Beefing Up Deutsche Bank

Pressure to compete globally revives an old dispute about which way to go

It was a clarion call -- and one that resounded especially loudly at Deutsche Bank (DB ). On May 5, German Chancellor Gerhard Schröder told an audience of bankers in Frankfurt that they should start merging. That came as a not-so-subtle attempt to prod Deutsche in particular, as Germany's largest bank, to find a way to make itself bigger. The unsolicited advice was the latest push by the government to create a national financial champion -- a megabank with enough heft and resources to compete on a global scale. "I appeal to Germany's private banks to start consolidation," Schröder said. "They have to get going, possibly by the first half of this year."

While Germany boasts Europe's largest economy, it has none of the Continent's top banks -- something that rankles German policymakers and business leaders. Deutsche, with $1.05 trillion in assets, is the logical candidate for that role. Its market capitalization of $44.3 billion is less than a quarter that of HSBC Holdings PLC and a fifth of Citigroup's. So Schröder's words reignited a long-standing dispute that has polarized senior management at the big bank.

One faction, led by supervisory board Chairman Rolf Breuer and fellow supervisory board member Ulrich Cartellieri, wants to acquire a domestic bank. That would better position Deutsche to take advantage of economies of scale and growth opportunities in its home market. The other group, headed by CEO Josef Ackermann, argues for merging with a foreign bank to give Deutsche a bigger role in cross-border banking. The dispute has been brought to a boil not just by pressure from Schröder but by the decision of Deutsche Post, Germany's post office, to spin off its giant retail banking subsidiary, Postbank, on June 21. Should Deutsche go after Postbank? Insiders say its own executives can't agree, although officially the bank denies there's any split over strategy.

POACHERS ON HOME TURF. While Ackermann and Cartellieri are locked in a pitched battle, both sides are in agreement that Deutsche alone is too small to make its mark as a global player. With 8.5 million private customers, the bank has a mere 7% share of the German banking market. In France, by comparison, BNP Paribas has around 20%. Advocates of consolidation at home say Deutsche needs at least that much in Germany to strengthen its domestic base. Postbank, which has 11.5 million customers and $158 billion in assets, could be a promising match: It would more than double Deutsche's market share.

Germany has remained mostly isolated from the waves of financial mergers that have swept through the rest of the industrialized world, especially the U.S. That's because of strict job protection laws and the large role that public-sector banks play in the German financial system. At the same time, foreign banks have moved deep into German territory, competing with the locals in everything from consumer lending to equity underwriting. "Consolidation in the U.S. presents a new challenge for most European banks," Ackermann said in a German newspaper interview on May 10.

But the question remains -- where should Deutsche look to make future acquisitions? Supervisory board members Breuer and Cartellieri are said to be keen on the idea of merging with Postbank. Neither was available for comment. Proponents of a Postbank deal note that its customers buy on average just 1.8 financial products from the bank, so there would be plenty of opportunity for Deutsche to boost revenues by selling them its insurance, asset management, consumer credit, and pension products.

But Ackermann is resisting the idea. Colleagues say the Deutsche CEO, who is Swiss, favors going abroad. He reasons it's hard to make a decent return on investment in Germany's fragmented market, where competition is distorted by public-sector banks that offer government-backed loans at low rates. In a bold bid to propel Deutsche to the top of global banking, Ackermann held tentative merger talks in January with Citi, but called them off. Bank officials hinted one sticking point was Citi's demand for large job cuts, which are politically untenable in slow-growth Germany. Citi declines to comment. Undeterred, Ackermann is still looking for a foreign partner. Among the possibilities: Amsterdam-headquartered ABN Amro (ABN ) or Zurich-based Credit Suisse Group. (CSR )

MATTER OF PRIDE. The dealmaking moves by Ackermann make German business leaders uneasy. That's because they would effectively be takeovers by the foreign banks, which would cost Germany its premier financial institution and hurt national pride. On Mar. 16 a group of chief financial officers from Deutsche Telekom (DT ), SAP (SAP ), DaimlerChrysler (DCX ), and other large German companies urged Schröder to prevent Deutsche falling into foreign hands.

Schröder seems willing to do his part to promote the notion of a national megabank. In his Frankfurt speech, the Chancellor maintained that "we need [a bank] in Germany that is globally competitive -- it would be even better to have two." But that vision may -- or may not -- involve Postbank. The word in Berlin, according to industry sources, is that Schröder's advisers ideally want Deutsche to merge with insurer Allianz, which owns Dresdner Bank, to create a financial services leviathan. But analysts say such a complex deal would be too difficult to pull off. Moreover Allianz has shown no interest in such a deal, so attention is now on Postbank.

There are signs that Ackermann and his internationalist allies such as Anshu Jain, head of global markets, and Kevin Parker, head of global equities, may be bending under the combined pressure from supervisory board members, politicians, and business leaders. Deutsche's 11-member executive committee, which is chaired by the CEO and dominated by his supporters, debated on May 11 whether to bid for Postbank. But the bank has yet to comment on the outcome. If Deutsche does launch a bid, the situation would be complicated because it has been retained alongside Morgan Stanley (MWD ) to advise Deutsche Post on Postbank's initial public offering. A Deutsche move to buy Postbank, which would cost an estimated $6 billion to $7.2 billion, would force it to give up its advisory role on the IPO.

For his part, Deutsche Post head Klaus Zumwinkel says the Postbank IPO (expected to raise $3.6 billion, making it the biggest German IPO in three years) will go ahead as anticipated. The plan is to float 50% minus one share in Postbank, with the rest going on the market at a later date. Of course, Zumwinkel may not be the only decision maker. The government owns 62% of Deutsche Post and could try to overrule him. But government spokesman Thomas Steg says: "The federal government is acting neutral. That means it's not an actor."

Even if Deutsche were to acquire Postbank, it's unlikely to curb Ackermann's ambitions abroad. He shows no signs of abandoning his belief that a cross-border deal is needed to make Deutsche more internationally competitive. However the boardroom struggle plays out, one thing seems certain: Deutsche is going to hit the acquisition trail soon, either at home or abroad.

By David Fairlamb in Frankfurt

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