Deutsche Penalty

Time for a New Beginning

  • Why it matters

    Why it matters

    The legal settlement in the United States puts one immediate crisis aside, but it doesn’t end the longer-term troubles for Germany’s largest financial firm.

  • Facts

    Facts

    •  
    • Deutsche Bank reached a $7.2 billion settlement with the U.S. Justice Department shortly before Christmas for dealing in questionable mortgage-backed securities ahead of the 2008 crisis.
    • The bank still has thousands of other legal disputes and regulatory investigations, including a major money-laundering case in Russia.
    • Deutsche Bank is in the process of cutting about a tenth of its workforce and pulling out of countries and sectors where it is no longer profitable.
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John Cryan
John Cryan can't rest on his laurels now that the U.S. settlement is finally in the bag. Source: DPA [M]

“In all beginnings dwells a magic force,” writes the German Hermann Hesse in his poem, “Stages.” It’s a revelatory thought that is also applicable to the beginning of a new year. Even if all the promising resolutions are often quickly forgotten, New Year’s Eve still presents the opportunity of redefining one’s self at least a bit.

A new beginning is exactly what Deutsche Bank needs after the annus horribilis of 2016. The bank laid the foundation for this fresh start shortly before Christmas, reaching a multi-billion dollar settlement with the judicial authorities in the United States.

The dispute over toxic mortgage deals had paralyzed its management for months during an extremely difficult stage. When word was leaked at the end of September that the Justice Department in Washington was opening the poker game of negotiations with penalty claims amounting to $14 billion, Germany’s most powerful financial institution was forced into defense mode. At times, Chief Executive John Cryan and his associates were completely absorbed with just one thing, fending off the fiercest blows.

That phase is now past. The settlement’s key figures have turned out to be such that the bank will not need an emergency capital increase and will be in a position to pay the interest for its most risky bond issues. This is likely to clear away investors’ greatest immediate concerns, but there is more behind the dramatic slide in share prices this fall than the acute concern over its financial stability.

The elimination of the greatest legal risks was a necessary prerequisite...But the managers are still in an unenviable position.

The crisis revolved primarily around a basic question: What will Deutsche Bank look like in the future, and how will it earn its money? Investors are very impatiently waiting for an answer. But the bank is still bogged down in such a messy situation that the potential for disappointment is enormous.

The elimination of the greatest legal risks was a necessary prerequisite for providing Mr. Cryan and his fellow managers with at least a modicum of planning security for the bank’s realignment. But the managers are still in an unenviable position.

For one thing, there is still so much in flux when it comes to global banking regulation that the formulation of a viable strategy is tantamount to a game of three-dimensional chess. And even the smidgen of planning security gained with the pre-Christmas news was dearly paid for by the bank, though the U.S. settlement was considerably below Washington’s initial demands.

Deutsche Bank must pay $7.2 billion. Of that, $4.1 billion represents payouts to customers, which the bank is able to spread out over a period of five years. That’s the good news. The bad news is, measured compared to the penalties that U.S. competitors got away with, the Frankfurt-based bank is paying a huge amount more.

If the Justice Department had used the same standards as it did on average with U.S. financial institutions, the fine would have come in at around $2.5 billion. Even taking the highest fine for the U.S. competition as a measurement, in the end it would have come out to be “only” $5.7 billion.

A lot suggests that Mr. Cryan at some point will indeed have to ask his shareholders once again for fresh billions.

So Deutsche Bank paid a steep price for its settlement. Added to that is the fact that the money-laundering affair in Russia is still a prominent and potentially expensive legal case waiting for its resolution. So a lot suggests that Mr. Cryan at some point will indeed have to ask his shareholders once again for fresh billions, at least if he wants to once and for all erase all doubt about the bank’s capital resources.

But the shareholders will only go along with it if the chief executive presents a credible strategy. That means a strategy that carries Mr. Cryan’s own signature and that proves the bank will be able to generate adequate returns even under the regulators’ increasingly more stringent guidelines.

To do that, the Englishman will have to uncompromisingly trim Deutsche Bank to restore profitability. A strategy formulated from the top down, to be virtually imposed on the bank, isn’t likely to be a very suitable instrument for that. More effective would be a systematic analysis of the strengths and weaknesses that begins at the base.

Mr. Cryan must pare down costs and above all radically reduce the complexity. That means significantly less products for significantly less customers, modular solutions instead of individually-tailored solutions. Profitability must take precedence over market share.

This process has already been initiated but needs to be considerably intensified once again. The responses to the key strategic challenges facing the bank should result from a comprehensive analysis of the key questions. Such as whether Deutsche Bank can still afford the role of a universal bank with global ambitions, or should it concentrate on its home market of Europe. And does it have a future there in the long run as an independent institution or does it need a partner to achieve critical size?

These are the questions for which Mr. Cryan and his associates need to find unsentimental answers. In keeping with the poet, Hesse: “Be ready, heart, for parting, new endeavor; Be ready bravely and without remorse.”

 

To contact the author: maisch@handelsblatt.com

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