Finance after the crisis: Deutsche Bank A tamer casino

Germany’s biggest bank is trying to make investment banking boring. The latest in our series of profiles of financial institutions after the crisis

JOSEF ACKERMANN, the head of Deutsche Bank, combines a silky manner with blunt words. When the German government set up a bail-out fund to stabilise the country’s banking system, he said he would be “ashamed” to use it. When Europe and the IMF bailed out Greece, Mr Ackermann said he doubted it would pay back the loans. And when regulators and economists say that big banks should be broken up, with “casino” investment banks split off from “utility” retail banks, Mr Ackermann retorts that “smaller banks will not make us safer.”

Mr Ackermann speaks with the authority of a man who steered his bank through the crisis more deftly than most. Deutsche did not escape unscathed. In 2008, a year in which it had confidently forecast a record profit of more than €8 billion ($11.7 billion), it posted a net loss of almost €4 billion because of a huge hit to its investment bank (see chart). Yet it emerged from the crisis as the leading member of an exclusive club of large banks—others include Barclays and Credit Suisse—that did not have to take direct injections of public funds (although all, of course, benefited from a wide range of other government props to the system).

More striking still is the fact that Deutsche was able to cover its losses without having to raise significant amounts of new private capital. The two small rights issues it undertook, totalling nearly €3 billion, were to fund its purchase of a minority shareholding in Deutsche Postbank, a large German retail bank.

Although Deutsche Bank placed proprietary bets by buying bonds and other securities for its own account, it did so on a far smaller scale than most of its main rivals. Many of the positions it took were tightly hedged. Its holdings of commercial-property securities, for instance, were partly protected by insurance policies written by AIG, an American insurer. By some estimates more than $12 billion flowed from AIG to Deutsche Bank in collateral as a result of these policies. Deutsche has taken its approach of hedging risks so much to heart that when it released details of its holdings of European government bonds earlier this year, it emerged that the majority of its holdings of German government debt was hedged against default.

Even though Deutsche was one of the biggest issuers of subprime securities it was also one of the first banks to place bets that these bonds would collapse in value, leading critics to charge that it was betting against its own clients. “There are always people who will say that if you lose less money you are too clever,” says one executive. “The proof [that we weren’t betting against clients] is that we also lost money.”

Deutsche Bank was quick to cut its losses when markets turned sour, too. Whereas some banks held on to positions, Deutsche quickly cut risk. In the weeks after Lehman Brothers’ collapse it dumped billions of euros in loans to private-equity firms and cut more than 900 jobs.

Underlying this relatively strong performance is the way Deutsche blurs the distinctions between casino banking and utility banking. Its investment bank’s long-standing strategy is to concentrate on client-driven “flow” businesses such as foreign-exchange, bonds and derivatives while holding as little risk as possible on its own balance-sheet. For the past six years Deutsche Bank has been the world’s largest currency trader: it now conducts almost one in five of the world’s foreign-exchange trades. It is also the world’s largest trader of interest-rate swaps and features among the top three traders of most other sorts of financial instruments.

The crisis has reinforced this positioning. Deutsche has reduced its proprietary-trading activities. And the collapse or merger of many of its competitors has enabled it to make big gains in trading for clients. In foreign exchange, for instance, the top five banks now command 55% of the market, compared with 36% in 2001. With less competition and volatile markets, the investment banks that are still standing have been earning fat margins trading in currencies, commodities and bonds.

Yet these spreads are already beginning to shrink as rivals regain their footing. Trading volumes fell in the second quarter across the industry. Investors are pressing Deutsche Bank to reduce its reliance on investment banking, no matter how stable its executives insist it has become. Deutsche has said in the past that it wants investment banking to account for no more than 60% of its total earnings. It has missed this target more often than hit it, however, and has quietly dropped mention of this goal. For the foreseeable future analysts expect investment banking to remain its main source of profit (see chart).

There are promising prospects elsewhere. Businesses such as private banking and wealth management offer juicier margins. Expanding abroad is another avenue. Early in 2010 Deutsche finalised the acquisition of Sal Oppenheim, a venerable banker to Germany’s richest families that had fallen on hard times by lending them too much. A few months later it closed the purchase of parts of the Dutch commercial-banking business of ABN AMRO.

A bigger challenge is to improve the performance of its retail-banking businesses. In Germany there are too many banks and the margins are razor-thin. In trying to expand at home, Deutsche Bank has already bought almost a third of Deutsche Postbank, which has the nation’s biggest branch network. But this badly run bank is short of capital and Deutsche Bank would be forced to bolster its capital reserves again if it were to buy all of it within the next six months (as seems likely). Mr Ackermann is due to retire in 2013. Having succeeded in making investment banking seem relatively dull, making retail banking more exciting may be his last big task.