When capital is tight, businesses must fight to show why they should be given it. Deutsche Bank DB 2.43 % has been struggling in that battle: that is why it trades at the biggest discount to book value of any big global bank.
The German lender’s shake-up of its business divisions, announced on Sunday, is one way to address this: it will foster clear internal competition to use the bank’s equity and shine a harsh light on the division that struggles to make the money it should.
Deutsche Bank’s chief executive, John Cryan, looks to have designed this competition with a loser in mind. The securities trading business, left to prove its profitability alone without any help from the higher-returning advisory operations, is hobbled from the start.
Investors and employees alike will get to see how costly and how unprofitable much of what that unit does has become. Fixed-income trading using a highly leveraged balance sheet simply doesn’t work in the way it once did.
It will be easier for Mr. Cryan and his team to cut people, costs and balance sheet use when this is more plainly apparent in the bank’s quarterly reporting. The equity that business is given must be used much more efficiently.
On the other hand, the investment bankers who advise corporate clients on capital-raising and deal-making have been combined with a unit that, like them, uses less capital and generates better returns.
This business, global transaction banking, sounds dull, but it provides two important things. First, it has a large pool of cheap corporate cash: the float of funds being shuffled around the world on behalf of companies. This can be used short-term to underwrite corporate fundraising and deal-making. And if, or when, interest rates rise again, such lending becomes a money-spinner in itself.
Second, transaction banking is also where many relationships between the bank and its industrial clients are most stable and sticky. Putting advisory bankers under the same management could help to improve coordination and service. (Similar thinking explains the decision to put private banking and wealth advice in the same stable as the rump of Deutsche’s retail bank.)
Of course, this doesn’t mean life will be a breeze for this new corporate and investment bank division. Transaction banking needs more than twice as much equity now than it did precrisis, while ultralow rates have weakened profitability.
But, across the group, cost-cutting and more judicious balance sheet use is still required to get overall returns on equity higher: many analysts struggle to see Deutsche beating its cost of equity even by 2019.
By highlighting to all exactly where the poorest returns are, Deutsche’s leadership will find it much easier to make the case for those cuts—inside and outside the bank.
Write to Paul J. Davies at [email protected]