CBM Assignment-4: Critical Analysis of Deutsche Bank Case

Submitted By: Group-9, CBM Section-B

Prashant Saxena (PGP/23/348), Mini Pateriya (PGP/23/148), Pratyush Barua (PGP/23/285),

Sandeep Mande (PGP/23/334), Abhishek Gautam (PGP/23/373), Abhishek Singh (PGP/23/127),
Sanjay Kumar Meena (PGP/23/357)

Deutsche Bank and the Road to Basel III

Deutsche Bank which was established in Germany with an objective of promoting trade relations
between Germany and the rest of the world. It was founded as a global bank which can provide
both investment banking services and also commercial banking services. After the World War I,
German economy was suffering from hyperinflation due to which Deutsche Bank lost most of its
foreign assets and borrowers failed to pay back the loans. During the great depression the
German army invaded countries which led to the World War II, by the end of which, Deutsche
bank had transferred the money and holdings from Jews to the German Government. After the
World War II, Deutsche bank was split into ten different banks. However, ten years later four
parts of Deutsche Bank were merged and were allowed to operate under the name of Deutsche
Bank.

With economy recovery post the World War-II in Germany and across the world, Deutsche Bank
started expanding into new territories aggressively and by the end of 2001 it was operating in
70countries. Deutsche Bank increased its focus on investment banking activities and shifted its
focus from commercial banking activities which took a back seat. By the end of 2002, Deutsche
Bank derived a large portion of its revenues from Investment Banking activities and by the end
of 2007, almost 62% of the total revenue of Deutsche Bank was coming from its Investment
banking activities. As a result, Deutsche bank was focused on increasing its asset base dedicated
to investment banking activities. Between 2002 to 2012, Deutsche Bank had significantly
increased its assets dedicated to the Investment Banking activities from EUR 640 billion at year
end 2002 to EUR 1860 billion at the end of 2012.

Revenues from sales and trading activities undertaken by the bank increased from 30%-42% of
total revenues between 2002-2007. Until 2008, Deutsche Bank achieved outstanding growth in
per share earnings of 83% annual growth rate, from EUR 0.63 to EUR 13.05 from 2002-07.
However, Deutsche Bank’s increased profits came from increased leverage and not from
productive assets which can be seen as one of the major issues which also increased the risk
profile of the bank due to high financial leverage.

Basel III was introduced in 2009 primarily to improve the regulatory framework for banks after
the happenings of the sub-prime financial crisis, according to which the banks were required to
increase minimum Tier-1 equity capital from 4% of risk weighted assets to 9.5% - 13.5% of risk
weighted assets which seemed to be a very tough task for banks already under stress. Also, the
risk weights assigned to certain classes of assets were required to be increased as per Basel III
norms. The banks were required to gradually start adopting the Basel III norms from 2013 and
have to comply with it mandatorily by 2019.

To finance asset growth on the balance sheet, banks primarily use one of the following methods:
1. Use profits/gains earned in the previous years

2. Issuing new equity capital thereby diluting the equity value of the existing shareholders

3. Borrow debt capital thereby increasing financial leverage

In 2012, Deutsche bank had risk weighted assets around EUR 488 billion with a core tier-1 ratio
of 7.2%. To comply with the Basel III norms, Deutsche Bank can either issue hybrid securities
like convertible bonds or warrants and at the same time reduce the asset base in order to maintain
a balance between ROE and ROA which will provide a realistic picture to its investors and
customers. To comply with the Basel-III norms, Deutsche bank laid off many of its employees
which was a negative development and also increased their stake to 93.7% in Germany based
Postbank in February 2012.

The Basel-III requirements were most likely to decrease Deutsche Bank’s profitability because
of the fact that the weighted average cost of capital will be higher as compared to the earlier
requirements. The bank was also needed to hold more equity which is not only more expensive
but also is connected to high opportunity costs which was also not suitable for the bank. In
addition, Deutsche Bank might not be able to raise that much equity to comply with the Basel III
norms in such a short amount of time because it would have to buy it for a high price.