Deutsche Bank and the Road

Deutsche Bank and the Road

to Basel III
to Basel III

Section A
Group 3
Sushmita Patel (056) I Aditi Pandey (066) I Monika Shruti Gupta (096) I Mrinal Sharma (098) I Pranav Bharti (106) I P. JayaBharath I (284)
 Banking Industry: Globalization

Advent of internet Investors/corporations Banks had to With economy of scale, Banks moved to be
led to easier global from developed provide full range investment banking one-stop shop
communication & economies started of commercial and activities (sales, trading, leading to debate
transactions pouring funds into investment asset management) on their role in
emerging economies banking services became more profitable society
 Banking Industry: Competition

Competitor banks Globalization and Competitors achieved To finance asset Competitors had
also started frenzied stock market most of global growth, lesser leverage
internationalization increased volume of revenue gain through competitors used leading to lesser
financial transactions investment banking past profits, new differential between
worldwide activities leading to equity capital and ROA and ROE than
more rivalry new debt capital Deutsche Bank
 Deutsche Bank’s History
• Deutsche bank was founded in Germany.
• The objective was to promote trade relations between
Germany and rest of the world.
• It was established as a universal bank providing both
investment banking and commercial banking.
• After the World War II German economy inflation rates
were higher.
• Deutsche Bank lost most of its foreign assets and
borrowers failed to pay back debts.
• During the depression the Germans invaded countries
and by the end of World War II Deutsche bank had
transferred money and holdings from Jews to the
German Government.
• Post World War II Deutsche bank was split into ten
different banks, however 10 years later 4 parts of
Deutsche Bank were merged and allowed to operate
under the name of Deutsche Bank.
• Germany started recovering in 1958 when Deutsche
Bank issued its first foreign –currency bond in 44 years,
thereby reopening the market to international firms.
• It acquired major banks in Italy, Spain, UK and USA.
• In another thirty years, they had expanded into
Canada, Brazil, Portugal, and Netherlands.
• By 2001 it was operating in 70 countries and was even
listed on the NYSE.
• Deutsche Bank increased their focus on investment
banking activities and commercial banking took a back
seat.
• The goal was to make it a “one-stop shop”.
• Around 62% of total revenue was contributed by
Investment banking activities in 2007 hence the bank
was focused on increasing its asset base dedicated to
investment banking activities.
 Deutsche Bank’s Financials

► DB achieved remarkable growth in per-share earnings – 83% annual growth rate.

► But increased profits failed to come from productive assets instead came from increased leverage.

DB – EPS DB - ROA VS ROE ROA

15 ROE
10 30%
20%
5
10%
0 0%
2002 2003 2004 2005 2006 2007 2008 2009 2002 2003 2004 2005 2006 2007 2008 2009
-5 -10%
-10 -20%
 Globalization of the Banking Industry

• Around 1990s, with commercial banks already focused on • Also, most investment banking activities, especially
providing investment banking activities & being a one- sales and trading and asset management benefited
stop shop for financial service needs, the world economy from economies of scale, meaning they became more
experienced globalization profitable as they grew in size
• Proliferation of internet being one reason which made • To gain new customers and maintain existing ones,
global communication & cross-border transactions easier Deutsche bank needed to provide services on a global
to facilitate. level and secure its position in the investment banking
• Moreover, many corporations & investors in developed market
economies were pouring funds into emerging markets in
response to staggering projections for GDP growth
• For banks, globalization meant they had to provide a full
range of commercial & investment banking services to
clients, & they had to do so in all the places their
customers were doing business
• Increasingly, their customers were conducting business
outside their home countries
 Global Competition
• Several competitors followed suit, as DB set its path on
internationalization
• This attributes to the effects of globalization and a
frenzied stock market from 2002 through 2007, which
saw an increase in the volume of financial transactions
worldwide
• Even the banks that had little history of activity in capital
markets vied for a piece of action such as Barclays, and
BNP Paribhas (these had small domestic markets)
• Most of the gains DB’s competitors achieved in global
revenues were the result of increased investments in
investment banking activities. As a result rivalry
intensified within the international investment banking
market
• Impressive growth in earnings masked the fact that
Deutsche bank’s increased profits failed to come from
productive assets, they came from increased leverage
• To finance the asset growth, banks had three primary
options: use profits earned in previous periods, issue
new equity capital thereby diluting existing
shareholders or borrow debt capital thereby increasing
leverage
• In contrast, one of DB’s major competitors, JPMC had a
greater ROA over the same time period- more than
twice that of DB in 2006
• To achieve a higher ROE without a significant increase
in ROA, DB employed massive leverage, increasing its
leverage ratio, which resulted in significant gains in
both ROE & EPS for a while
 Basel I, Basel II and Basel III

Basel I (1988) Basel II (2006)

 Set out the minimum capital requirement of financial  Upgrade Over Basel I
institutions to reduce credit risk.  Included 3 pillars
 Bank assets classified into 5 categories on the basis of risk.  Minimum capital requirement
 Banks required to maintain a capital which is 8% of its risk  Supervisory review of banks
weighted assets.  Effective disclosure of bank activities to
 Only considered credit risk, operational and market risk not improve market discipline
covered.  Better classification of asset risk categories.

Basel III (2010)

 To improve the banking sector's ability to deal with financial and economic stress, improve risk management and
strengthen the banks' transparency
 Released after Basel I and II norms proved insufficient to avoid the 2007 crisis
 Enhanced disclosures on the detail of the components of regulatory capital and their reconciliation to the reported
accounts. Aims at improving the transparency in banking.
 Movement towards Basel III

• To improve the regulatory framework for banks, Basel III was introduced in 2009 as per which the banks
were required to increase minimum Tier 1 equity capital from 4% of risk weighted assets to 9.5% to 13.5% of
risk weighted assets.
• Also the risk weights assigned to certain classes of assets were required to be increased as per Basel III.
• The banks have to gradually start abiding by Basel III norms from 2013 and have to comply with it
mandatorily by 2019.

• Deutsche Bank had a core Tier I ratio of 10.2% and a total Tier I ratio of 13.6% by July 31, 2012 based on
Basel II rules.
• While it could meet the requirement according to Basel III rules in the beginning of 2013 (Tier I ratio of
7.2%), it was far from the 9.5% core Tier I ratio that it had to meet by 2019.
• Deutsche bank took the route of inorganic expansion in European retail bank business by acquiring a 50.2%
stake in German-based Postbank
• Meanwhile, Deutsche Bank consolidated its position by having the largest market share in U.S. fixed income
trading by July, 2012.
 Valuation

• July 31 2012 Shares traded

• = 8.2X(P/E)
• = 0.6X(Tangible book value per share=P/TB) => Trading in the same range of 2008-2009 crisis
 Valuation

Analysts Projection
2012-2013 Predicted share value = EUR 4.00 Against Revenue of EUR 32.8bn
2013-2014 Predicted share value = EUR 4.92 Against Revenue of EUR 34bn
Both years showing sharp increase from trailing 12month value of EUR3.04/share
 Concerns

• Doubt on Deutsche Bank’s ability to meet new regulatory framework as per Basel lll norms
• Phase-wise implementation starting from 2013 till 2019
• Need to increase regulatory capital to comply with increased ratios and to offset additional capital
required with new risk weights assigned to certain assets
• In an attempt to raise new equity, capital value of existing shares will get diluted
• There will be reduction in profitability and increase in insecurity in Europe due to debts.
• Deutsche Bank’s increased profits came from increased leverage and not from productive assets; in
2011 DB’s ROA was just 0.2% while ROE was 9.02%
Analysis
 Conclusion

As per the projections

 Total Capital as a % of Risk Weighted Asset is 7.476% (38,830 million euros) for 2012
 The minimum requirement as per Basel III norms is 8.00% (8% of 519384.72 million euros)
 New Capital can be raised from existing stakeholders by the way of a rights issue which is to be
followed by a Follow on Public Offering
Hence, bank needs to raise an additional 2,721 million euros ( 41,551-38,830 ) to meet Basel III requirements.

• To finance asset growth on balance sheet" banks primarily use one of the following methods.
• Use profits used in the previous years.
• Issue new equity capital thereby diluting the equity value of the existing shareholders
• Borrow debt capital thereby increasing leverage (In 2012 Deutsche bank had risk weighted assets around
EUR488 billion and core tier 1 ratio of 7.2%).
• To comply with Basel III norms Deutsche Bank can go ahead by issuing hybrid securities like convertible bonds
or warrants and reducing the asset base in order to maintain a balance between ROE and ROA and provide a
realistic picture to its investors and customers.