Deutsche Bank to shrink to achieve leverage target

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Deutsche Bank plans to shrink its vast balance sheet by as much as a fifth in order to comply with incoming stricter rules for financial soundness.

In a big strategic step by Germany's largest lender by assets, Deutsche is expected to tell investors that it aims to achieve a minimum 3 percent ratio of overall equity to loans by the end of 2015, people briefed on the plans said.

Such a clear timetable, likely to be announced with its second-quarter results at the end of the month, will address investors' concerns that Deutsche Bank has one of the lowest leverage ratios of large banks globally.

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It is also considering issuing at least 6 billion euros in hybrid equity capital such as convertible bonds – debt instruments that can convert into shares – once the German banking regulator has clarified which instruments will be recognized under a new global capital regime for banks.

Rival bankers and analysts have long carped that Deutsche has operated at much lower capital levels throughout the financial crisis than some peers, complaints that have intensified as European competitors from UBS to BNP Paribas have drastically cut back their balance sheets.

The German lender's estimated ratio of equity to assets stood at 2.1 percent at the end of the first quarter, the second-lowest of 18 banks ranked by Morgan Stanley analysts.

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European regulation based on the Basel III global rule book calls for the minimum ratio of 3 per cent to be achieved only in five years' time. But the topic has risen on investors' agenda after UK, Swiss and US regulators have drawn up plans for either stricter timetables or higher ratios.

Deutsche Bank aims to trim its balance sheet by up to 20 percent to about 1 trillion euros under U.S. accounting rules in the next two and a half years. The bank believes the measures it is planning would have a very small impact on earnings.

Its strategy to achieve the minimum ratio includes the application of new regulatory rules for the accounting of derivatives, reducing its vast cash pile of 240 billion euros and shrinking the 90 billion euros of assets in its so-called non-core unit, mostly non-performing loans.

Analysts say investors will push for banks to reach the minimum ratio much earlier than the Basel III rules demand.

"Our expectation is that most European banks will aim to meet requirements by 2015," Kinner Lakhani, analyst at Citigroup, wrote in a note to clients.

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The discussion around leverage ratios has brought Deutsche Bank's capital position back into the spotlight only months after senior managers thought the issue had been taken off the table.

A year ago, the bank was seen as lagging behind in its core tier one level, the new regime's main capital gauge that allows banks to underpin assets with different amount of equity depending on their perceived riskiness.

Twelve months on and helped by a capital increase in April, the bank became the fifth-strongest capitalized lender globally with a core tier one ratio of 9.6 percent.

Analysts and bankers said there would not be a similar race to the top on leverage ratios as there had been with the core tier one ratio. "Markets will only expect a bank to achieve minimum compliance," one European bank executive said.

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The focus on leverage ratios has drawn the ire of bank executives, who warned it would incentivise lenders to concentrate on riskier products and reduce cash holdings.

"A leverage ratio is undoubtedly important," Anshu Jain, Deutsche Bank's co-chief executive, said at a recent conference. "But [it] has significant flaws that could lead to perverse outcomes."

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