Unsolicited advice for Deutsche Bank

After giving Tidjane Thiam the benefit of my wholly unsolicited advice a month ago, I thought I’d try the same thing with Deutsche Bank, on the occasion of their new big strategic plan. Deutsche has been a perennial Cinderella of the European banking sector — its main problem has been that it managed to avoid being bailed out in the crisis, so rather than taking all of the pain of reinventing itself in one go and passing it on to taxpayers, shareholders have had to cough up for the whole lot.

And, due to Deutsche’s tendency to remain in denial about the unviability of return targets and the inadequacy of capital levels, over that period the management team have developed a largely justified reputation for unreliable communication. But nevertheless, there are some genuinely excellent businesses in there, albeit ones that have come under sustained regulatory attack. As far as I can see, the key to Deutsche’s future is to answer the question — how do you go about being a European investment bank in a US-dominated world? So the sorts of things they need to be thinking about are …

1. How can you use the few regulatory advantages that you have over US competitors?

Deutsche has had a tough time with US regulators — without going into details, it’s been penalised severely for holding the goodwill and tax losses from past acquisitions in a US subsidiary rather than at head office. The reason for this has been quite clear — starting in 2010, the Fed started to worry about the proportion of the US money market that was accounted for by non-US banks, and the way it chose to address that issue was to raise capital requirements for highly leveraged banks like Deutsche Bank. Back home in Europe, Deutsche also has a particularly tough regulator in the shape of the ECB/BaFin, in most of its trading businesses.

But it does have one big advantage — it’s not subject to the Volcker Rule. As well as proprietary trading, the Volcker Rule bans US firms from investing directly in venture capital. And this could be a big deal going forward. The investment banking industry, broadly speaking, is always in either a tech industry cycle, a resources industry cycle or a FIG (Financial Institutions Groups) cycle. At present, it seems to be ending a resources cycle and beginning in tech. And from previous tech cycles, we know that being able to co-invest with VCs is an important way of getting into deals. In my view, Deutsche ought to be — in as quiet and unshowy a way as possible — beginning to devote some of the capital and expertise of its Corporate Investments division in the direction of Silicon Valley.

2. Are you going to be leaders in Bitcoin For Banking?

“Bitcoin for Banking” is a bit of a silly slogan, but I put it there to attract attention. What it really means is what the experts call “shared ledger” technology. The idea here is that the important thing about Bitcoin is that every BTC “block” contains a complete record of every transaction made using it. The real innovation is not so much the cryptographic protocols of Satoshi Nakamoto, but the development of a standardised format for recording transactions and sharing the records between different parties while keeping them consistent — it’s sort of a MIDI or HTTP for financial transactions.

Shared ledger matters because anyone who has spent any time on new financial products knows that they often have the most dreadful settlement systems imaginable, and settle with long delays and loads of errors. This isn’t even a problem confined to innovative products — even cash bond trading often has quite embarrassingly bad settlement. The prospect of a standardised and shared set of protocols could be really quite revolutionary for the industry. There is a chance here for a new market leader to clean up.

Deutsche has a very strong payments business, as it was keen to remind everyone at the strategy presentation. It’s planning on spending a further €1bn on digital technologies in payments over the next five years. That’s a good start but it might not even be enough. They will also have to be smart and subtle about how they spend it — the biggest factor delaying the adoption of shared ledger technologies is the mutual distrust of the big banks for one another and their reluctance to get locked in to a standard owned by any other player.

3. What are you going to do about dollar clearing?

Also in the payments space, it’s now clear that, because of the convention of clearing US dollar-denominated trades in New York, the position of the regulators is that not only is every $-denominated transaction in the world subject to the USA’s foreign policy, but also that the New York State Department of Financial Services can insert itself into any misconduct case it wishes and force the penalties up. This is not a very happy state of affairs for banks based in countries that don’t want to have New York State policy enforced on them extraterritorially.

If there is going to be a dollar clearing arrangement established outside the USA, Deutsche Bank is one of a small number of natural candidates to operate it, and shared-ledger technology is probably the only way to make it work. This is going to require very careful handling, but it’s also potentially incredibly lucrative.

4. What kind of person does the chief executive of Deutsche Bank need to be?

For the last three CEOs including Anshu Jain, the answer has been “a clever, very aggressive trading specialist with a fixed income background”. That’s been the criterion at the time of appointment, anyway; as they have gone on in the role, Breuer, Ackerman and Jain have all rather matured into “a tired, grumpy guy with strong opinions on macroeconomic issues of the day”. Obviously, this has been great in terms of building up a fixed income business. But … there’s more to the franchise than FICC. Deutsche has a management culture which kills asset management franchises — one or two of them might be bad luck, but when you’ve bought Morgan Grenfell, Bankers’ Trust AM, Scudder and Sal Oppenheim, and all you have to show for it is DeAM, then you have to suspect that there is some kind of sick building syndrome at work.

Similarly, the Equities franchise has spent the last twenty years cycling between “We’re top three in FICC so we should be top three in Equities! Hire some people!” and “We’re top three in FICC so why aren’t we top three in Equities! Fire some people!”. Deutsche doesn’t have all that great a record in the management of any kind of talent which doesn’t have a particular set of personal characteristics, which is why they managed to lose both Michael Cohrs and Rob Rankin. Once the immediate fire fighting is over, the capital base is finally stabilised and the key strategic direction set, it’s worth paying some attention to succession after 2020, and having some outside involvement in that plan rather than having it shaped by an internal power struggle.

There’s a lot to agree with in Deutsche’s new direction. There is space for a European player in the global investment banking world, and Deutsche is the most likely candidate. But in order to get to where they want to be, they need to move a long way out of their comfort zone.

Dan Davies is Senior Research Advisor at Frontline Analysts