Deutsche Bank Is Not Above Shuffling a Few Pieces of Paper To Keep Nosy Regulators From Demanding $20bn in New CapitalBy Matt Levine
Two things always worth talking about are bank regulation and path dependency so here’s this Journal story about Deutsche Bank that is like ooh-evil-Germans but also kind of meh:
Deutsche Bank AG changed the legal structure of its huge U.S. subsidiary to shield it from new regulations that would have required the German bank to pump new capital into the U.S. arm. … Taunus [the sub] — which at the end of last year had about $354 billion of assets and 8,652 employees, making it one of the largest U.S. banking companies — won’t have to comply with a provision of the U.S.’s Dodd-Frank regulatory-overhaul law that essentially forces the local arms of non-U.S. banks to meet the same capital requirements that American banks face.
Deutsche Bank has two main U.S. units. One is a trust company that has a banking license and must adhere to stringent U.S. bank-safety rules. The other is an investment-banking arm that isn’t technically a bank. Until recently, both units were housed under Taunus, which didn’t need to meet U.S. capital requirements, thanks to a waiver provided by the Fed a decade ago.
A provision of the Dodd-Frank Act, designed to prevent a repeat of the financial crisis, repealed the law under which that waiver and others were granted. That change was going to require Deutsche Bank to infuse Taunus, which for years operated with thin capital cushions, with what executives feared could be as much as $20 billion, according to people familiar with the matter.
Deutsche Bank responded last month by moving the trust company out of Taunus, named for a mountain range near Frankfurt. That means Taunus is no longer a bank-holding company and won’t have to comply with the new, tougher capital rules, even though Taunus still houses Deutsche Bank’s U.S. investment bank.
Instead it will be SEC regulated, like … well, every other US holding company that houses only an investment bank and not a bank bank. Bank. The bank bank subsidiary, on the other hand, will be owned directly by Deutsche Bank, which as the Journal previously explained gets to follow German but not US capital regulation. The bank sub will be a US trust company, so not quite true that it won’t have to meet the same capital requirements that American banks face. It will have to meet the same capital requirements that American banks face. Its just that its holding company will not be a US bank holding company, but will rather be a German thing regulated by Germans.
It’s hard to feel too many feelings about this, and any feelings you do have are probably attributable mostly to path dependency. Like: if Bank of Jupiter opened a US bank subsidiary tomorrow; the sub would be subject to US bank regulation (like Deutsche’s is) and the holding company would not be subject to US BHC regulation, but only to Jovian capital rules. Similarly if BoJu opened an investment bank it would be SEC, not Fed, regulated, because that’s how investment banks roll. The reason to get angry about Deutsche is that it is not some German bank opening a US subsidiary; rather, it is a big German bank with an existing US investment banking presence (though no real commercial banking presence) that is shuffling its US subsidiaries to optimize its US capital treatment and avoid some rules that apply to US banks.
Should anyone care? Well, Deutsche – and its predecessor in this variety of very slight shadiness, the artist formerly known as BarCap – will still be subject to capital rules administered by nice sensible Western European governments and would probably even pass US-grade stress tests. Of course adding another layer of juicy well-capitalized goodness above Deutsche’s risky risky i-bank couldn’t hurt, could it?
Funny you should ask. John Carney has a very smart piece today arguing that the extension of Basel II capital requirements to investment bank holding companies in 2004 helped cause the financial crisis by encouraging them to put all their money into products that got preferential capital treatment, meaning basically mortgage-backed structured credit: “The amendments contributed to the financial crisis not by permitting too much leverage, but by cajoling the investment banks into adopting the view of risk held by international regulators and subsequently, loading up on mortgage-related securities.” I like this a lot and find it plausible that spending all your time focusing on Basel-y risk-weighting leads you into error, though I’m not sure that the advantage of capping holding company leverage is outweighed by the disadvantage of defining it sub-optimally. In any case, though, if you do believe it too literally, then yay, getting rid of capital requirements at Taunus will make things safer.
There’s one maybe interesting implication of this. First of all, realize that though DB is getting a little bad press for the Taunus-shuffling, it also got to do it without much of a squeak from the Fed, which probably had at least some ability to step in and cause trouble if it wanted. Second, realize that though DB is getting out of some of Dodd-Frank, it’s not avoiding the most annoying item, which is the Volcker Rule: the current draft Volcker restrictions “cover the activities of any bank with a connection to the U.S., even a single branch in one state, according to lawyers and bank executives.” So the Taunus malarkey probably won’t get DB out of that.
But it does set the precedent that a thing that is a US bank holding company can stop being a US bank holding company with no hard feelings, Fed-wise. Other things that are kind of awkwardly US bank holding companies, what with their not really being US commercial banks in any meaningful way, include Morgan Stanley and Goldman Sachs. Unlike Deutsche Bank, for those domestic firms, de-BHC-ifying would, maybe, in theory, save them from the clutches of the Volcker Rule. Path-dependency, and also too-big-to-fail-ification, being what they are, that would get them some pretty bad press. But the Deutsche precedent suggests that it might fly with regulators.