German Finance Minister Wolfgang Schäuble recently gave a German banker the most brutal lesson to date -- delivered in a series of apparently incidental comments. At a press conference last Thursday afternoon, Schäuble launched into one of his notorious lectures on sound fiscal policy in times of crisis.
But then, finally, he had an opportunity to air his frustration over the incorrigible banker caste. A journalist asked Schäuble about his response to recent comments by Deutsche Bank co-CEO Jürgen Fitschen. The previous day, Fitschen had accused Schäuble of irresponsibility and populism, because the finance minister had insinuated that the banks were still bypassing financial industry regulations.
"I don't know if Herr Fitschen has understood what I mean," Schäuble complacently replied. He also noted that he had only recently reminded the bank executive that the financial crisis had not been caused by politicians. Then, as if he hadn't already sufficiently lambasted one of the country's leading bankers, Schäuble added: "If Herr Fitschen carefully reviews his statement, he will undoubtedly come to the conclusion that he is incorrect in this matter." And Fitschen has undeniably adopted the wrong tone, he said.
The head of the venerable Deutsche Bank reprimanded like a schoolboy? Ouch.
Schäuble's slap in the face is a warning to Deutsche Bank. The minister's portfolio includes Germany's Federal Financial Supervisory Authority (BaFin). These days, the Bonn-based financial watchdog is conducting far more than the usual number of investigations into Germany's largest bank, and the consequences of these probes -- for the bank and its co-CEOs Fitschen and Anshu Jain -- are ultimately a political issue.
Taking An Aggressive Approach to Banks
During the second year of the new leadership duo, it looked as if the two men had tamed the bank and its milieu. But now critics in Germany, throughout Europe and in the US are again asking tough questions about banking regulation: Has the financial industry learned from the crisis? Have those who were responsible been held accountable for their actions? Has the financial system become more stable?
Government agencies around the globe are taking an aggressive approach toward the financial industry. In London regulators are investigating banks that allegedly manipulated the price of gold. In Brussels the European Commission has slapped financial institutions with billions in penalties for rigging key interest rates.
This impressive move has directed attention toward a question that has played an astonishingly small role in efforts to come to terms with the financial crisis: How dangerous is the market power of the leading investment banks?
A handful of financial companies dominate the trading of currencies, natural resources and interest-rate products. Although millions of investors and companies participate in these deals, buy and sell, hedge their bets and speculate, these transactions are handled by an exclusive club of global institutions like Deutsche Bank, J.P. Morgan or Goldman Sachs. These are also the financial giants that determine the reference rates that serve as a benchmark for deals worth trillions.
The main profiteers of these deals write important rules of the game themselves -- and the events of recent weeks have shown that they often abuse their power in the process.
Massive Fines Imposed
The industry and its watchdogs received a wake-up call last Wednesday when European Competition Commissioner Joaquín Almunia announced that he was imposing fines amounting to €1.7 billion ($2.3 billion) against eight financial concerns, because they were members of a cartel that manipulated money market interest rates like the Libor. Deutsche Bank alone is paying €725 million, by far the largest amount.
Additional penalties by international regulatory agencies are in the cards, and the Frankfurt-based bank is usually among the alleged wrongdoers. The European Commission suspects that banks -- including Deutsche Bank -- rigged credit default swap deals. London investigators and BaFin are looking into allegations that financial institutions tampered with gold and silver rates -- and Deutsche Bank is suspected of getting a piece of the action here as well.
The most explosive revelations, though, may come from current investigations into the foreign-exchange markets, which boast a daily volume of $5.3 trillion. Analysts at KBW, a unit of Stifel Financial Corp., say that the alleged manipulation of currency rates could lead to another $26 billion in legal costs for the investment banks, with Deutsche Bank alone facing a possible burden of $3.4 billion.
The names of the same big banks crop up in nearly all of these investigations. This is no coincidence. After all, these financial powerhouses are gaining an increasingly large share of the global volume of trade in financial instruments. In 1998, nine banks controlled three-quarters of the foreign exchange in Germany; now it's only five. Across all currencies and countries, four leading banks handle half of the trade: Deutsche Bank, Citigroup, Barclays and UBS.
Such dominance is practically an invitation to make backroom deals. "The smaller the number of market players, the easier it is to coordinate their actions," says Daniel Zimmer, head of the German Monopolies Commission.
Colluding With the Competition
And the larger the sums involved, the more profitable it is to influence the currency rate, even if it only affects the third decimal place. Every day at 4 p.m., at the London afternoon fixing, exchange rates are established for important pairs of currencies, like the euro/dollar. Countless financial holdings of companies and investors worldwide are tied to this figure.
The fixing is calculated based on the currency transactions that are conducted during the minutes around the 4 p.m. deadline. Because the trading orders for this are primarily handled by the big investment banks, they can sense in what direction the exchange rate is moving just before the fixing. It's possible that they capitalize on this information for their own business transactions and collude with their competitors -- at least that's what investigators in New York, London and Frankfurt suspect.
This prompted the FBI to visit the New York offices of Deutsche Bank currency trader Robert Wallden a few weeks ago. The agents waved a log of an online chat under Wallden's nose. Investigators say this proves that Wallden bragged about how he had manipulated currency exchange rates. Deutsche Bank has declined to comment on the probe, but fellow colleagues say that he was joking.
An insider from the bank says: "You shouldn't take at face value what's said there because everybody knows by now that the chats are recorded." Anybody wanting to manipulate exchange rates would use other approaches, he contends.
Nevertheless, Deutsche Bank has banned its traders from taking part in online chats at work. But this does not change the dramatic consequences that can result from their traders' behavior. Since early last summer, British investigators have been scrutinizing the currency trading business for signs of manipulation, and they are targeting a dozen banks.
Libor Making BaFin Suspicious
Germany's BaFin has also been conducting its own investigation into the matter since last summer, but the agency says that there are still no indications that Deutsche Bank was involved. For the time being, BaFin has merely made a request for information. This means that the bank has launched an internal review, and BaFin will only intervene if it is dissatisfied with the information that Deutsche Bank's lawyers provide.
The Libor case must have made BaFin rather suspicious. After conducting an internal investigation, the chairman of Deutsche Bank's supervisory board, Paul Achleitner, absolved the entire board of directors -- including Anshu Jain -- of any wrongdoing back in the summer of 2012.
To this day, BaFin doubts that Jain and other top executives can simply wash their hands of the matter. The agency is pursuing a criminal investigation to find out who -- right up to the board of directors -- knew about the manipulations. Consequently, it is still possible that the Libor scandal could topple Jain. The currency exchange rate rigging scandal could also prove to be his undoing if the suspicions of investigators are confirmed.
If it turns out that the exchange rates were manipulated, it is hardly conceivable that Deutsche Bank was not involved, at least according to numerous sources in the banking sector. Why is that? Because the bank -- with a 15 percent share of the global foreign-exchange market -- has almost continuously been the leader in this business for the past 13 years.
It was exactly 13 years ago that Jain assumed responsibility for trading in commodities and currencies, and later in interest-rate products as well. Within just a few years, he made these departments into the leading sources of income for Deutsche Bank.
An Institutionalized Conflict of Interest
Later, Jain rose to become the head of the entire investment banking division, and his right-hand man Alan Cloete ran the rates and foreign exchange sections. Jain rewarded him later by promoting him to a position on the expanded executive board. Soon thereafter, the Libor scandal erupted in full force.
Part of Jain's and Cloete's strategy -- at least according to dealers who have worked with both of them -- was to closely link the various trading areas with each other.
This interweaving went so far, however, that in some cases one and the same person was a trader and, at the same time, responsible for helping to determine the Libor interest rate. Annika Gey, a judge at the Frankfurt labor court, said in a decision that this was an institutionalized conflict of interest.
Still, Deutsche Bank adamantly insists that the dubious rate manipulation was the work of individuals acting alone. Even after the EU's cartel ruling, the bank boldly spoke of "modes of behavior by individual employees in the past." Commissioner Almunia sees this as nonsense. "We are not investigating individuals, but rather cartels by institutions," he said when he announced the fines.
The bank's leadership is coming under increasing pressure, as witnessed by Schäuble's finger-wagging toward Fitschen and the insistent digging of the regulatory watchdogs.
'Make Executives More Accountable'
And undisguised criticism has also now emerged from the circle of Anglo-Saxon investors: "We'd like to see boards make executives accountable for total risk control and not just financial performance," Colin McLean, founder and CEO of SVM Asset Management Ltd. in Edinburgh, told the Bloomberg news agency.
Anat Admati, a professor of finance and economics at Stanford University, also sees this as the key problem in the battle against fraud on major financial markets. "In these settlements," she says, referring to the penalties that are currently being imposed on the industry, "the people who were responsible are rarely affected." This hardly increases the incentives to improve risk management.
It's very possible that criticism from investors has also encouraged lawmakers to take a tougher line with the banks. European Commissioner for Internal Market and Services Michel Barnier has put forward one bill after another to end the uncontrolled activities of the banking sector.
But the financial industry is stubbornly resisting. The big firms are hoping that many proposals for stricter regulation will not be passed into law before the fall of 2014, when the legislative period of the current European Commission expires.
Barnier's draft legislation aims to force the banks to organizationally split off their risky branches of business, such as proprietary trading in securities and the financing of hedge funds. But the proposed law has been repeatedly delayed, although a commission under the leadership of Finnish central banker Erkki Liikanen made concrete proposals over one year ago. Now internal sources say that the bill will be put forward "over the coming weeks," in a considerably watered-down version. This means that there is virtually no chance that the law will go into effect next year.
Large Banks Will Continue to Grow
Barnier first wants to wait and see how far the Americans will go.
For the past three years, US lawmakers have been cobbling together draft legislation aimed at curbing the banks' excessive power. The rules, named after former Federal Reserve Chairman Paul Volcker, are expected to be approved this week. But experts predict that the large financial institutions will continue to grow unabated. The banks have become increasingly powerful over the past five years, "and the Volcker rule is not going to solve this problem," says Andrew Lo, a professor of finance at the Massachusetts Institute of Technology (MIT).
Indeed, for bank CEOs like Jamie Dimon at J.P. Morgan and Anshu Jain, size means above all lower costs and better chances of balancing out losses from one area of business with gains from another one.
Every bank CEO with any sense at all will endeavor to continue to grow, says Lo: "The new rules have actually increased the motivation to become too big to fail. It has become more difficult for small banks to emerge," he says. To deal with the mountains of paperwork and complex new regulations, financial institutions now need armies of lawyers. This will make many operations too expensive for smaller banks.
"It's very clear that capital market operations are concentrated in the hands of fewer and fewer players," says Christoph Kaserer of Munich's Technical University. "This means that fewer individuals are making decisions of enormous material importance," he argues. Kaserer contends that this creates a big incentive to commit fraud.
The large penalties and costly settlements that many banks are currently paying won't significantly change any of this. "The fines often don't even balance out the profits that have actually been achieved," says Mario Mariniello, a competition researcher at the Brussels-based Bruegel think tank. He also notes that the chances of getting caught are very slim with these kinds of arrangements in the financial sector.
'Too Strong to Fail'
What kind of lesson does a bank CEO learn from recent events? Bank researcher Lo asks this question and immediately provides the response: "You are better off being too big to fail, because you otherwise couldn't survive a fine like $13 billion, as J.P. Morgan now has to pay in the US."
Deutsche Bank co-CEO Fitschen apparently takes a similar view. Instead of constantly repeating the "nonsense" of "too big to fail," he says one could also ask whether it wouldn't be better if banks were "too strong to fail" -- words of praise for the indestructible megabank.
Top-flight bank executives like to argue that we need large, universal banks to be able to accompany the IPOs, corporate mergers and promissory note issues of global industrial giants. But the question is whether a bank like J.P. Morgan really needs a balance sheet total of $2.5 trillion, or whether a few hundred billion would also do the job.
The state has to limit the banks' growth, says Lo -- and he urges governments to take a global approach here. National regulations merely ensure, he says, that the banks would continue to grow elsewhere.
Still, as long as primarily national regulatory agencies are responsible for monitoring the financial sector, such proposals will remain vain ideas with no prospects of being implemented. National regulators are often overwhelmed, and their governments ultimately want to see their own financial institutions play a leading role in global competition. That's something that Jürgen Fitschen and Wolfgang Schäuble can definitely agree on -- despite all their verbal skirmishes.