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Deutsche Bank’s travails are merely
representative
1 6 October 2016
NEWS
S
ince the start of the Global Financial Crisis
back in 2008, European and US policymak-
ers and regulators have blamed the
international banking system for systemic
risks and abuses. Regulatory and supervisory
authorities have begun designing and implementing
system-wide responses to the causes of the crisis. What
emerged from these efforts was an explosion of regula-
tory authorities. Regulatory, supervisory and compliance
jobs mushroomed, turning legal and compliance depart-
ments into a new Klondike, mining the rich veins of
regulations, frameworks and institutions. The edifice, it
was presumed, would address the causes of the recent
crisis and create systems that can robustly prevent
future financial meltdowns.
At the forefront of these global reforms are the EU and
the US which took two distinct approaches to beefing up
their responses to the systemic crises. Yet, the outrun of
the reforms is the same.
The US has adopted a reform path focused on restruc-
turing of the banks – with the 2010 Dodd-Frank Act the
cornerstone. The capital adequacy rules closely followed
the Basel Committee which sets these for the global
banking sector. The US regulators have been pushing
the folk at Basel to create a common ‘floor’ or level of
capital a bank cannot go below. Under the US proposals,
the ‘floor’ will apply irrespective of its internal risk cal-
culations, reducing banks’ and national regulators’
ability to game the system, while still claiming the banks
remain well-capitalised. Beyond that, the US regulatory
reforms primarily aim to strengthen the enforcement arm
of banking supervision.
Enforcement actions have
been flying since the ‘recovery’
set in, in 2010.
Meanwhile, the EU has gone about
the business of rebuilding its financial markets in a tra-
ditional, European, way. Any reform momentum became
an excuse to create more bureaucratese and to engineer
ever more Byzantine, technocratic schemes in the hope
that somehow the uncertainties created by the skewed
business models of banks get entangled in a web of
paperwork, making the crises if not impossible at least
impenetrable to the ordinary punters. Over the last eight
years, Europe created a truly shocking patchwork of vari-
ous ‘unions’, directives, authorities and boards – all
designed to make the already heavily centralised system
of banking regulation even more complex.
The ‘alphabet soup’ of European reforms includes:
•
the EBU and the CMU (the European Banking and Capi-
tal Markets Unions, respectively);
• the SSM (the Single Supervisory Mechanism) and the
SRM (the Single Resolution Mechanism), under a
broader BRRD (Bank Recovery and Resolution Direc-
tive) with the DGS (Deposit Guarantee Schemes
Directive);
•
the CRD IV (Remuneration and prudential require-
ments) and the CRR (Single Rule Book);
•
the MIFID/R and the MAD/R (enhanced frameworks for
securities markets and to prevent market abuse);
• the ESRB (the European Systemic Risk Board);
• the SEPA (the Single Euro Payments Area);
• the ESA (the European Supervisory Authorities) that
includes the EBA (the European Banking Authority);
•
the MCD (the Mortgage Credit Directive) within a
Single European Mortgage Market; the former is also
known officially as CARRP and includes introduction
of something known as the ESIS;
•
the Regulation of Financial Benchmarks (such as LIBOR
& EURIBOR) under the umbrella of the ESMA (the Euro-
pean Securities and Markets Authority), and more.
Deutsche Bank’s travails are merely
representative
The US has adopted a reform
path focused on restructuring
banks. The EU has created a truly
shocking patchwork of various
‘unions’, directives, authorities
and boards designed to make
regulation even more complex
October 2016 1 7
The sheer absurdity of the European regula-
tory epicycles is daunting.
Eight years of solemn promises to end the
egregious abuses of risk management, business
practices and customer trust in the American
and European banking should have produced at
least some results when it comes to cutting the
flow of banking scandals and mini-crises. Alas,
as recent events illustrate, nothing could be fur
-
ther from the truth.
In the Land of Freedom [from individual respon-
sibility], American bankers are wreaking havoc
on customers and investors. The latest instal-
ment in the saga is the largest retail bank in
North America, Wells Fargo.
Last month, the US Consumer Financial Pro-
tection Bureau (CFPB) announced a $185m
settlement with the bank. It turns out the cus-
tomer-focused Wells Fargo created over two
million fake accounts without customers’ knowl-
edge or permission, generating millions of
dollars in fraudulent fees.
But Wells Fargo is not alone.
In July 2015, Citibank settled with CFPB over
charges that it deceptively mis-sold credit prod
-
ucts to 2.2 million of its own customers. The
settlement was many times greater than that of
Wells Fargo, at $700m. And in May 2015, Citi-
corp, the parent company that controls Citibank,
pleaded guilty to a felony manipulation of for-
eign currency markets – a charge brought
against it by the Justice Department. Citicorp
was joined in the plea by another US banking
behemoth, JPMorgan Chase. You heard it right:
two of the largest US banks are felons.
And there is a third one about to join them.
This month news broke that Morgan Stanley was
charged with "dishonest and unethical conduct"
in its dealings in Massachusetts securities “for
urging brokers to sell loans to their clients”.
A snapshot of the larger cases involving Citi
and its parent company shows they have faced
fines and settlement costs of over $19bn
between 2002 and 2015. Today, the CFPB has
over 29,000 consumer complaints against Citi
and 37,000 complaints against JP Morgan Chase
outstanding.
Citi was the largest recipient of the
US Fed bailout package that fol-
lowed the 2008 Global
Financial Crisis. It obtained
heavily subsidised loans
totalling $2.7tr or roughly
16 percent of the entire
bailout in the US.
But there have been no
prosecutions of Citi, JP
Morgan Chase or Wells
Fargo executives.
This state protection is matched in the case of
another serial abuser of market rules: Deutsche
Bank.
According to US Government Accountability
Office (GAO) data, during the 2008-2010 crisis
Deutsche got $354bn of emergency financial
assistance from the US authorities. In contrast,
Lehman Brothers got only $183bn.
Last month, Deutsche entered into talks with
the US Department of Justice over the settlement
for mis-selling mortgage-backed securities. The
original fine was set at $14bn – enough to effec-
tively wipe out the capital reserves cushion in
Europe’s largest bank. Latest financial-market
rumours are putting the final settlement closer
to $5.4-6bn, still close to one third of the bank’s
equity value. To put these figures into perspec
-
tive, Europe’s Single Resolution Board fund,
designed to be the last line of defence against
taxpayers’ bailouts, currently holds only $11bn
in reserves.
Last month it emerged
Wells Fargo created over
two million fake accounts
without customers’
knowledge or permission,
generating millions of
dollars in fraudulent fees
1 8 October 2016
The Department of Justice demand blew
Deutsche’s troubled operations wide open. The
business model of the bank resembled a house
of cards. Deutsche’s problems are threefold:
legal, capital, and leverage risks.
The bank has already paid out some $9bn
worth of fines and settlements between 2008
and 2015. At the start of this year, the bank was
yet to achieve resolution of the probe into cur-
rency markets manipulation with the Department
of Justice. Deutsche (along with 16 other finan-
cial institutions) is also defending a massive law
suit by pension funds and other investors. There
are ongoing probes in the US and the UK con-
cerning its role in channelling some $10bn of
potentially illegal Russian money into the West.
The Department of Justice is also after the bank
for alleged malfeasance in trading in the US
Treasury market.
And in April 2016 the German TBTF (Too-Big-
To-Fail) goliath settled a series of US lawsuits
over allegations it manipulated gold and silver
prices. The settlement amount was not dis-
closed, but the manipulations involved tens of
billions of dollars.
Two years ago, Deutsche was placed on the
“enhanced supervision” list by the UK regulators
– a list, reserved for banks that have either gone
through a systemic failure or are at a risk of such.
This list includes no other large banking institu-
tion, save for Deutsche. As reported by Reuters,
citing the Financial Times, in May this year, UK’s
financial regulatory authority stated, as recently
as this year, that “Deutsche Bank has "serious"
and "systemic" failings in its controls against
money laundering, terrorist financing and
sanctions”.
As if this was not enough, last month, a group
of senior Deutsche ex-employees was charged
in Milan “for colluding to falsify the accounts of
Italy’s third-biggest bank, Banca Monte dei
Paschi di Siena SpA (BMPS)”. Of course, BMPS
itself needs a government bailout, as it has been
haemorrhageing capital over recent years while
nursing a mountain of bad loans. One of the
world’s oldest banks, the Italian lender, which
has been deemed ‘systemically important’ has
been teetering on the verge of insolvency since
2008-2009.
All in, at the end of August 2016, Deutsche
Bank is dealing with some 7,000 law suits,
according to the Financial Times.
Beyond its legal problems, Deutsche is sitting
on a capital structure that includes billions of
notorious CoCos – Contingent Convertible Capi-
tal Instruments. These are a hybrid form of
capital instruments, favoured by European and
Irish pillar banks, that are structured to absorb
losses in times of stress, by automatically con
-
verting themselves into equity. They appease
European regulators and, in theory, provide a
cushion of protection for depositors. In reality,
CoCos hide complex risks and can destabilise
those who deal in them.
Moreover, Deutsche’s balance sheet is loaded
with trillions of Euro worth of opaque and hard-
to-value derivatives. At of the end of 2015, the
bank held an estimated €1.4tr exposure to these
instruments in official accounts. A full third of
the bank’s assets is composed of derivatives
and ‘other’ exposures, with ‘other’serving as a
financial euphemism for anything other than
blue-chip, safe, investments.
Eight years after the blow-up of the global finan-
cial system hundreds of tomes of ‘reform’
legislation and rule books have been thrown at
the crumbling façade of the global banking
system. Tens of trillions of dollars in liquidity and
lending supports have been pumped into the
banks and financial markets. And there are
never-ending calls from the Left and the Right for
Government solutions to banking problems.
Still, the American and European banking
models show little real change after the crisis.
Both the discipline of the banks boards and the
banks’ strategies for rebuilding their profits
remain unaltered by the lessons of the crisis.
Election after election candidates compete
against each other to promise a regulatory nir-
vana of de-risked banking. And time after time,
as the electoral smoke dissipates, the gross-
risk-neglecting system subsists, disregarding
customers on the implicit assumption that, if
things get hot again, taxpayers’ cash will rain on
the fires threatening the too-big-to-reform bank-
ing giants.
NEWS
Leverage Risk
0
27.5
55
82.5
110
Systemic Risk, USD millions
0
25,000
50,000
75,000
100,000
Deutsche Bank
Bank of America
HSBC Holdings
Prudential Financial
Morgan Stanley
Systemic Risk, US$ million
Leverage
Higher risk
Higher risk
Deutsche got $354bn
of emergency financial
assistance from the US
authorities. In contrast,
Lehman Brothers got
only $183bn
- Systemic Risk and Leverage Risk
Source: bsed on d
from NY Universiy
V-lb. Sysemic Risk is
he moun of finncil
insiuion's cpil
shorfll in he cse of
sysemic crisis. Lev-
erge is he rio of
qusi-mrke vlue of
sses o mrke vlue
of equiy
