The main challenge of Deutsche Bank is not its business model, but Capital Optimization.

Dear,
Some days ago, several finance news agencies published comments about the rumors that the Deutsche Bank’s board is considering a dramatic reduction of its retail division.

http://www.reuters.com/article/2015/03/21/us-deutsche-bank-restructuring-idUSKBN0MH0LA20150321

http://www.cnbc.com/id/102339240

http://www.bloombergview.com/articles/2015-03-25/deutsche-bank-doesn-t-want-checking-accounts

Last night I talked about it with a former executive of Deutsche Bank and reader of this blog.

If rumors become true, it would mean a drastic change in the bank’s strategy, considering that just 5 years ago Deutsche Bank acquired Postbank and its 14 million retail clients for 6.3 billion Euros.

https://www.db.com/medien/en/content/press_releases_2010_3173.htm

With the acquisition of Postbank, Deutsche Bank doubled its number of retail customers (from 10 million to 24 million) and branches (from 1,800 to 2,900 in Germany).

Josef Ackermann, chairman of the bank's management board at the time of Postbank acquisition, said in a statement: "In the future, the Deutsche Bank Group will have more stable revenues and a more balanced earnings mix".

Unfortunately, what Mr. Ackerman expected to be “more stable revenues” has ended in higher costs and limited profits.

On 2010, before Postbank acquisition, Deutsche Bank was generating more than 80 percent of its profits from investment banking.

But remember that just two years earlier, the difficulties and insolvencies of the main investment banks (Lehman Brothers, Bear Stearns, Merrill Lynch, etc.) brought very bad reputation to their business model.

A logical alternative was growing in the retail banking, for instance acquiring Postbank.

But today, the challenges are quite different; very low interest rates and limited economic growth is making very difficult for banks to make significant profits in the retail business.

Just one thing is common in the challenges of 2008, 2010 and 2015, capital scarcity of the financial system, a very critical issue which is here to stay.

You could read it here before; capital scarcity is driving a paradigm change of the Financial System, from a business model based in volume to a business model based in efficient capital management.

I can imagine, that 5 years ago, when Deutsche Bank’s executives considered Postbank acquisition, they asked themselves “what would be the profits generated by the investment”.

This is a good question in times of capital abundance, but in times of capital scarcity the question should have been slightly different; “what would be the profits generated by the investment, weighted by capital consumption”.

Today, forced by rising capital requirements and limited profits, Deutsche Bank’s executives are considering a reduction of the bank’s retail arm, getting cash to raise capital and improving their solvency ratios, but it’s likely that they will have to offer a discounted price to do so.

Determining the profit of an investment weighted by capital consumption is the core value of SAP Bank Analyzer, planning the profit of the bank’s investments weighted by capital consumption is the next step.

Just last week I was discussing these ideas with a colleague, when I tried to explain him why SAP Bank Analyzer is not just an Accounting System but an Integrated Financial and Risk System.

The quick answers is that an Accounting System would tell you what’s the value of the bank’s portfolio, while an Integrated Financial and Risk System tells you what’s the value of your portfolio, and how much capital is consumed by the bank, for holding the portfolio.

I’m sure that Deutsche Bank’s executives are very aware of the difference.

Looking forward to read your opinions.
K. Regards,
Ferran.

Clearing Houses, Payment Engine, Capital Optimization and SAP Bank Analyzer.

Dear,
A couple of weeks ago, the EU General Court in Luxembourg ruled that the European Central Bank lacks legal powers to dictate the location of the clearing of euro-denominated trades.

http://www.bloomberg.com/news/articles/2015-03-04/u-k-defeats-ecb-in-clash-over-city-of-london-s-clearinghouses

The decision concerns the ECB’s policy requiring clearinghouses handling euro-denominated trades to be located in the 19-nation currency bloc, a proposal that would have threaten London’s position as Financial Capital of Europe.

Clearing houses play a very important role in the Financial System; they’re the financial institutions that provide clearing and settlement services for financial and commodities derivatives and securities transactions. They act as third parties to all futures and options contracts; as a buyer to every clearing member seller and a seller to every clearing member buyer.

This responsibility comes with a lot of power for the clearing houses in the capital allocation processes; by facilitating some transactions in front of others, clearing houses have the capacity of influencing the international flows of Capital.

A couple of years ago, in the middle of the Euro crisis, you could read the following post about the power of the clearing houses in the new model.

http://blogs.sap.com/banking/2012/07/04/the-role-of-the-clearing-houses-in-a-liquidity-crisis/

In the old model of Capital abundance, efficient Capital management was not a priority for the clearing houses. In general, and with little exceptions, financial agents decided to believe that the chances of a clearing house becoming insolvent were zero. An interesting exception to this rule was the Black Monday of 1987 when freezing capital markets were close to pull down several clearing houses with catastrophic consequences for the financial system and the whole economy.

Former US Federal Reserve chairman Ben Bernanke, is one of the greatest experts in the 1987 crash and he’s well aware of the weaknesses of the Financial System and the critical role that the Clearing Houses are going to play in the new environment of Capital scarcity. Just four years ago, he gave the following speech.

http://www.federalreserve.gov/newsevents/speech/bernanke20110404a.htm

The SAP banking business suite provides two components for supporting the functions and responsibilities of the Clearing Houses and other Clearing Partners in new Financial System that will emerge from the Financial Crisis.

- Payment Engine.- Which helps banks and other financial institutions to determine the most efficient route in their Capital allocation flows.

- Bank Analyzer with its Integrated Financial and Risk Architecture, which supports the efficient management of Capital in the financial institutions (including Clearing Houses).

But overall, SAP Banking provides integrated capabilities that will support integrated scenarios for improving capital efficiency on the management of capital flows.

Today, when a bank determines the preferred route for Capital transfers, it follows “static” routes looking at traditional parameters like “Fees” or “Service Level Agreements”.

As we move deeper into the financial crisis, selecting one route in front of other will require considering the capital costs of the alternative routes.

This will open the gate to new scenarios in Capital Optimization, at the end efficient capital management is not just a requirement for banks, but the most critical activity of the whole financial system.

Looking forward to read your opinions.

Join the SAP Banking Group at: http://www.linkedin.com/e/gis/92860

K. Regards,
Ferran.