Archive for the ‘Financial Markets/ Finance’ Category

The Deutsche Bank Downfall: How a Pillar of German Banking Lost Its Way

November 7, 2016

The plot of the story is so so familiar to those who have followed banking history. It is ironic that a bank as old as Deutsche Bank (146 years) which should know history became its own victim.

Ullrich Fichtner, Hauke Goos and Martin Hesse of Spiegel in a long article explain what went wrong with the institution. In one word it was just “greed” which eventually took over all the culture and trust created by the bank:

Greed, provincialism, cowardice, unfocused aggression, mania, egoism, immaturity, mendacity, incompetence, weakness, pride, blundering, decadence, arrogance, a need for admiration, naiveté: If you are looking for words that explain the fall of Deutsche Bank, you can choose freely and justifiably from among the above list.

The bank, 146 years after its founding, has become the target for all manner of pejoratives, and not just from outside observers. All of the above terms were used in interviews held during months of reporting into the causes of the downfall of Germany’s largest financial institution. They popped up over the course of several hours of interviews with four Deutsche Bank CEOs, three former and one current. And they were uttered in interviews with eight additional senior bank managers and board members conducted over the course of several years, from the 1990s until today, and in meetings with captains of industry who know the bank well and during encounters with major stakeholders. More than anything, the disparaging words come up frequently in interviews with those who have worked or still work at the bank as customer service advisors, as branch managers or in positions lower down on the food chain.

What we have found in the course of these myriad interviews — combined with the hours spent analyzing bank balance sheets, thousands of pages of files, committee meeting minutes and archive material — is that the collapse of Deutsche Bank is the result of years, decades, of failed leadership, culminating in the complete loss of control of the company by top managers during the period between 1994 and 2012.

It is a story about how Hilmar Kopper, Rolf E. Breuer and Josef Ackermann, the leaders of Deutsche Bank during those fateful years, essentially turned over the bank to a hastily assembled group of Anglo-American investment bankers before Anshu Jain, the prince of these traders, rose to the top and spent three more years sailing the bank full-speed-ahead into the shoals.

It is also a story of how these bank heads, along with numerous other members of the management and supervisory boards, stood aside as Jain and the many other new investment banking heroes modified the staid German financial institution to serve their own purposes — essentially looting it and robbing it of its very soul — without leaving behind a better, stronger bank.

The subject is vast and convoluted, given the many aspects and paradoxes that come with the decline of such a large financial institution. One of those is the fact that, even as Deutsche Bank is rapidly losing value, it is still seen today as the largest systemic risk for the global finance world. Every detail in the sequence of its decline is controversial, partially because the financial world still considers it normal that nobody take responsibility for anything but themselves. All of them are most concerned with painting their own role in the best light possible and presenting the decisions they made as the only ones possible at the time.

But their claims must be examined critically. When looking back at past decisions, one can easily seem like a know-it-all, but it’s just as inappropriate to fall prey to historical relativism. When a bank like Deutsche, once an icon of respectability and solidity, transforms into a caricature of “The Wolf of Wall Street,” something must have gone wrong and someone must have been responsible.

And there are people who deserve blame: management board spokesmen (the bank’s equivalent to a CEO before a true CEO leadership model was introduced in the 2000s), members of senior management and advisory board members over the course of several years. Their leadership failures were not primarily the result of professional incompetence, since the people involved were and are extremely well educated, often proven professionals with significant amounts of experience. The source of their mistakes lies elsewhere, in cultural factors and psychological disposition.

Well, even if it is inappropriate to fall to historical relativism for answers, it provides most of the answers..

Bank of England member joins HSBC…

November 4, 2016

There are several classes in the world. But I guess the highest class is that of top echelons in world of banking and money. It is just shocking to see how one on reaching this class continues to move from one organisation to the other with aplomb. It is as if the entire class takes care of you.

The crisis has exposed the ill-effects of this arrangement but it just does not end. One keeps moving from private bank to central bank/finance ministry and then back to the private world with amazing ease. Countries like Nepal are trying to put an end to the exercise but there is no such thing in the developed part of the world.

Infact, the whole thing is getting bolder. There seems to no cooling period whatsoever. How else does one explain this recent Bank of England revolving door? In this case, one Financial Policy Committee Member quits the central bank and the decision to appoint her at HSBC came in quick succession. Even worse is that newswires knew of the moves much in advance.

Just keeps getting worse..

How culture (or lack of it) is becoming the major issue in finance….

October 28, 2016

Not too long ago, mention of culture in finance space was scoffed. It was seen as this soft issue which does not bring much value. Finance  was this hard subject all about numbers and jazz. This hard bit has taken a huge hit and has become really a soft target now. As a result, again people are going back to talking about the once soft things like culture, ethics etc in finance.

NY Fed has been organising conferences trying to figure the culture bit. The first was in 2014 and second in 2015.

In the 2016 edition, NY Fed chief William Dudley talks about things which central banks never thought they would – norms, ethics etc:

The evidence is pervasive that deep-seated cultural and ethical problems have plagued the financial services industry in recent years.  Bad conduct has occurred in both investment banking and securities market activities as well as in retail banking.2  This has eroded the industry’s trustworthiness.

This erosion impedes the ability of the financial services industry to do its job.  That job is financial intermediation—to facilitate the efficient transfer of resources from savers to borrowers, and to help customers manage the financial risks they face.  Verification—whether through regulation or internal controls—is an expensive substitute for trustworthiness.  Fines for bad behavior drain resources that could be better used to expand access and improve services, but billions of dollars in avoidable penalties are just the start.  The time spent handling a legal crisis is time not spent on more productive pursuits.  Moreover, I worry that, in the long term, an industry that develops a reputation for dubious ethics will not attract the best talent.3 

In contrast, a trustworthy financial services sector will be more productive and better able to support the economy.  Reliable financial intermediaries can help increase the flow of credit, promote economic growth and make the financial system more stable.  This is why restoring trustworthiness must be the ultimate goal of reforming culture. 

The industry’s shared norms—its culture—will not change by mere exhortation to the good, whether from me or from the industry’s CEOs.  In my experience, people respond far more to incentives and clear accountability than to statements of virtues and values.  The latter are worthy and necessary, but remain aspirational or even illusory unless they are tied to real consequences.4  What does it mean for a firm to profess to putting the customer first, if employees are compensated and promoted regardless of what’s good for customers?  Or, worse, if they are not held to account for activities that can harm customers?  If we focus on nothing else in today’s conference, let’s explore how best to structure incentives and reinforce accountability to align with core purposes and first principles.

To put it very simply, incentives drive behavior, and behavior establishes the social norms that drive culture.  If the incentives are wrong and accountability is weak, we will get bad behavior and cultures.  This implies a role for both firms and supervisors.  Firms need to continually assess their incentive regimes so that they are consistent with good conduct and culture.  When they are not consistent, the incentives need to be changed.

He says private sector should play the main role. But even the govt can help:

The primary responsibility for reforming culture—and changing incentives—belongs to the industry.  However, the industry does not act alone.  The public sector can play an important role as well.  I’ll discuss that issue this morning with my colleagues Norman Chan, chief executive of the Hong Kong Monetary Authority, and Minouche Shafik, deputy governor of the Bank of England.  Later this morning another panel will discuss the ways in which supervision can further contribute to improving bank culture.

Let’s also consider ways in which new laws or regulations might help—especially to overcome perennial collective action and first-mover problems that are common across the industry.  Two years ago I proposed solutions to two such obstacles to reforming culture.  First, there should be a database of banker misconduct to combat the problem of “rolling bad apples.”5  Second, a baseline assessment of culture is needed in order to measure progress.  I proposed an industry-wide survey, but there may be other good alternatives.  Once again, I invite the industry to take the initiative on these issues, and to look to the public sector for support.

I also hope that we will attend to issues that we may have overlooked in our earlier discussions.  Gillian Tett of the Financial Times argues in her new book, The Silo Effect, that the key to understanding any culture is identifying and explaining “social silences”—the issues that are not being discussed.

Database of banker misconduct…

There was a time when these databases only reported high salaries and bonuses of the sector. Now it is about misconduct..

Is higher finance education beyond bachelor’s degree merely a sideshow?

October 25, 2016

The more you read financial history the more you would agree to the above question. How is it that people managed to do much of finance without any of today’s fancy degrees? Much of finance then was bouts of common-sense backed by some intuition which builds from work experience. Much of finance today is reduced to less common sense and more degrees. But what to do? You do not get a job based on common sense alone.

Lilia Mukhlynina and Kjell G. Nyborg show much of the above is true. People at work hardly care for the valuation exercises taught in finance:

It is really interesting how much one has to unlearn at the finance workplace. The degrees just get you in and after that begins the game of learning how finance really works…

250 years of the bond-equity correlation in UK – from positive to negative

October 20, 2016

The word correlation seems to have magical powers till you enter a statistics class. The class rubbishes the claim “correlation implies causation” and with it dies all the magic associated with the word. So whenever you read the word correlation, your reactions are mixed.

This post by Matt Roberts Sklar of BoE Blog Bank Underground shows 250 years of correlation between bonds and equities.  Interestingly, the correlation was positive till 1990s and has been negative ever since:

For most of the 18th-20th centuries, government bonds usually behaved like a risky asset. When equity prices fell, bond yields rose, i.e.  bond and equity returns were positively correlated (bond prices move inversely to yields). But since the mid-2000s, bond and equity returns have been negatively correlated, i.e. bonds became a hedge for risk. Before this, the last time this correlation was near zero for a prolonged period was the long depression in the late 19th century.

Bond-equity correlation

Source: Thomas and Dimsdale (2016) and author calculations.
Line shows ten year trailing correlation of monthly returns.

The change in the bond-equity correlation since the mid-2000s partly reflects investors being less worried about inflation risks. As well as demand-type shocks being more prevalent than supply-type shocks, the introduction of credible inflation targeting has helped anchor inflation expectations and reduced the likelihood of high inflation risks. Investors may also have become more focussed on bad states of the world.

At the same time, there has been a structural increase in demand for ‘safe assets’, with more investors demanding safe government bonds for reasons unrelated to their expected cashflows. This has been exacerbated during and since the financial crisis, with deterioration in risk sentiment leading to episodic ‘flight to safety’.  And the addition of QE and forward guidance to the monetary policy toolbox may mean long-term bonds react differently to previously.

The long historical perspective is interesting.

We usually think of stock and bond prices correlations like this. Say inflation goes up. Markets then expect central bank to increase rates and as a result bond yields go up and prices fall. In equity markets, the expectation is that valuation of firms will be lower in future down due to higher interest rates. So, the equity prices also decline. Thus, we see a positive correlation in the two assets.

But this monetary policy thing is recent development in 250 year history even if central banks are not. After all BoE came up in 1694, much before this data which is from 1750s. So to see this positive correlation even back in 1750s is interesting. Even more as during those times inflation was relatively stable due to commodity/gold standard. Prices hardly changed and inflation was hardly a risk. The shocks then mist be more around due to crop failures, sudden  rise in price of gold/silver , banking panics etc.

So say there is a banking panic this would have led both bond and stock investors shunning both and prices declining.

I would imagine this correlation has changed mainly due to increased central bank adventurism. In case of a shock people know central banks will infuse liquidity mainly via buying more bonds. Thus bonds are never really out of favor and only equities suffer.

There is a lot of interesting stuff in this one graph..


Learning basic finance from Norway’s Wealth Fund

October 20, 2016

Espen Henriksen and Knut Anton Mork write about a committee report (headed by Prof Mork himself) to look at portfolio of Norway’s Sovereign Wealth Fund. It has some useful finance lessons to offer:

 Index funds whether explicitly or implicitly seem to get better of the active ones..

Mauritius’s long history of banking..

October 4, 2016

Nice speech by Mr. Rameswurlall Basant Roi of Central Bank of Mauritius. It is on occasion of Bank of China opening a branch in the island country.

He says Mauritius was a regional finance hub in 17th century:


How did white become the main color for bridal outfits? (historical tale of economics and marketing)

September 30, 2016

Victoria Finkle has a nice piece on history of bridal outfits:


What’s Warren Buffett’s Secret to Great Writing?

September 29, 2016

Warren Buffet is obviously seen as the gold standard for the investment world. But there is something else he excels at as well – financial writing. His annual letters to shareholders are gold standard as well for financial and economics writers.

Lawrence Cunningham of George Washington University looks at the secret behind the other gold standard – financial writing. He looks at few of these letters and analyses how Buffet argues for Berkshire’s strategy using rhetoric, humor and wit.

In nut shell it is about loving your job which shows in words as well:


Conceptual challenges in international finance..

September 29, 2016

The mainstream things taught in economics textbooks are increasingly being questioned. Infact not just being questioned but proven wrong when checked against real time evidence.

Stefan Avdjiev, Robert McCauley and Hyun Song Shin point to similar problems with International Finance.


Struggles to open a bank in UK..

September 28, 2016

I had just posted on how an app based bank got a licence to open a limited bank in India. One might be tempted to think it is easier to open a bank in UK.

However, this is hardly the case. Kevin Dowd posts about struggles of Dave Fishwick to open a bank in the country:


Chameleons: The misuse of theoretical models in finance and economics

September 23, 2016

Well Paul Romer’s paper scathing state of macro has been much talked about. Romer even defended the paper.

However, there are others as well who have been questioning state of economics who are not as well known. Here is a 2014 paper by Paul Pfleiderer of Stanford (what is it with Profs named Paul!?) who says we have a new problem. There are certain models which are full of assumptions yet are played at a policy/real world level. These models obviously don’s meet the filter of real world once assumptions are done away with. Still they remain the main ideas.

He calls such models as chameleons:


The Trade of the Century: When George Soros Broke the British Pound

September 21, 2016

Rohin Dhar has a nice piece narrating the trade of the last century:

In 1992, George Soros brought the Bank of England to its knees. In the process, he pocketed over a billion dollars. Making a billion dollars is by all accounts pretty cool. But demolishing the monetary system of Great Britain in a single day with an elegantly constructed bet against its currency? That’s the stuff of legends.

Though it occurred just two decades ago, Soros made his nation-shaking bet in a very different time. Back then, hedge funds hadn’t yet entered the public consciousness, restrictions on capital flowing from one country to another were just lifted, and the era of the 24-hour news cycle had just begun. 

To appreciate how Soros made a fortune betting against the British pound requires some knowledge of how exchange rates between countries work, the macroeconomic tools governments use to stimulate economies, and how hedge funds make money. Our readers are invited to correct us if we stumble in explaining any of these concepts. 

And so onwards with the story of how George Soros led a group of traders to break the entire foreign currency system of Great Britain—and profit handsomely at the expense of British taxpayers and others who were on the wrong side of the greatest financial bet of the 20th century.

Read the whole thing..

Italian Banking woes update..

September 20, 2016

One is really sick of pointing to banking woes and upcoming crisis but they keep coming.

Italy is hardly a new player and its fiscal/banking woes have been talked for a while. The concerns have increased recently following Brexit. Infact, all this is happening in a country which apparently gave birth to idea of banking in Europe. Bankers from Italy migrated elsewhere to shape banking in other parts of Europe. And now they have just forgotten their own history lessons.

Caroline Gray of Focus Economics has an update on Italian banking:


How and why lender of last resort function differs across the countries?

September 19, 2016

Charles Calomiris , Marc Flandreau and Luc Laeven have a really interesting paper on the topic.

Similarities in Wells Fargo’s fake bank account opening and Indian Banks’ Jan Dhan 1 Rupee deposits…

September 14, 2016

Banking and its crazy targets have similar stories across the world.

Wells Fargo employees got caught in a fake account opening case. Soon thereafter Indian Express reported how Indian bankers contributed Re 1 to several Jan Dhan accounts which had zero balances till date. Post Wells Fargo and before IE break out, Dhirendra Kumar of Valueresearch anyways said how these events are quite common to Indian banking.

Much of this is due to crazy pressure to meet quarterly/annual targets…It is amazing how all the banks/other firms keep revising their target upwards each year. Ask any sales person and he will tell you how difficult it was to meet previous year’s targets only to see management revise it upwards next year!

Growth at the cost of anything is the bottomline for most companies/banks..The model had to break down someday…

World’s most elite bond trading club (Fed and US Primary Dealers) is losing its sheen

September 14, 2016

All elite things are either going through a backlash or losing their sheen on their own.

One such is the most elite bond trading system –  Fed and Primary Dealers. There was a time when firms would compete/fight to be a part of the system. Now they are just giving up:


Who Wants to Start a New Bank? A case of drought in opening new banks in US…

September 13, 2016

US Banking structure is perhaps one of the weirdest in the world. It has a multiple regulatory structure at the federal level and state level:

Which agencies you’ll go to depends on whether you plan to operate a national bank or a state bank. The Office of the Comptroller of the Currency oversees and approves national banks, and national banks are always Fed members as well. Each state has its own chartering agency for state banks; in addition, state banks must choose either to become members of the Federal Reserve System (placing them under the Fed’s oversight) or to be nonmembers (placing them under the FDIC’s jurisdiction). Finally, while banks are not required to apply for deposit insurance from the FDIC, the conventional wisdom is that it would be difficult to compete without it.

Not many know of this structure and just blindly say we should have as many banks as US. But the structure of regulation is very different. As states have their own charters, one could just open a local unit bank and remain a small community bank. There is obviously a lot of history behind this kind of multiple regulation structure. US always dissented central control of financial matters and thus states set their own agenda on banking matters. This has allowed many small unit banks to mushroom across the country apart from large banks.

Compare this to India where banking and finance are mainly a responsibility of Central govt.

Though post-2008 things have changed. There is a near drought in opening of new banks in US:

In late 2013, the Bank of Bird-in-Hand opened its doors in Pennsylvania’s Amish country. Even in normal times, a bank featuring a drive-through window built for a horse and buggy would have drawn curious onlookers. But the Bank of Bird-in-Hand made headlines for another reason: It was the first newly chartered bank anywhere in the United States in three years. According to the Federal Deposit Insurance Corporation (FDIC), there have been only seven new bank charters since 2010. By way of comparison, there were 175 new banks (or “de novos,” as they are called in the industry) in 2007 alone. Indeed, from 1997 to 2007, the United States averaged 159 new banks a year.

To be sure, the number of banks has been falling for decades. Before the late 1970s, banks were prohibited from operating branches in most states, which inflated the number of unique banks in the country. States gradually did away with these unit banking laws in the 1970s and 1980s, a process that culminated on a national level with the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. The total number of banks has fallen by about 9,000 since the mid-1980s, as weaker banks merged with stronger ones. (See chart below.) But there was always a steady influx of new banks to replace some of those lost — until now.

t has been many years since anyone even talked to us about starting a new bank,” says Wayne Whitham Jr., a lawyer in the Richmond office of the law firm Williams Mullen who has worked with banks and financial institutions since the early 1980s.

When it comes to de novos, the last seven years stand out in stark contrast to any time before. (See chart below.) What can explain this trend, and what does it mean for the future of banking?

Low interest rates followed by complex regulation has kept people away from opening new banks..

What about future when rates will eventually rise (hope so):

there are signs that banks in general have been moving away from small-business lending. According to a 2013 paper by Ann Wiersch and Scott Shane of the Cleveland Fed, the share of banks’ nonfarm, nonres­idential loans worth less than $1 million has fallen steadily from just above 50 percent in 1995 to less than 30 percent in 2012. Some of this decline more recently may be due to increased competition from nonbank online lenders. While their share of consumer lending is still small, it is growing: In 2014, these marketplace lenders equaled under 4 percent of traditional consumer lending, but by 2015 their share had jumped to more than 12 percent.

These many changes highlight the uncertainty of banking’s future. Will new bank entry bounce back as interest rates eventually rise? And if it does, will those new banks look like the community banks of previous generations?

Marshall says blueharbor is sticking with the old model. “We’re just a good old-fashioned, general consumer community bank. If we tried to specialize in any one thing, we wouldn’t be serving our community,” he says. At the same time, he recognizes the environment is changing. His daughter is studying banking and finance in college (he hopes she will be the fourth-generation banker from his family), but he says many of the young bankers he meets or works with have expressed frustrations with current regulatory and economic conditions. “There are a lot of folks who say it’s just not worth it to start a bank today,” he says.

Mahan thinks the future is bright for new banks — if they’re willing to adapt to changing consumer demands. “You’ve got to be focused on technology and deliver products and services with a beautiful user experience,” he says. “Because at the end of the day, who wakes up and thinks about their bank?”


Alexander Hamilton: A finance genius or a second-hand dealer in retrograde mercantilist ideas?

September 9, 2016

There is a lot of discussion on Hamilton not just in US but in Europe too.This is the usual bit on Hamilton saying he was a financial genius.

However there is a contrarian piece as well by Lawrence White:


Singapore’s financial centre – resilience, dynamism, trust

September 9, 2016

Just a few days ago, HK Monetary Authority chief TL Chan pointed to two factors for HK brand of finance: quality and credibility.

Now Monetary Authority of Singapore, Ravi Menon points to three factors for Singapore financial centre:  resilience, dynamism and trust. Not much difference between the two.

The competition between the two for higher share of financial services has been there for a while. But core values of finance remain the same across  countries..