The long journey home
Deutsche Bank inserted two bold new financial targets into its annual report in 2000. Thanks to “the enhancement of our organisational structure”, the German bank committed itself to “planned annual growth in earnings per share of at least 15 percent” for the subsequent three years, and an average annual return on equity of “more than 15 percent”.
The plans did not pan out. Earnings per share in 2003 were just a quarter of what was achieved three years earlier. Deutsche did manage 6 percent annual EPS growth between 2000 and 2007, but then the financial crisis reset profitability at a much lower level. The firm eked out EPS of 1.31 euros last year, 85 percent less than in 2000. Return on equity over the past 15 years has averaged 7 percent, less than half the target level. The share price was as high as 91 euros in 2001. It closed on March 24 at barely more than a third of that, at 32.50 euros.
Deutsche’s ride over the past 15 years is not unusual. Back in 2001, its growth and profitability targets were standard stuff for investment banks. No one seemed to worry that such high returns can only be earned in a competitive industry by taking high risks or breaking laws against unfair practices. Nor was Deutsche’s experience especially bad compared to some rivals. It did not need a takeover or a direct government rescue.
Still, the lender that had been a distinguished servant of the German economy since its founding in 1870 and that had survived wars and dismemberment could have done better. The problem was not the decision, made in the 1980s, to expand from the traditional businesses of lending and trade finance into capital markets. That looked like a typically canny move from a bank with a reputation for taking only measured risks and making long-term commitments.
It made sense for Deutsche to follow its business customers, which increasingly wanted to use markets to raise capital and hedge risks. At first, the bank wisely followed a path of steady internal development. The 1989 purchase of a leading if somewhat diminished investment banking franchise, the UK’s Morgan Grenfell, was riskier, but the capital markets business was probably still small enough for the old-style bankers to manage.
Soon, though, it lost its way. I had a notion of the problem sometime around 2000, when I was an equity analyst. A presentation by Rolf Breuer, then Deutsche’s chief executive, left me worried.
What troubled me then was his attitude, which was something between blind optimism and dangerous hubris. In particular, I was worried by his enthusiasm for what were sometimes euphemistically known as transaction businesses – profiting from very short-term positions in currencies, debt instruments and derivatives.
Breuer was sure Deutsche would be the place the best traders wanted to work, because his bank offered them strong capital backing and the freedom to exercise their talents. Gradually, he said, the trading franchise would help build the bank’s presence in underwriting securities and advising companies.
At the time, I could not articulate exactly what was wrong with his argument. In retrospect, I think Breuer’s big mistake was to underestimate the importance of corporate culture. Neither he nor his successor Josef Ackermann, imported from the investment bank at Credit Suisse, really understood how the new businesses undermined Deutsche’s greatest strengths.
The push into capital markets did serve its customers, but the emphasis on trading took the bank far away from its traditional corporate mission. In the trading business, the customers were mostly other financial institutions, not real-economy companies and their owners. Long-term relationships are essential in lending, scarce in trading. Lending is essentially a partnership, trading a contest. Deutsche was a quintessentially German lender yet now wanted to be a global trading powerhouse.
Considering the differences, it is not surprising that the ingrained Deutsche culture was all wrong for trading. The bank had a crucial role in the German establishment. Its leaders were expected to be thoughtful partners to politicians and industrialists. Alfred Herrhausen, the chief executive who first moved the bank towards capital markets, was well known for his moral analysis of poor countries’ excessive debts.
The trading culture is pretty much the exact opposite. It is greedy, boastful and hovers between the amoral and the immoral.
Managers who excelled at the old-style Deutsche were ill-suited for this new business. Breuer should have realised that it would take at least a generation to create a management board capable of supervising and balancing both new and old activities. The crisis has probably accelerated the change.
In the past six years, Deutsche has regrouped. It wants to expand in what the industry now calls global transaction banking: the traditional business of helping companies manage their cash flows. It also is building up asset management, which offers steady revenue and usually rewards longer-term thinking.
The trading business has been cut back and further reductions are expected from an imminent strategic review. The Deutsche of 2020 could well end up looking more like an internationalised version of the bank of 1985 than the 2005 “flow monster”.
The financial bubble and bust of the 2000s teaches many lessons about financial excess. The saga of Deutsche bank teaches something relevant to every organisation: it is hard and dangerous to change corporate cultures.