Deutsche Bank’s strategy is still on probation. The German group decided earlier this year not to follow Barclays, its largest European rival, in cutting back its investment bank. The bet will only pay off if the recent slowdown in bond trading is merely cyclical, not part of a structural decline. The evidence from the third quarter results is inconclusive.
A key reason for the ongoing confusion is all too familiar: the costs of litigation and regulation. A year ago, these costs reduced the 860 million euros of third quarter profit before interest and tax at the group’s investment bank to 361 million euros. A year on, 938 million euros turned into 374 million euros, leading to a loss for the group in the quarter.
Neither cloud has been fully lifted. The costs of manipulating Libor and wrongdoing in the foreign exchange markets are still unclear. And a comfortable pass in the latest European bank stress tests offers only modest comfort. The Basel Committee’s upcoming fundamental review of trading books could bring a big increase in the amount of capital needed to support normal operations.
Leaving aside the sins of the past and the doubts about the future, the third quarter’s performance was respectable. A 15 percent year-on-year rise in fixed income trading was in line with the average for U.S. peers, while equity trading outperformed the peer group. The optimistic case is based on the positive trends continuing, helped by higher interest rates sometime soon. Rate rises would prolong the uptick in the foreign exchange business and vivify currently moribund client activity in credit trading.
But low rates may be a secular trend. And some rule changes are just bad for a bank which wants to profit from trading. New accounting rules for the fair value of derivatives are consistently hurting returns.
Deutsche is shaking up its leadership, replacing Finance Chief Stefan Krause and reassigning its group head of audit to focus on legal issues. Investors, though, remain to be convinced the bank has made the right call on FICC. After a $12 billion rights issue earlier this year, the shares trade at only half book value. Given the uncertainties, that looks fair.