Europe and Investment Banking Are a Bad Match
Deutsche Bank is undercapitalized and may be facing "insurmountable headwinds," James Chappell, an analyst with the private bank Berenberg, wrote in a recent note. He's not just down on Europe's biggest investment bank, which he thinks should trade at 9 euros ($10.2) per share rather than the current 14.7 euros -- he's irritated with the entire sector, which is dying out in Europe and is still disproportionally powerful in the U.S.
Just a decade ago, Chapell's chief gripe with investment banking -- that it's not very profitable -- would have made no sense. Now, the Berenberg analyst describes it as "an industry in structural decline":
Each weak quarter is seemingly greeted with an excuse that it could have been better if not for the wrong type of volatility, client uncertainty or central bank intervention. Q1 2016 saw the absence of one-off profitable events that have protected revenues in the past. We have perhaps had the first glimpse of what core profitability in the investment banking industry really is (ROEs in the mid-single digits at best) and it could be even worse if the traditional seasonality occurs.
Deutsche Bank, which Berenberg says is more than 40 times levered, in need of fresh capital and at the same time unable to offer a decent return on it, has become a symbol of Europe's failed investment banking ambitions. Before the 2008 financial crisis, European banks sought a foothold on Wall Street, where Deutsche, Barclays and Credit Suisse cracked the "bulge bracket" banking elite to rank alongside the likes of Goldman Sachs, JP Morgan and Morgan Stanley. Now they're losing out to U.S. giants even on their home turf, according to Bruegel, a Brussels-based research institute:
Their global market share is declining too: In the past five years, European Union- and Swiss-based banks have dropped to 30 percent from 35 percent of the total investment banking market, Bruegel says. And in North America, their share dropped to 22 percent from 28 percent in the same period.
Deutsche is a major contributor to that slip. Its debt underwriting business in Europe shrank 24 percent last year, and its equity underwriting volume dropped 25 percent, far more than the market as a whole. It's also scaling back its U.S. investment banking business that started with the 1999 acquisition of Bankers' Trust.
It's customary to ascribe Europe's investment-banking retreat to tighter regulation, and indeed, the U.K. has forced its banks to "ring-fence" their retail operations from investment banking, and imposed a bonus cap. But Deutsche, as a German bank with a large U.S. operation that is exempt from the cap, doesn't suffer much from these, and all banks, including U.S. ones, have recently faced increased capital requirements.
Rather, Deutsche's drama is that of a social climber who tried too hard. As it fought to establish a reputation in the hypercompetitive U.S. marketplace, it took too many risks and cut too many corners. It has already paid out 12.6 billion euros ($14 billion) in fines and legal costs for its part in various scandals, from interest-rate fixing to tax evasion. For an old European bank that once used the slogan "Everything starts with trust," the transgressions are a major departure from core values, but also from core skills; that may be why Deutsche keeps getting caught. As it expanded internationally, Germany's biggest bank never planned to become "America's Foreclosure King" in the wake of the financial crisis. Its Wall Street invasion turned into a defeated army's slog through an ocean of mud.
Last year, before Deutsche's co-chief executives Anshu Jain and Juergen Fitschen resigned in disgrace, German financial regulators told the bank's management board that it considered Deutsche's culture to be badly broken. But a 2014 Swiss study showed that bankers, who typically behave honestly, became less honest in tests when reminded of their professions and employers. "The prevailing business culture in the industry weakens and undermines the honesty norm," Alain Cohn and his colleagues wrote.
Wall Street's culture of all-encompassing greed turned out to be a bad fit with European banks. Barclays has gone through a period of soul-searching prompting it to crawl back into its retail shell -- perhaps even too deeply; recent attempts to revive its investment banking haven't really worked. At Credit Suisse, chief executive Tidjane Thiam's is working to unwind the very un-Swiss, overly risky positions that have long sat unnoticed on the bank's trading books.
Maybe U.S. bankers are better at handling the risks that come with their cutthroat culture. Maybe, as critics such as Bernie Sanders assert, they are "too powerful to jail." Or perhaps they are too powerful, period. It's difficult to imagine, for example, the U.S. capping bankers' bonuses as the EU has done, even though such caps are the most effective way to curb risk-taking; nor is it likely that the next U.S. president will follow Sanders' advice on breaking up the big banks, or even adopting the U.K. approach.
As a result, U.S. banks -- though they have also seen shrinking profits lately -- are still powerful, and some worry that the Europeans are leaving the capital markets entirely to them. This could potentially reduce European corporates' access to funding; after all, providing that access, not running financial casinos minting socially useless derivatives, is what banks are really for.
I wouldn't be too concerned. There are multiple ways to finance business expansion, as any tech entrepreneur or German Mittelstand company will attest. In Europe, bank loans have always been the preferred way of financing. Last year, the volumes of bond and equity underwriting -- both mainstays of the investment banking business -- declined in Europe, according to Bloomberg Intelligence, and the EU economy still expanded.
It's painful for European banks to shrink as they realize they've been playing an American game that didn't quite fit their skills, traditions or goals. The global investment-banking fad was clearly a mistake; Deutsche Bank will probably never be a European Goldman Sachs, and Barclays and Credit Suisse won't be a JPMorgan or a Morgan Stanley. Europe's banks can, however, still rely on their strengths to be both socially useful and profitable for their shareholders -- high-class retail divisions, strong relationships with corporate borrowers, and quality wealth management with a lot of personal care.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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