Deutsche Banks Business Strategy - Case Study Example

DEUTSCHE AND THE PATH TO BASEL III By Student’s Name Code + Name of Course Professor/Tutor Institution City/State Date Deutsche and the Path to Basel III Deutsche Bank (DB) ventured into the world in 1870 and constituted one of the first financial institutions to undertake universal banking. The bank facilitated and extended trade relationships between Germany and other markets abroad. The bank acquired smaller banks within Germany to become the most dominant bank in the local base and to have an international reach (Aue & Kalkbrener 2006, pg. 49). By 1958, DB started to assert its footing in the international market by acquiring main banks in the U.S. Spain, and the UK. By 2001, the bank was present in seventy countries and listed on the stock market of New York. Apart from becoming a global bank once more, it changed its business focus from retail banking to international investment banking making it an “all-in-one shop.” The reasoning behind the business strategy was good because it enabled the firm to extend to new markets, making the bank an alternative for more clients and also providing additional services to present customers. The change into investment banking culminated in extreme growth, which increased leverage to address its costs but these came with a higher degree of risk. Historical Perspective of Deutsche Bank’s Business Strategy: Deutsche Bank was formed during the start of the 1870s economic crisis (University of Virginia 2013, pg. 2). The bank made its entry with international aptitude because of the actions of Adelbert Delbruck. He intended to use the economic interdependence between states and evade the dominance of the British banks, which had controlled global foreign trade. From that time, the bank intended to transact banking services of all sorts is specific to promote and motivate the trading activities between Germany, other states in Europe and overseas markets. From the start, the bank diversified its banking and created global trade financing and services of commercial investment banking across borders within the bank. The strategy was justified because the bank would be the first to assume universal banking and in the diversification, the bank widened its economic connections to the other parts of the world. As the bank extended to reach the global markets, it did not prevent its growth at its home ground. With the Germany business developing, Deutsche Bank gorged up smaller banks, which were unprofitable during the economic crisis of the 1870s. The bank handled its global businesses for Germany firms, which further extended its global reach such as financing the Railway of Baghdad. With the increasing global nature, Deutsche Bank was preferred for handling securities issued by the government and controlling capital markets of the government. After WWI Germany faced an economic and political crisis, which lead to increased inflation making the Deutsche Bank to lose most of its overseas assets. Borrowers defaulted to repay debts forcing the company to offset most of its holdings. The bank was forced to focus on survival, which subsequently decreased its international reach. A series of efforts of consolidation in 1929 among banks in Germany saw the bank merging with Disconto-Gesellschaft, its longtime competitor to become the leading bank in the state. During the inflation in the country, the banking industry was devastated, thus a shortage of liquidity paralyzed banks. By the end of the WW II, Deutsche Bank had transferred holdings and money from almost all its Jewish clients to the government of Germany. After WW II, Germany banks were disintegrated into smaller regional banks resulting in DB being broken down into ten bank’s name being outlawed. After about ten years, former segments of DB in Hamburg, Munich, Frankfurt, and Dusseldorf were merged and let to operate under the old name (University of Virginia 2013, pg. 3). By 1958, the country was beginning to regain financial resilience as a creditor state again. DB gave its initial foreign-currency bond in 44 years on the capital market of German thus renewing the market to global firms. DB’s international bank history repeated as it opened units and acquired main banks in the UK, the U.S., Spain, and Italy. After thirty years, DB had stretched into 12 states within the Asia-Pacific area and into Portugal, Brazil, the Netherlands, and Canada. The political changes in Eastern Europe in the 1990s assisted DB create many subsidiaries globally and by 2001, it has penetrated into seventy countries and was listed on the NYSE. Main Business Strategy: Apart from regaining its global stature, DB changed its classical retail banking to global investment banking. In the period between the late 90s and through the 2000s, most commercial banks started to pay attention to the provision of services of investment banking on top of the common commercial banking services. In my opinion, the strategy of diversifying into global investment banking enabled was beneficial to the bank because it added its services, which was a good move that made the bank an “all-in-one business” to satisfy the customer’s wants (Yemen et al., 2014, par. 6). Towards the 2002 end, DB derived a noteworthy portion of its incomes from investment banking undertakings, which peaked in 2007. Incomes from trading and sales rose from thirty percent to forty-two percent of total incomes between 2002 and 2007, whereas incomes from usual retail and commercial banking dropped from 22 per cent to nineteen percent. Between 2007 and 2011, DB’s income composition had differentiated significantly. Total investment banking activities comprised sales and trading (42 %) while other investment banking comprised origination (5%), investment banking (Loan products, Advisory, Others)-15 %. The revenues represented 62 % of its total revenue of 2012. Overall, the bank’s total revenue was 31, 428 million Euros by the June 30, 2012. On the other hand, its commercial and retail banking services comprised 19 % (9, 908) million Euros (University of Virginia 2013, pg. 4). By 30 June 2011, DB operated 3,064 branches globally. Of these, 2036 were based in Germany. In the preceding ten years, DB increased its assets to activities of investment banking from 640 billion Euros in 2002 to 1, 860 billion Euros by 2012, June 30. By the beginning of 2010, retail and commercial bank assets had increased substantially on a relative and absolute foundation. By the time the company changed its leadership in 2012, the bank’s headquarter was still based in Frankfurt and was still the biggest financing institution in Europe and the entire world. Why the Company’s Business Segment and International Stretch is Appropriate: DB’s business segments and global nature can be regarded as the best due to its profit growth and profitability. Thus, DB’s business model is considered as an illustration of stability and robustness in Europe (at least going into 2007). The perspective fully acknowledges account awareness of the significant risk exposure of the bank. The proposition can be translated into another account: The business model of DB is good during periods of expansion, but one predominantly exposed to the influences of economic downturns. The business strategy utilized by DB management has been indisputably effective during the expansion of its business models. Profits before taxation were positive between 2002 and 2007 in which figures rose from 3.5 to 8.75 million Euros (Yemen et. al., 2014, par. 7). During the same period, DB’s pattern of activity was followed by high-risk exposure. When the financial crisis gripped, the strategy transformed positive gains into losses. The reason for the banks high sensitivity to the downturn can be found in the major cornerstones that underlie DB’s business model: attention on increases in revenue rather than on cost and focus on non-interest business having high risk-returns. The implementation of the strategy culminated in a rise of net incomes (total) from 20.16 (in 2003), to 30.13 (in 2007). Simultaneously, bank expenditures for non-interest commercial activities rose from 17.4 to 21.4 million euro. Effect of Globalization Strategy on DB’s Activities With the attention of the DB already focused on the provision of investment banking services and being an “all-in-one” business for financial services necessities, the world economy witnesses an increased trend in globalization. The spread of the Internet in the late 90s made communication easier around the globe. Thus, cross-border transactions were facilitated. DB was pouring monies into emerging markets in reaction to confounding projections for growth in the GDP of China, Brazil, and India. Globalization meant that banks had to offer a wide range of investment banking and commercial services to customers and they were compelled to do so in regions their clients conducted business. Similarly, to DB’s customers, they conducted businesses in overseas countries. Moreover, most investment banking services, particularly asset management, trading and sales gained from economies of scale suggesting they became more profitable as they increased in size. On top of the gains from economies of scale, the transformation to a one-stop business brought the debate around the role of banks in the society. To attract new clients and retain the existing ones, DB had to offer services on the international level and secure its position in the investment-banking sector (Aue & Kalkbrener 2006, pg. 51). As DB increased its international banking reach in global markets, several rivals followed suit. The globalization effects and frantic stock market from 2002 to 2007 augmented the number of financial transaction internationally and had banks with limited activities in capital market competing for some action. These included BNP Paribas and Barclays. Thus, rivalry increased within the global investment-banking sector. Part 2: Deutsche Bank’s Profitability Ratios in Terms of ROA/ROE: Within the banking industry, there were large differences in the profitability of banks. Whereas the period before the financial crisis meant that banks in Europe and the US reported recorded profit levels, the U.S. banks were not badly off whereas their European peers struggled to remain sustainably above the zero line. By 2008, DB attained an outstanding growth in earnings per share, which increased from 0.63 Euros to 13.05 Euros from 2002-2007, an eighty-three percent yearly growth rate (University of Virginia 2013, pg. 8). However, the remarkable growth in earnings masked the idea that DB’s increased profitability did not come from productive assets. Rather, they came from its augmented leverage as could be observed with comparing its ROA (return on Assets) with its ROE (return on equity). To attain a greater ROE with no significant rise in ROA, DB used a huge leverage, augmenting its leverage ratio, which culminated in momentous gains in ROE and earnings per share for some time. The year 2008 demonstrated that leverage increased returns in both ways as a -0.18 % culminated in a 7.61 Euros loss to shareholders From its 2007 peak, DB de-levered its balance sheet significantly. The major push came from a decrease in its liabilities and trading book assets. In this case, both were scaled down by about 700 billion Euros between 2008 and 2009. To proceed with the process, DB would have to shed more assets or augment its equity base by raising capital or through retained earnings. The Implications of Banking under Basel III: With the pending Europe’s sovereign debt crisis of the late 2009 and the American economic recovery slowing down, international banks were not anticipated to return to pre-crisis profitability immediately. Volumes of investment banking business had been in a descending trend beginning 2009 with fees from activities of deal making (Equity/Debt Origination, M & A, etc) down twenty-five percent over two-year period. Moreover, income from fixed revenue at ten biggest international banks dropped 25 per cent yearly beginning 2009 and it was about 73 billion USD annually by 2012. As leading banks turned into “one-stop shops,” augmenting leveraging in the banking industry lead to greater returns during the deeper and the boom financial issues that occurred during the international financial crisis of 2008. The reaction was a revised international banking regulatory model — Basel III (Eubanks 2010, pg. 49). It sought to ensure that the international financial system was safer by augmenting liquidity and bank capital requirements including other things. Basel III was expected to fundamentally alter the landscape of the banking industry. Undeniably, the Basel III requirements rendered implications on the profitability ratios of DB under their new co-CEOs. With the dwindling volumes in investment banking services and volumes of business, the Basel Committee of Supervising Banks appropriated a new supervisory framework for global banks (Basel III) substituting the Basel II framework). The new demands would effectively augment the least Tier one equity capital demand from 4 % of risk-weighted assets to between 9.5 per cent and 13.5 per cent of risk-weighted assets (Aue & Kalkbrener 2006, pg. 87). Moreover, the risk weighted given to particular assets would be augmented, culminating in a double whammy because banks would have to augment their regulatory capital in compliance with the augmented minimum ratios and to balance the additional capital necessitated with the new risk-weights. The supervisory transformations would be implemented in phases beginning 2013; complete compliance was needed by 2019. The transformations were expected to culminate in significant drops in ROE sector-wide, as banks were needed to employ more equity than previously done. By the end of July 2012, DB had a main Tier 1 ratio of 10.2 % and a total Tier 1 ratio of 13.5% grounded on 373 billion Euros of risk-weighted assets, with ratios grounded on Base II regulations. Starting in 2013, management estimated risk-weighted assets of 488 billion Euros and a main Tier one ratio of 7.2 % under the new rules of Basel III. Whereas it would attain the least requirements for 2013, it was further from the 9.5 core Tier one ratio, which DB would be expected to meet in 2019 after the implementation of the full Basel III regulations. The prevailing conditions of capital markets during the end of 2007 were challenging for present day Deutsche Bank under its new CEO John Cryan. The context of the Basel III requirements meant that the company needed a new way of going about its business activities based on the company’s profitability ratios. For the bank, the selection of co-CEOs Anshu Jain and Jürgen Fitschen lent some way to how the firm strategized to go about the new setting moving forward. Based on the issues facing the bank at the time, the bank had desire to maintain candid ties with the political elites. Thus, the appointment of the two co-CEOs was a strategic option in the wake of the new frameworks. Before his selection as co-CEO, Fitschen was DB’s regional management head. His appointment was considered as transitional and mirrored the desire of the company to maintain its close connection to political leaders in Germany whereas Jain who was formerly the international investment banking operations head became familiarized to his new responsibility and gained articulacy in addressing political and regulatory matters in Germany (Eubanks 2010, pg. 58). The new strategic option in leadership was in tandem with DB’s current business activities. The Implications for the Strategic Options Facing the New co-CEOs: Basel III raised concerns for investors that the bank would have to give new equity capital to achieve the requirements, thus diluting the importance of existing shares. Moreover, profitability within the banking sector had dropped steadily following the crisis, and investors were concerned that stricter rules would further minimize profitability. Consequently, the bank needed alternate ways to make profit. The management of Deutsche bank needed to improve their profitability and address its capital concerns. The bank considered that the best way to address the issue was minimizing leverage between 2007 and 2011. Towards the end of 2010, DB raised 9.8 billion Euros in equity capital to obtain a consolidated stance (50.2 %) in Germany’s Postbank to assert the bank’s powerful position in the domestic market and to lead the retail banking business of Europe. The acquisition of Postbank would strengthened DB’s deposit base giving it an alternative source of revenue and diversify its revenue mix (Yemen et al., 2014, par. 4). It was expected that the deposit base of Postbank would provide a robust funding base for DB. The consolidation of Postbank lead to the surge of the banks shares by about 5 per cent after it documented the best initial quarter before the start of the financial crisis in 2007. The firm’s net profit increased by 17 per cent to 2.1 billion Euros fueled by the acquisition operations of Postbank. Net income jumped seventeen percent to 10.5 billion euros (Deutsche Bank AG 2007, pg. 16). The strategic option reflects the aim of the bank’s management to rebalance the institution’s earning combination away from investment banking did not weigh on the bottommost line. The integration of Postbank finished in December, is the core of a wider business strategy to minimize he reliance of Deutsche Bank on trading including other lucrative (though risky) investment-banking operations. Investment banking represented nearly 60 per cent of earnings, a drop from over 70 per cent in the past. According to CEO John Cryan, the integration generated a considerable effect on the bank. In 2010, the bank had reiterated its estimations that pretax revenues would rise to 10 billion Euros in 2011 from 6.5 billion Euros the previous year excluding costs of acquisition (Deutsche Bank AG 2007, pg. 22). The shares of the bank increased from 1.98 to 43.78 € in Frankfurt. Apart from improving its presence of retail banking in European local markets, DB used the downturn in investment banking business to obtain money share because many rivals were being compelled to leave the business. By 2012 July, DB had the biggest market share in U.S. fixed income trading. The bank expanded its equity in Europe underwriting business activities from 9.3 % in 2011 to twelve percent. The form also held the leading rank in its research platform of European Equity. Main Lesson: Given the bank’s profitability ratios and the strategic option of diversifying its revenue mix, the acquisition by the new management assisted to address the prevailing marketing situations. Thus, the main lesson was that the acquisition provided the bank with low-cost financing which drew the firm’s business model nearer to its international peers. The new regulatory framework established areas of the business, which were more enticing and others, which were less attractive. Thus, banks would have to estimate the effect on their past strengths. Bibliography Aue, F & Kalkbrener, M 2006, ‘LDA at work: Deutsche Bank’s approach to quantifying operational risk.’ Journal of Operational Risk, Vol. 1, no. 4, pp. 49-93. Chorafas, DN 2004. Economic capital allocation with Basel III: Cost, benefit, and implementation procedures. Butterworth-Heinemann. Deutsche Bank AG, 2007. Annual report. [Pdf]. Available at :< https://www.db.com/turkey/docs/Annual_Report_2007_ENG.pdf> [Accessed 03 May, 2016] Eubanks, WW 2010. Status of the Basel III Capital Adequacy Accord. DIANE Publishing. University of Virginia, 2013. Deutsche Bank and the Road to Basel III. Darden Business Publishing. Yemen, G, Allayannis, G, Doughherty, M & Wicks, A 2014. How Deutsche Bank Found Alternative Ways For Profitability Under Basel III Regulations. (Updated 7 March. 2014). Available at: https://www.washingtonpost.com/business/how-deutsche-bank-found-alternative-ways-for-profitability-under-basel-iii-regulations/2014/03/07/48cbd3b0-a316-11e3-a5fa-55f0c77bf39c_story.html [Accessed 03 May. 2016] Read More