It was supposed to be an uneventful conference call for senior executives at Deutsche Bank, one of Europe’s largest lenders. But a nerve was clearly struck as the executives took questions from analysts on Thursday.
The source of the provocation A set of new rules proposed in December by the Federal Reserve, a primary bank regulator in the United States. The regulations aim to make sure that the American operations of foreign banks have the financial strength to absorb losses. Deutsche Bank executives, however, feel the rules are unnecessarily restrictive - and spent part of the call complaining about them.
Deutsche Bank’s chief financial officer, Stefan Krause, said the regulations “are really not very helpful in terms of helping global financial markets to properly work.†Because of the flaws he perceives in the rules, Mr. Krause said he was confident they would ultimately be revised. But if, however, the Fed institutes tough rules for foreign banks, he said “retribution†by Eurpean regulators was possible.
Deutsche Bank’s co-chief executive officer, Anshu Jain, also let his fears be known. “I think this will rapidly escalate into an industry issue and indeed with very significant global G.D.P. and growth consequences,†he said.
Other European banks haven’t been anywhere near as critical about the Fed’s rules. But that’s because the rules may hit Deutsche Bank a lot harder than others.
Banks are required to protect themselves against losses by having a financial buffer called capital. The Fed’s proposed rules would effectively force banks with large operations in the U.S. to comply with the same capital rules as domestic lenders. So, if a big American bank had to have regulatory capital that was equivalent to 7 percent of its assets, so would the operations of a large foreign bank.
But Deutsche Bank likely has very little capital in its U.S. operations. The last time the bank reported a key regulatory capital ratio for its U.S. unit, ! then called Taunus Corporation, was at the end of 2011. Then, a key regulatory measure of capital was actually in the red. The deficit was equivalent to 6.13 percent of its assets. A bank normally doesn’t get to operate with negative capital. Indeed, regulators start to think about taking tough action against a bank if its capital ratios dip below 3 percent.
But foreign bank operations were allowed to have low capital because it was assumed that their parent companies would supply capital if the subsidiary got into trouble. The financial crisis showed that this might not happen, though. A trouble parent bank may get seized or collapse, leaving its subsidiaries dry. With its new rules, the Fed wants to guard against that by making foreign bank operations hold the same capital as American ones.
“I support the Fed’s approach,†said Sheila C. Bair, the former chairwoman of the Federal Deposit Insurance Corporation, a primary bank regulator. Ms. Bair was concerned by Deutsche Bank’s negativ capital ratios when she was at the agency.
A person familiar with Deutsche Bank’s thinking said the bank isn’t against holding more capital in its U.S. operations.
But this person felt the Fed’s rules are too blunt, and could be improved if they were applied to distinct U.S. entities, like Deutsche Bank’s Wall Street operations. This person also said that the combined capital ratio for Deutsche Bank’s U.S. operations has improved, but didn’t quantify the improvement.
Deutsche may find few sympathizers, however.
One reason is that it restructured its American operations last year, a move that led analysts to deduce that it was trying to skirt U.S. regulations.
“That reorganization was a slap in the face to the Fed, the regulators and the U.S. taxpayers,†said Dennis Kelleher, president of Better Markets, a lobbying group that supports robust financial regulation.
The person familiar with the workings of Deutsche Bank’s U.S. operations said the reo! rganizati! on was done to avoid having to report financials under both U.S. and German accounting rules.
Deutsche’s rivals on Wall Street may not support the bank’s position. Deutsche’s low U.S. capital may have allowed it to operate at a competitive advantage (capital effectively costs a bank, so the more it has, the harder it is to make an overall profit).
Getting U.S. capital ratios up to the required levels could be far more expensive for Deutsche Bank than other European banks, says Andrew Lim, a bank analyst with EspÃrito Santo Investment Bank in London. “Barclays has a similar issue but nowhere near as bad in terms of magnitude,†said Mr. Lim.
One mystery is why Deutsche, a huge lender, didn’t just raise the capital and put it in the U.S. operations many months ago. A key part of the Dodd-Frank legislation, passed in 2010, made it clear that foreign banks couldn’t operate in the U.S. on thin capital.
Deutsche Bank may have hoped to operate for as long as it could with lowcapital, to increase returns. But Deutsche may simply not had sufficient capital at the parent level.
“The irony is that Deutsche may end up better capitalized in the U.S. than anywhere else,†said Marty Leary, deputy director of research at Unite Here, a union that represents employees in casinos owned by Deutsche Bank.
