Deutsche Bank May Find Silver Lining as Basel Hits Capital

Updated on
  • Basel Committee finished revamp of global standards last month
  • Supervisors may give banks a pass on fallout from legal costs

Deutsche Bank AG’s big hit from stricter global capital standards may be softened by the small print.

New rules give supervisors the option to exclude banks’ litigation payouts when calculating their so-called operational risk. If that happens, it would be a boon for Deutsche Bank and potentially improve returns for shareholders. The lender declined to comment specifically on the issue for this article.

The Frankfurt-based bank has racked up more than $16.3 billion of fines and legal settlements since 2008, the most of any European lender, leaving it one of the best placed firms to benefit from the supervisory discretion under Basel III. A top European banking regulator told Bloomberg that he favors using the option to lessen the impact on banks’ capital. He asked not to be identified because he wasn’t authorized to speak publicly.

“This could be a real benefit to Deutsche Bank,” said Andreas Meyer, who helps manage more than 3.3 billion euros ($4.1 billion), including Deutsche Bank bonds, at Aramea Asset Management in Hamburg. “The bank hasn’t had much good news to communicate, and life is pretty difficult for them at the moment with fundamental problems in the trading business.”

Gaming System?

The Basel Committee on Banking Supervision wrapped up changes to the Basel III capital rules late last year that are intended to stop firms gaming the system. As of 2022, banks no longer have the option of using their own statistical models to drive down capital charges for operational risk, which covers losses from misconduct and systems failures.

Read more about how banks emerged as winners from Basel III talks

Still, while the rules force banks to measure operational risk using a standard formula, the ability of supervisors to factor out a firm’s losses means Deutsche Bank’s required capital for operational risk could actually go down.

“We expect the investment banks to be a beneficiary of national discretion to help prevent a sharp increase in capital requirements,” said Thomas Hallett, an analyst at Keefe, Bruyette & Woods in London.

If national discretion is applied, Deutsche Bank’s operational risk-weighted assets could decline by 20 percent to 73.7 billion euros, according to KBW. Without discretion, KBW’s estimate would increase by 52 percent, Hallett said.

Deutsche Bank Chief Executive Officer John Cryan said in mid-2016 that operational risk was the “big issue” facing the lender in the Basel overhaul. The numbers show why. The bank had 92.7 billion euros of operational risk-weighted assets at the end of 2016, making it the second-biggest component of the calculation that underlies the company’s key capital ratio. Only credit, at 220 billion euros, accounted for a larger share.

Heavy on Loans

Credit makes up the largest chunk of Deutsche Bank's risk-adjusted balance sheet

Source: Company filings for the end of 2016

The Basel deal would hand supervisors two ways to give banks a pass on operational risk. Firstly, they could approve requests to remove large individual losses from their risk calculations. Secondly, they could allow all banks under their jurisdiction to exclude all historical losses.

Measuring Impact

Measuring the impact of the revised Basel III rules on Deutsche Bank, which reports 2017 full-year earnings this week, or any other major lender in the European Union necessarily involves some educated guesses at this point. That’s in part because the standards only become binding when they’re converted into EU law, a process that could lead to alterations.

The ECB will treat banks equally, while also addressing their “specific risk profile,” if it opts to use discretion, Sabine Lautenschlaeger, deputy head of the central bank’s supervisory board and a member of the Basel Committee, said at the conference.

‘Ultimate Impact’

When asked about the Basel III impact, a Deutsche Bank spokesman referred to comments published on Jan. 8, when the lender said it was “difficult to speculate at this stage on the ultimate impact” of the standards.

It’s “not possible now to predict the impact of ‘national discretions’ on the framework when it ultimately comes into effect in any given jurisdiction, notably the EU,” the firm said.

The Basel Committee also overhauled its rules for how banks calculate credit risk and is calibrating new standards for market risk.

Applying those two sets of expected changes would increase Deutsche Bank’s risk-weighted assets by 14 percent, according to Daniel Regli, an analyst at MainFirst in Zurich. That would have cut its common equity Tier 1 ratio, a key measure of financial strength, from 13.8 percent to 12.4 percent at the end of September, he said.

“That’s not a very generous capital ratio, but it’s enough,” said Regli. “The bank also has the ability to reduce the more capital-intensive parts of its loan book and generate capital. The ten years it has to do so should be sufficient.”

— With assistance by Alexander Weber, and Steven Arons

(Updates with comment, analyst’s estimate on ratios from 12th paragraph.)
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