they
grew in size. In addition to the benefits from economies of scale, the move to being a one-stop
shop fueled the debate around a bank’s role in society. To gain new customers and maintain
existing ones, Deutsche Bank needed to provide services on a global level and secure its position
in the investment banking market (Figure 4).
Global Competition
As Deutsche Bank increased its global banking reach in international markets, several
competitors followed suit. The effects of globalization and a frenzied stock market from 2002
through 2007 increased the volume of financial transactions worldwide and had banks with little
history of activity in capital markets vying for a piece of the action. That was especially the case
with other European banks such as Barclays and BNP Paribas, which had small domestic
markets (Figure 5).
9
To illustrate that, you could imagine starting a sales and trading operation and making (U.S. dollars) USD1.00
for every trade your customers made. To provide that service, you would have to invest in computers, trading
software, office space, and employee pay. Assume that costs were fixed at USD100 per year. If your sales and
trading operation made five trades all year, the return on USD100 invested would be 5% (5 × USD1/USD100 =
5%), but if you made 50 trades for your customers, your return on the USD100 investment would be 50% (50 ×
USD1/USD100 = 50%). By spreading fixed costs out over more trades, banks lowered the total cost per trade,
making each additional trade more profitable than the last.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-7- UV
V6662
Most
M of the gains Deutssche Bank’s competitorrs achieved in global reevenues werre the
result of increased in nvestments ini investmennt banking aactivities (Fiigure 6). Ass a result, riivalry
intensifieed within thee internation
nal investmen
nt banking m
market.
Figu
ure 6. Investtment bankin
ng assets vs. investment banking revvenues, CAG
GR 2002–11..
Data
D sources: Deutsche Bank,
B JPMorgaan Chase, Ciitigroup, and
Barclays
B comppany filings.
To
T finance th he asset grow
wth on their balance
b sheeets, banks haad three prim
mary optionss: use
profits earned
e in previous
p peeriods, issu
ue new equuity capitall thereby ddiluting exiisting
shareholdders, or borrrow debt cap
pital thereby increasing leeverage (Figgure 7).
Figure 7. Industry leeverage ratios: Deutsche Bank vs. inddustry peerss total assets to Tier 1 cappital.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-8- UV6662
Until 2008, Deutsche Bank achieved remarkable growth in per-share earnings, which
grew from EUR0.63 to EUR13.05 from 2002–07, an 83% annual growth rate (Figure 8). Yet the
impressive growth in earnings masked the fact that Deutsche Bank’s increased profits failed to
come from productive assets; they came instead from its increased leverage as could be seen
with a comparison of its return on assets (ROA) with its return on equity (ROE) (Figure 9).
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
(7.61)
17.37%
15.18%
12.25%
9.02%
6.15% 6.00%
1.75%
0.05% 0.17% 0.30% 0.39% 0.47% 0.36% 0.27% 0.14% 0.20%
‐0.18%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
‐12.91%
Return on Average Assets (ROA) Return on Tier 1 Equity Capital (ROE)
In contrast, one of Deutsche Bank’s major competitors, JPMorgan Chase, had a greater
ROA over the same time period—more than twice that of Deutsche Bank in 2006. Deutsche
Bank’s ROE was almost 800 basis points higher than that of JPMorgan Chase (Figure 10).
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-9- UV
V6662
To
T achieve a higher ROE R withoutt a significcant increasee in ROA, Deutsche Bank
employed d massive leeverage, increasing its leverage
l ratiio, which resulted in siggnificant gaiins in
both ROE and earniings per shaare for a whiile; 2008 shhowed that lleverage amp mplified returrns in
both direections, as a –0.18%
– ROA A resulted in
n a EUR7.611 loss to sharreholders (F
Figure 11).
The New
w Banking Environmen
E nt and Basell III
With
W the latee 2009 Euro opean soverreign debt ccrisis yet to be sorted oout and the U.S.
economicc recovery sp puttering, ev
ven in 2012, global bankks were not eexpected to rreturn to preecrisis
profitabillity anytime soon. Invesstment bankiing businesss volumes haad been in a downward sspiral
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-10- UV6662
since 2009 with fees from deal-making activities (M&A, Equity/Debt Origination, etc.) down
25% over a two-year period. Additionally, revenue from fixed income at the 10 largest global
banks declined 25% per year since 2009 and was at roughly USD73 billion annually by 2012.10
Within that environment and with declining business volumes, the Basel Committee on
Bank Supervision officially approved a new regulatory framework for global banks called Basel
III (replacing the existing Basel II). The new requirements would effectively increase the
minimum Tier 1 equity capital requirement from 4% of risk-weighted assets to between 9.5%
and 13.5% of risk-weighted assets (see Appendix 2 for an overview of Basel II and Basel III). In
addition, the risk weights assigned to certain assets would be increased, resulting in a double
whammy, as banks would need to increase their regulatory capital to comply with the increased
minimum ratios and to offset the additional capital required with the new risk weights. Those
regulatory changes would be phased in gradually starting in 2013; full compliance was required
by 2019. The changes were expected to result in significant decreases in ROE industry-wide as
banks were obligated to employ far more common equity than they had in the past.
By July 31, 2012, Deutsche Bank had a core Tier 1 ratio11 of 10.2% and a total Tier 1
ratio12 of 13.6% based on EUR373 billion of risk-weighted assets—with ratios based on Basel II
rules. Beginning in 2013, management projected risk-weighted assets of EUR488 billion and a
core Tier 1 ratio of 7.2% with the new Basel III rules. While it would meet the minimum
requirements for 2013, it was far from the 9.5% core Tier 1 ratio that Deutsche Bank would be
required to meet by 2019 under the fully phased in Basel III rules.13
For Deutsche Bank, the naming of co-CEOs Jürgen Fitschen and Anshu Jain offered
some sense of how the company planned to navigate the new environment going forward. Prior
to being named co-CEO, Fitschen had been Deutsche Bank’s head of regional management. His
appointment was seen as a transitional one and represented the company’s desire to maintain the
bank’s close ties and influence to German political leaders, while Jain, who was previously the
head of the bank’s global investment banking operations, became accustomed to his new role
and gained fluency in dealing with German political and regulatory issues.
The measured leadership strategy was in line with Deutsche Bank’s recent business
actions as well. In late 2010, Deutsche Bank raised EUR9.8 billion in equity capital to acquire a
consolidated position (50.2%) in Germany-based Postbank to expand the company’s “strong
position in our home market, take a leading position in the European retail banking business, and
significantly enhance Deutsche Bank’s revenue mix.”14 Postbank’s deposit base would offer a
10
Ambereen Choudhury, Elisa Martinuzzi, and Elena Logutenkova, “Last Man Standing Means Europe
Investment Banks Resist Cuts,” Bloomberg, August 22, 2012.
11
Core Tier 1 Capital primarily consists of retained earnings, common shares, and paid-in capital.
12
Total Tier 1 consists of Core Tier 1 and Additional Tier 1. Additional Tier 1 includes certain types of hybrid
securities that are senior in position to Common Equity.
13
Deutsche Bank Presentation at UBS Global Financial Services Conference, May 8, 2012; Annex 4 of Basel
III: A Global Regulatory Framework for More Resilient Banks and Banking Systems (Basel, Switzerland: Bank for
International Settlements, June 2011).
14
Deutsche Bank press release, September 12, 2010.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-11- UV6662
solid funding base for Deutsche Bank. In February 2012, the company increased its stake to
93.7%.
As the newly appointed Deutsche Bank co-CEOs approached their first conference call in
July 2012, analysts and shareholders alike would be raising questions based on their own
calculations and assumptions about the business. At the start of trading on July 31, 2012,
Deutsche Bank’s shares traded at 8.2× its trailing 12-month earnings (P/E) and 0.60× its tangible
book value per share (P/TB).17 Since 2006, Deutsche Bank’s average quarterly P/E and P/TB
ratios had fluctuated widely (Figures 12 and 13). Historical ratios needed to be placed in the
context of the company’s financial strength and outlook at that point in time. For example, at
0.60× P/TB, Deutsche Bank was trading in the same range that it did during the depths of the
15
Choudhury, Martinuzzi, and Logutenkova.
16
Stats pulled from fn.dealogic.com.
17
P/E and P/TB are calculated as:
P/E = current share price/net income per common share.
P/TB = current share price/tangible equity per share.
To determine the proper P/E ratio to apply to a bank’s net income or tangible book value, an analyst must
take into account a bank’s current and projected profitability outlook as well as how its ratio compares to industry
peers. What does its ROE look like today? What will it look like going forward? Will it have to write down assets
and by how much? How does its ratio compare to its peers? Essentially, the P/E ratio prompts the analyst to ask,
“How much am I willing to pay for USD1 of this company’s earnings?”
A P/TB ratio, however, asks the analyst what he or she is willing to pay for a company’s total assets after
deducting out liabilities, goodwill, and other intangible assets. A P/TB of 1.0× means that the bank is worth no more
or less than the accounting value of its net tangible assets, while a P/TB greater than 1.0× suggests that the
company’s assets will grow its book value over time by earning profits in excess of its cost of capital. A P/TB less
than 1.0× suggests that a company is not expected to increase to earn profits in excess of its cost of capital, and
therefore book value will deteriorate over time.
Both ratios are also affected by anticipated dilutive activities such as issuing equity, which increases the
number of shares outstanding and therefore decreases the denominator of both ratios.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-12- UV
V6662
global fin
nancial crisiis in 2008 an
nd 2009. Someone woulld likely askk if that disccounted valuuation
was justified in light of the comppany’s curren
nt financial pposition andd outlook.
Data sou
urce: Capital IQ
Q.
Figure
F 13. Deutsche Ban
nk quarterly P
P/TB ratio, 22006–12.
Data source:
s Capital IQ.
In
n addition to
o historical valuation
v meetrics, analyysts would w
want to knoww about Deuutsche
Bank’s valuation
v commpared to its
i industry peers. Whatt was drivinng these muultiples? How w did
Deutschee Bank’s proofitability co
ompare to itss peers? Whaat about its leverage andd dividend yyield?
(See Tabble 2 and Ex
xhibit 2 for innformation on
o Deutschee Bank and itts industry ppeers.)
Table
T 2. Deu
utsche Bank
k valuation veersus industrry peers.
P/E P
P/TB ROA ROE Divvidend Leve
erage
LTM
M EPS 2012E EPS 2013E EPS
2 MRFQ
M LTM LTM Y
Yield Ratio
JPMorgan Chhase 8.3
3x 7.8x 6.9x 1
1.04x 0.72% 11.2% 3
3.0% 15.4x
Citigroup 7.9
9x 6.8x 6.1x 0
0.54x 0.54% 7.3% 0
0.1% 13.5x
Barclays 13.1x 10.0x 4.9x 0
0.46x 0.10% 3.1% 3
3.5% 31.4x
BNP Paribass 6.5
5x 5.5x 5.6x 0
0.54x 0.29% 9.1% 3
3.8% 31.2x
Average 9.0
0x 7.5x 5.9x 0.65x
0 0.41% 7.7% 2.6%
2 22..9x
Median 8.1
1x 7.3x 5.8x 0
0.54x 0.42% 8.2% 3
3.3% 23..3x
Deutsche Baank 8.2
2x 6.2x 5.0x 0
0.60x 0.13% 5.7% 3
3.0% 44.3x
Data sourcces: JPMorgan Chase, Citigro
oup, Barclays, and
a BNP Paribbas company fiilings.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-13- UV6662
respectively.18 That represented a sharp increase from its trailing 12-month EPS of EUR3.04. The
global economic outlook, the outlook for the banking industry, and Deutsche Bank’s future
offered little visibility. Determining an appropriate multiple or range of multiples to apply to
Deutsche Bank’s shares was going to be a difficult task.
18
Capital IQ consensus estimates.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-14- UV6662
Exhibit 1
DEUTSCHE BANK AND THE ROAD TO BASEL III
Deutsche Bank Historical Financials
(data in millions of euros, except per share)
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-15- UV6662
Exhibit 2
DEUTSCHE BANK AND THE ROAD TO BASEL III
Deutsche Bank Comparable Company Valuation and Metrics
(data in millions, except per share)
Data sources: Deutsche Bank. JPMorgan Chase, Citigroup, Barclays, and BNP Paribas company filings.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-16- UV6662
Appendix 1
DEUTSCHE BANK AND THE ROAD TO BASEL III
Overview of Commercial/Retail Banking and Investment Banking
Net Interest Income: Commercial Loans, Residential Loans, and Interest-Yielding Securities
For most banks, the largest component of revenue was net interest income. Essentially, this is the
difference between the interest that a bank paid to borrow funds and the interest that a bank was paid from
loaning funds to borrowers or buying interest-earning securities. For example, a bank would attract
savings deposits by paying depositors a small amount of interest (savings deposits interest rates were
slightly under 1.00% per year in 2012). With its borrowed funds, the bank would make loans to borrowers
(e.g., residential mortgages to home buyers, equipment loans to manufacturing companies) or invest in
interest-earning securities (e.g., U.S. treasury bonds). The difference or “spread” between the 1.00% paid
to depositors to borrow funds and the interest earned from owning U.S. treasury bonds or providing
mortgages to homebuyers was called net interest income.
In addition to net interest income, commercial banks generated revenues through fees,
commissions, and various other activities—noninterest income. Those revenue-generating activities ran
the gamut from fees earned from originating and servicing mortgage loans to charging overdraft fees on
checking accounts. Regardless of the source of that income, if it was not earned from receiving interest, it
was considered noninterest income.
When a bank loaned money, it took a risk that when due, the borrower might be unable to pay
back the loan in its entirety. To compensate for that, the bank assumed that a certain percentage of the
principal amount of the loan would not be paid back. That amount was called a loan or credit loss
provision and was charged as an expense on the bank’s income statement. The amount of the provision
was left to the discretion of the bank’s management, taking into account the borrower’s credit, the value
of the loan’s collateral, and various other factors. Because the provision was just an estimate, it was
inherently uncertain, and the actual loss on the loan could be significantly more or less than the amount
provisioned by the bank.
As was the case for any business, banks incurred expenses associated with day-to-day operations.
The largest components of these expenses were typically salaries and employee benefits, as well as
general and administrative costs (e.g., rent, utilities, insurance).
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-17- UV6662
Appendix 1 (continued)
Sales and trading activities engaged in the purchase and sale of corporate or government
securities, currencies, and derivatives (e.g., options, futures, forwards) on exchanges or in over-the-
counter (OTC) markets. Such trading, either for the customer’s or the bank’s account (proprietary trading)
generated commissions and trading profits for the firm. In addition, most sales and trading departments
had in-house securities research departments with analysts offering buy and sell recommendations on
individual securities.
A broad range of services was covered under the category of corporate finance. One of the
largest was origination and advisory services, which ranged from helping companies raise equity
(e.g., IPOs) and debt (e.g., bond sales) in public markets to advising companies in mergers and
acquisitions and restructuring activities. In addition, corporate finance included assisting companies with
other financing issues such as hedging, cash management, asset securitization, and trade financing. The
investment bank providing these services generated fees and/or commissions.
Asset Management
Asset management services provided investors (whether institutional or private) with investment
advice and portfolio construction that was tailored to meet the individual needs of each client. Sometimes
banks referred to the division as private wealth management or private banking. Regardless, investors had
varying investment goals, risk tolerance levels, and capital to invest. Clients paid fees for asset
management services that attempted to address their needs.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-18- UV6662
Appendix 2
DEUTSCHE BANK AND THE ROAD TO BASEL III
Basel II versus Basel III
The Basel Accords, published by the Basel Committee on Banking Supervision (Committee)
housed at the Bank for International Settlements, sets a framework on how banks and depository
institutions must calculate their capital. The goal of this framework is too keep banks from taking
excessive risks that threaten the safety of depositors’ funds or the stability of the financial system. In
1988, the Committee introduced a capital measurement system commonly referred to as Basel I. In 2004,
this framework was officially replaced by a significantly more complex capital adequacy framework
commonly known as Basel II. In response to the global financial crisis, Basel II would be replaced in
2013 by a revised framework called Basel III.
Although the regulatory framework is established by the Basel Committee, a bank’s national
regulator has some discretion in setting and enforcing regulatory capital requirements for its country’s
banks. For example, in the United States, this authority rests in the hands of the Board of Governors of
the Federal Reserve. In the case of Deutsche Bank, regulatory requirements are set by the Federal
Financial Supervisory Authority, or “BaFin” for short.
A bank’s regulatory capital ratio can be broadly defined as its total regulatory capital divided by
its risk-weighted assets (regulatory capital/risk-weighted assets); however, depending on the regulatory
framework, the definitions for regulatory capital and risk-weighted assets are both varied and complex.
The following section provides an overview of these subjects.
Risk-weighted assets
In terms of calculating risk-weighted assets, this means that if a bank had USD100 of U.S. bonds
and USD100 of mortgage loans on its balance sheet, its total risk-weighted assets would equal USD35
(0% × USD100 U.S. bonds + 35% × USD100 mortgage loans = USD35).
19
The Basel II framework also offers an Internal Ratings Based (IRB) approach, but it is very complex and falls
outside the scope of this case.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-19- UV6662
Appendix 2 (continued)
The actual calculation of a bank’s risk-weighted assets is much more complicated than this, but
the general premise is quite simple—the value of a bank’s assets multiplied by the respective risk weights
for those assets equals the bank’s risk-weighted assets. It should be noted that under Basel II, much
discretion is given to banks’ risk management departments to determine their own risk-weighting
frameworks. Under Basel III, this freedom is expected to be curtailed significantly.
Common Equity Tier 1 (CET1) consists of common shares and retained earnings. Additional Tier
1 consists of certain hybrid securities (e.g., types of trust-preferred securities). Tier 2 Capital comprises
certain hybrid securities and subordinated debt that is senior to Common Equity and the hybrid securities
allowed as Additional Tier 1.
In addition to the Minimum Capital Ratios, Basel III implemented certain capital buffers (see
Table A1) that would all require additional Common Equity Tier 1. So while total minimum capital ratios
appear to remain constant at 8%, the capital buffers serve to substantially increase Common Equity Tier 1
requirements.
Additional Capital Buffers as % of Risk‐Weighted Assets
Capital Conservation Buffer N/A 2.5%
Countercyclical Buffer N/A 0.0%‐2.5%
Surcharge for Systemically Important Financial Institutions N/A 1.0%‐2.5%
0.095
Minimum Capital Ratios + Capital Buffers
Common Equity Tier 1 2.0% 4.5%
Add: Capital Buffers 0.0% 3.5%‐7.5%
Total Common Equity Tier 1 2.0% 8.0%‐12.0%
Additional Tier 1 2.0% 1.5%
Total Tier 1 Capital 4.0% 9.5%‐13.5%
Tier 2 Capital 4.0% 2.0%
Total Capital (Tier 1+Tier 2+Buffers) 8.0% 11.5%‐15.5%
Data source: Basel III: A Global Regulatory Framework for More Resilient Banks
and Banking Systems.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.
-20- UV6662
Appendix 2 (continued)
Liquidity
The Basel Committee had also approved the establishment of a maximum Leverage Ratio, based
on total assets (a Liquidity Coverage Ratio) to ensure banks had adequate amounts of liquid securities in
financial downturns. It also established a Net Stable Funding Ratio to ensure banks could access
additional funds when needed. Specific limits had yet to be set but were to be determined and
implemented during the phase-in period from 2013–19 (Table A2).
Leverage Ratio ‐ Minimum standard to be introduced in 2015
Liquidity Coverage Ratio ‐ Minimum standard to be introduced in 2015
Net Stable Funding Ration ‐ Minimum standard to be introduced in 2018
Data source: Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems.
This document is authorized for use only in Prof. Pankaj Kumar Baag's Commercial Bank Management/ at Indian Institute of Management - Kozhikode from May 2020 to Nov 2020.