Dr. Josef Ackermann’s keynote speech to delegates at the Risk Management Forum of the Federation of European Risk Management Associations (FERMA) basically described the global financial system as broken and in need of a “fundamental reassessment.” As the Chairman of the Management Board and of the Group Executive Committee of Deutsche Bank, his words carried significant weight, and were sobering indeed.
While banks have been in the spotlight ever since the global financial crisis exploded in 2008, the insurance industry is also affected. Returns on investment are at an all time low with U.S. long bonds paying a meager 2 percent. Unemployment, especially among younger people remains entrenched. Many businesses have seen their sales decline and are foregoing expansion plans and cutting costs. The dire condition of the Greek economy threatens to spread to other European countries, and world governments seem to be unable to deal with the situation in any meaningful way.
Ackermann told the assembled risk managers, brokers, insurers and reinsurers that the crisis has “required a rethinking of the structure, methods and practices of risk management.” Moreover, it has “led to a wide ranging review of the outlook for the financial industry as managers and investors reassess it long term prospects.”
He noted that the volatility in the financial markets “reflects the considerable uncertainity that hangs over the global economy. Sentiment indicators, like the Purchasing Managers’ Index (PMI), suggest that the global economy is on the brink of a sharp slowdown. Growth forecasts have been lowered. And of course, uncertainty about the management of sovereign debt problems, especially in Europe, lies at the heart of the market turmoil. Investors are clearly unsure whether the necessary deleveraging will be achieved via austerity measures and deflation or via inflation. As long as this uncertainty persists, it is almost inevitable that investors will reallocate their funds between asset classes to protect themselves against either deflation or inflation – as a result we will see asset price volatility.”
That condition has already hit the financial industry, which, Ackermann pointed out, “was considered a growth industry” prior to the financial crisis.” Today the shares in most banks are trading below their book value, and are showing no signs of recovery. He cited “strict and unpredictable regulations, as well as volatile earnings” as two of the causes, along with government efforts to limit “the size of the financial sector, rather than promoting its growth.”
As a result “growth prospects for the Western world are limited.” The combination of rising levels of debt, or leveraging, by individuals and financial firms, which then collapsed, has decreased tax revenues. At the same time the crisis has greatly increased public debt, to the point that many politicians are now calling for and imposing austerity measures. Companies and individuals are also trying to build savings to decrease their debt load, or deleveraging.
All of this has led to what Ackerman describes as a “tectonic shift” with serious consequences. However, in his view it doesn’t end there. European populations are ageing and the populations of most countries are declining, which means “lower GDP growth – and this in turn, goes hand in hand with lower financial market growth.”
Conversely growth continues in emerging markets, notably in Asia (China and India) in Latin America (Brazil) and in the Middle East. European and U.S. banks will therefore face increased competition in those markets. As recently as 2004 there were no emerging market-based banks “on the list of the top 25 banks worldwide by market capitalization,” Ackermann said. “Today seven rank among that group, accounting for approximately 35 percent of the combined total market capitalization of the group.”
He also believes that reversing the trend towards deregulation of the financial industry and imposing new regulations – the Dodd/Frank law in the U.S., Basel III in Europe, as well as others, will have a “massively negative cumulative effect.” This is being worsened by the financial crisis and the “ensuing scandals,” which “have undermined trust and integrity” in the financial system.
Ackermann does have some prescriptions to regain that trust and re-empower the financial system to be able to do its job. They include “a solid capital base” with “rigorous capital management and “risk discipline;” achieving stability through a “broad product mix,” and an emphasis on deposits and “high quality assets,” rather than taking “exposure to the wholesale financial markets.” He also called for industry leaders to “establish a presence in growth markets,” if they want to maintain that status, keep costs down, and seek consolidation within the industry.
What can governments do to help the financial industry out of its crisis? Ackermann outlined the following steps:
– First by getting on top of the sovereign debt problem;
– second by doing no undue harm via financial regulation, and
– third, by supporting growth in general and opening growth prospects for the financial sector.
On the debt problem, Ackermann came up with a rather interesting statistic: “Public debt in mature markets is expected to soar from around 100 percent back in 2010 to 126 percent of GDP in 2020, even under the assumption of a gradual tightening of fiscal policies. In contrast, emerging markets’ public debt-to-GDP ratio will fall from around 46 percent in 2010 to 35 percent in 2020.”
In his conclusion Ackermann reiterated his belief that “we are witnessing a period of transformational change, with the entire structure of the industry being redesigned. And all of this is taking place while we are also trying to control risks in our daily business in a highly uncertain environment.”
Ed. Note: The day after he made that speech Ackermann encountered the crisis directly, as he announced that Deutsche Bank was lowering its profit forecasts for the year because the third quarter results were significantly below expectations.