Will Deutsche Bank Survive Its Latest Crisis?

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Wharton's David Zaring and William Black from the University of Missouri-Kansas City discuss alleged money laundering at the bank.

Deutsche Bank faces its most severe test yet in the wake of police raids on its Frankfurt offices last Thursday over suspicions of helping its clients in money laundering. The scene was dramatic: 170 officers descended on six Deutsche Bank buildings, including its headquarters, and seized documents and files, according to an NPR report.

German authorities are investigating whether Deutsche Bank employees – specifically two individuals – helped set up offshore companies in tax havens for some 900 clients to launder about $354 million from criminal activities. The investigation is related to the Panama Papers expose of 2016, Deutsche Bank said, adding that it has provided the relevant documents to the investigators.

The Panama Papers refer to the legal records of a Panamanian law firm that revealed the financial holdings in tax havens of numerous influential people including a dozen national leaders. Fourteen German banks used the Panamanian law firm of Mossack Fonseca to set up more than 1,200 anonymous shell companies, according a report in The Guardian newspaper of the U.K., which worked with the International Consortium of Investigative Journalists to publish the Panama Papers expose.

Penalized Out of Existence?

“The bank could face a world in which it gets penalized out of existence,” said David Zaring, Wharton professor of legal studies and business ethics. He noted that Deutsche Bank has a history of scandals involving regulatory transgressions. “It just pays fines all the time.” The bank is paying a $425 million fine in New York for helping Russians move money out of Russia; the Federal Reserve fined Deutsche Bank $41 million for failing to have effective compliance measures in place; and “German bank regulators have appointed a monitor for Deutsche Bank to make sure that it’s not laundering money and financing terrorism,” Zaring noted. According to one list, the bank has attracted some $12.5 billion in fines in 28 cases since 2000.

“Deutsche Bank is a classic [case of] ‘control fraud,’” said William K. Black, associate professor of economics and law at the University of Missouri-Kansas City. He explained that “control fraud” occurs when “a seemingly legitimate entity and the people that control it use it as a weapon to defraud others and commit other predation and crimes.” A former white-collar criminologist, Black had referred to the concept in his 2005 book The Best Way to Rob a Bank is To Own One: How Corporate Executives and Politicians Looted the S&L Industry. “[Deutsche Bank] poses as the largest bank in Germany, but it’s actually the largest criminal enterprise in Germany, which is something, because it has to compete with Volkswagen,” he added, referring to the German automaker’s 2015 emissions scandal.

“The bank could face a world in which it gets penalized out of existence.” –David Zaring

Zaring and Black discussed what lies ahead for Deutsche Bank on the Knowledge@Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)

Fall of a Champion

Deutsche Bank has been intimately involved with the German economy since its founding in 1870. Its status as a national icon grew along with its role in Germany’s reconstruction after World War II and its rise as a global bank over the last three decades. But the latest controversy threatens to upset that iconic image. “The problem is it is perceived as a national champion,” said Black. “The greater problem is that it’s a national champion that loses every joust, and it’s revealed to have cheated every time it gets into a joust. … So it’s a pathetic and embarrassing national champion in that regard.”

Zaring noted that at first sight, there is “nothing illegal” about Deutsche Bank helping its clients minimize their tax bills. “The question is whether they were using the Panama Papers [route] to fraudulently hide the money that the tax authorities would have wanted to get.”

Black identified problems on several fronts that Deutsche Bank currently faces. One is with the suspected link to the Panama Papers. That comes close on the heels of an investigation by U.S. law enforcement agencies into the alleged role of Danske Bank of Denmark in laundering money out of Russia and other former Soviet states. The U.S. subsidiary of Deutsche Bank was named as being involved in laundering $150 billion, according to a Financial Times report. (Deutsche Bank has clarified in a fact sheet  that the latest investigations are not related to the Danske Bank scandal.) Last, President Trump and his family’s relationships with Deutsche Bank in earlier years could trigger a game of political football after the Democratic Party gains control of the House of Representatives in January 2019.

Zaring noted that Deutsche Bank also failed a stress test the Federal Reserve conducted in June. “Clearly, American regulators are worried about basic questions such as whether it’s resilient enough to survive a shock to the system,” he said.

Deutsche Bank has also managed to avoid having to comply with Basel 3, the tight capital adequacy standards set by the Bank of International Settlements in Basel, Switzerland, said Black. “Its stock prices have tanked, its bonds are being downgraded and most people think it’s in a death spiral,” he added. Deutsche Bank ADRs trading on the New York Stock Exchange fell to an all-time low of $9.02 intraday on Dec. 4.

“The greater problem is that [Deutsche Bank] is a national champion that loses every joust, and it’s revealed to have cheated every time it gets into a joust.” –William Black

Black expected some executive heads to roll at Deutsche Bank as an outcome of the latest controversy. Both Black and Zaring also predicted that the bank will reach a settlement with regulators instead of fighting its case in court. “These are very difficult cases if they prosecute; almost always, Deutsche settles,” said Black. Added Zaring: “Deutsche doesn’t get a lot of joy out of fighting these things, so it will probably settle. And then, there will be a question over criminal prosecutions of the two executives who are allegedly facilitating this money laundering.”

Ducking Regulation

Black said that Deutsche Bank has failed to fulfill promises made to regulators each time it was fined for lapses over the last 12 years. “Deutsche Bank has used up all of its second, third, fourth, fifth and six chances.”

Black pointed out that Deutsche Bank’s CEOs seem to have taken the heat of its regulatory skirmishes in recent years, while its chairman, Paul Achleitner, has stayed in the job since 2012. “The tone presumably starts with him,” he said. The bank’s CEOs have had an uneasy tenure since 2011, when it experimented with two co-CEOs before they quit over the next four years. John Cryan, who succeeded them, was replaced earlier this year by current CEO Christian Sewing.

According to Black, Gresham’s Law is at work in the Deutsche Bank case – a monetary principle that bad money drives out good. “Deutsche Bank either needs to be under completely new management, where you have to rip out the entire top leadership, or it needs to be merged [with another bank],” he said.

Zaring agreed with Black. “It could be that a course correction could save the bank,” he said. While a merger may be explored between Deutsche Bank and “a couple of other, smaller German banks that the Germans trust more,” it’s not clear that is the best option. “I wonder if [Deutsche Bank] is going to be able to downsize and wait this out.”

“It looks like Deutsche Bank is ripe for cultural change, and it’s not clear whether the German regulators have figured out a way to do it.” –David Zaring

Fixing a Flawed Culture

Across a broad range of countries, “the culture of finance at really high levels has suffered greatly,” Black noted. “Part of it is [the role of] institutional structures and incentives. We need to make significant changes, because if you don’t fix the culture you will have recurrent problems.”

Zaring wondered if culture correction is a feasible goal. “Can you create the right kind of compliant, law-abiding culture in a bank? And how do you do it?” He noted that U.S. and Dutch regulators, for example, have attempted to foster within banks a culture of compliance with regulation, and have encouraged bank executives to put their clients’ interests ahead of their own bonuses. ”What we need to do is create that tone at the top, and get everybody in the bank to approach rules … the same way. It looks like Deutsche Bank is ripe for cultural change, and it’s not clear whether the German regulators have figured out a way to do it.” He wondered if the bank’s shareholders would also push for such a cultural transformation after tiring of the impact of fines on its bottom line.

The overriding concern now is whether it might be too late for all those changes, and if Deutsche Bank could withstand the pressure of yet another set of heavy penalties. Zaring noted that two years ago, when the U.S. government considered imposing a fine of around $14 billion on the bank for selling faulty mortgage-backed securities, its market capitalization shrunk to nearly the same amount. “In other words, they would have had to pledge all of their equity to meet their financial penalty obligations,” he noted. The bank eventually settled for about half that amount as a fine.

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