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March 16, 2016

Pavel Teplukhin, Chief Country Officer of Deutsche Bank Group in Russia, gave interview to Vestnik NAUFOR magazine.

Pavel Teplukhin, Chief Country Officer, Deutsche Bank Russia, speaks to Irina Slyusareva about the current global trends and why these are becoming more local, how DB's short-term strategy for Russia has changed and how the current import substitution processes can be described.

Pavel, what exactly has changed in Deutsche Bank Russia's operations, and why? What are your goals and objectives for 2016? What kinds of transactions, what markets and strategies will you focus on?

Firstly, we have changed a lot because the world is constantly changing. Heraclitus noticed that a long time ago. Crisis periods are particularly prone to change. Moreover, today's crisis is a global one. Many business models in many markets are being revised, and the banking sector is part of this process. Clearly, as a global financial institution, Deutsche Bank is also fully involved in the overall economic trends. Under these circumstances, Deutsche Bank, as a joint stock company, must care for it shareholders and clients as well as for its employees. For objective reasons, these three categories, which we are actively engaged with on an individual basis, have very diverse interests. Each of these groups has its own vision of the goals of banking operations. Shareholders want to see Deutsche Bank as a sustainable financial institution, look to timely and, whenever possible, generous dividend payments, and strongly oppose any depreciation of shares of the business they have invested in. Employees have their own concept of the due course of things, and customers also have their own, too. Each category has a dissimilar view of what management should do, what strategy should be followed by the Bank, etc.

There is yet another group of stakeholders that must never be ignored: regulators. They have their own mandate to confidently supervise the financial institutions that they are responsible for. Meanwhile, banking laws are being toughened up virtually everywhere. However, they have to be complied with.
So each of those stakeholder groups has its own requirements. It is the Bank's undertaking to regard all those sets of requirements with great care and to meet the above expectations because all of them are important.

As you know, global Deutsche Bank has changed its management. John Cryan became Deutsche Bank's Co-Chief Executive Officer in July, following the resignation of the Bank's previous co-CEO, Anshu Jain. The shareholder meeting resolved that Jürgen Fitschen, the Bank's second co- CEO, would keep his office during the transitional period (until the conclusion of the Annual General Meeting on May 19, 2016) in order to ensure the consistent transfer of all major business functions. After Jürgen Fitschen resigns, John Cryan will become sole CEO of the entire Deutsche Bank business.

In his public announcement, Mr. Cryan has already stated the priorities that will form the basis for the Bank's new strategy. This happened in October 2015. I will not analyze the strategy in much detail, but the key points have to be mentioned. In particular, the Bank has to streamline its product line and reduce its risks. It should reduce its debt load, increase its stability and raise its capital adequacy standard.

These are the key aspects.

The next point is to focus on our strategic customers. We value our customers and want to do a lot for them; however, those responsible relationships have to be mutually beneficial and future-oriented. We do not view one-off projects and transactions as very compelling. It is more important to build a long-term perspective around a comprehensive range of products.

The Bank will have to withdraw from some countries or, in certain cases, change the scope of its presence. Therefore, changes in scope will inevitably cause changes in local product lines.

The countries from which Deutsche Bank is withdrawing, have already been announced. The streamlining of business operations is being actively discussed.
We should ensure higher return on capital for our investors. Before everything else, this is done through considerable cost savings.

How much are "considerable cost savings"?

It is not my intention to give any figures right now. Otherwise, each figure would have to be accompanied with a lengthy disclaimer, and an interview is not the best genre for that.

In brief, I suggest that we discuss qualitative changes rather than quantitative ones.

Cost savings are difficult for a global institution that employs nearly 100 thousand staff. You cannot solve the problem by reducing the number of light bulbs or subscriptions for periodicals purchased. It is a global program that we need. In such cases it could be prudent to sell non-core assets, for example. This is a wide-ranging topic, and I would like us to merely outline it without going into much detail.

Another efficient measure is to considerably improve the Bank's technological infrastructure, and this is costly.

Indeed, in a short-term scenario, technology purchased makes operations more expensive as it requires substantial investments. From a longer-term perspective, however, it enables you to cut your costs, including personnel costs, by reducing the number of personnel. Again, I will not give any target figures for the number of employees because I would have to give a lengthy disclaimer as well. However, such targets also exist, and these have been mentioned in some mass media, even though I would not comment on whether the journalists are correct in the figures they provide.

How are those approaches implemented in Russia?

They do exactly as I mentioned. Deutsche Bank's local presence will be streamlined. This means that the sophisticated products previously existing in the Russian market will be either discontinued or moved to hubs, primarily, to London. In most cases, we follow the second scenario - change of location.

Russia retains a simplified, less risky business that is primarily focused on transaction banking: loans for current capital, cash management and other straightforward, classical commercial banking products. Structured products will be available at the hubs only.

Therefore, we view Deutsche Bank's global customers who have been working with us everywhere, permanently, and over many years, as our major customer group. In other words, we give priority to major global corporations that have presence, among other countries, in Russia and that require banking services here.

Are Russian companies among those selected few?

Yes, a limited number of major Russian companies are also included in this priority group. We will maintain detailed dialog and seek for mutual benefits with each of such customers. Whether or not we will work with any specific customer will depend upon the outcome of such discussions that determine our future relationship.

How will this affect the Bank's balance sheet?

The balance sheet will be shrunk by means of unprofitable assets. Also, the balance sheet of Deutsche Bank Russia will no longer have sophisticated structured products. This will reduce our risks, which is what we intend to do. Simplified operations will also influence the headcount. Most employees will continue to work as they did before. Some of them will be relocated to the hubs together with the products: London, Dubai, possibly Frankfurt and some other locations. And, unfortunately, we will have to say goodbye to some other employees. We hope that they will be able to apply their Deutsche Bank experience and expertise in their future career.

How will the capital adequacy standard be raised?

There are multiple methods for that. Firstly, non-payment or reduction of dividends and recapitalization of earnings. Secondly, raising of capital using other means. Thirdly, reduction of the total assets. We assume that all those methods will be used. Infusion of capital is the least possible way because Deutsche Bank recently resorted to such mechanism a couple of times, which was quite effective, but now it is probably time for other methods. I think that reduction of the total assets will be option number one. This, again, is connected with expiration of the existing products that are currently shown in the balance sheet, and with non-renewal of such products in the future. In other words, there is no need to take urgent emergency measures. This is not one of our objectives. Risks will be reduced in a step-by-step, systematic manner.

It was not until fairly recently that the Russian market was growing throughout, and investors had very high profit expectations. What kind of return could be appealing for investors in our market now?

This is one of the parameters that are undergoing global transformation. Classical reference points have been lost due to the crisis, while a new reference system has not taken shape yet. This is work in progress. Clearly, Russia is a risky territory in the eyes of a global investor. There are many risks here, no matter which way you look at it. The word "risk", however, should not be interpreted as completely unfavorable: a risk is equivalent to volatility. Everything Russian is pertained as highly volatile. This is triggered by high volatility of the global raw materials market, for example, rather than Russia's internal developments (whether political or not). Such volatility, in its turn, causes high volatility in Russia's FX market and equity market. All those factors impact the people's spending capacity and investment potential because a high inflation rate causes inability to prepare an accurate long-term business plan or results in considerable errors in business calculations. If the inflation rate is 11-12-13%, then the error is too significant over a three-year period, which does not provide the level of forecasting accuracy that is required, for example, for issue of loans.
One factor is linked to another, and, when combined, results in a highly volatile environment. And volatility means risk.

In a riskier territory (Russian, in our case), an investor needs higher return that adequately reflects the extent of risk. And when you begin to calculate that rate of return in a mathematical, straightforward manner, you get shocked because no investment project can survive such rate of return. Does that mean that the calculations are fundamentally erroneous? You start thinking about the second tier: we have high volatility today, while we are measuring a three-year project, and volatility can potentially subside in a year, and we will have a reason to re-calculate all figures. Theoretically speaking, such speculations seem to be correct and, therefore, everybody is expecting stabilization. So far, however, everyone remains somewhat shocked: both external and domestic investors (including governmental ones) and financial experts. We all expect at least something to settle down: exchange rates or interest rates or oil prices. Whatever it is.

On the other hand, domestic investors in Russia have a slightly different reference system after all. They keep in mind that they are cut off the external markets due to a number of geopolitical factors, while the domestic market is what it is. This market has its participants (including such major ones as the government) and its people. This market's reference system is different for a mere reason that its sovereign risk is actually point zero, a reference point. You can calculate certain aspects in this local system.

So far, however, the two reference systems - figuratively speaking, the local one and the global one - are fluctuating between one another, and the global system produces systemic risks.

By the way, in late 2015 some mass media began publishing forecasts by some domestic experts that had been announced early in the year: those regarding the Ruble rate, oil prices and some other important macroeconomic indicators, and started mocking the blazing inaccuracy of such forecasts because the real figures turned out to be different. In this case, however, there is nothing to mock as the forecasts were taken out of context and given without that very disclaimer. Analysts always state marginal conditions: the Ruble/US dollar rate will be such and such if the oil price is such and such. A forecast is invalid without a disclaimer.
The same applies here. Happiness will come when those two reference systems -  figuratively speaking, the global one and the local one - are fixed in relation to each other, and when the difference between the reference points represents Russian sovereign risk. Then one will be able to say that local risk exists and is fixed; you can build a yield curve for major corporations, the government etc. around it. Things will be put in order. This will enable market access to any companies, both big and small.
So far, however, we are at sea.

Still, what is your basic macroeconomic forecast?

It does not exist at the moment due to high volatility of the factors beyond our control. In such circumstances, any forecast is flawed.
You can only create scenarios: for example, pay wages to public sector employees in petrodollars, even though such design may seem absurd. But what can you do if about 60 percent of Russia's economy depends upon oil prices?

How do you view the potential of import substitution, both from the short-term and long-term perspectives?

When I hear the term "import substitution" I believe that it would be reasonable to start by giving some definitions. If import substitution is a governmental policy, then it is only good to the extent that it is possible to allocate investment resources to create businesses that would implement such substitution. Where such resources are non-existent or scarce (and they are very scarce indeed), then the government's policy in this respect can only be restrictive. But barriers are always destructive. In addition, they are not needed today because there is a single, very serious and natural barrier - the exchange rate. It gives a very clear indication both to every particular individual and business as to what they can afford and what is prohibitively expensive. You do not need to create any additional restrictions. In terms of a conscious governmental investment policy - to support, subsidize etc. - the budget has no money for such measures.

So some kind of import substitution will come by its own. People will find some resources and identify some lines of business.

As such, some import substitution is already happening, even though it is slower than you would like. And you cannot pursue a conscious policy today. But maybe you do not need to.

Can the Central Bank succeed in harnessing inflation?

By the way, I think highly of the Central Bank's efforts over the past year or year and a half. I believe that the CB has done many important things in macroeconomic policy, mainly monetary policy. It would have probably been appropriate to make the decision on the floating rate earlier, and this would have brought about better results. But it is good that is was made after all, and it has worked. This safety net has considerably absorbed external shockwaves and protected both Russian manufacturers and the state budget. In addition, (and it is far more important!) the Russian Central Bank has managed to prevent stagflation, which would be a disaster comparable to the 1990-s. Stagflation is where GDP is declining against the backdrop of high inflation. After all, to re-launch GDP, they usually use the money intervention mechanism to promote economic growth, consumer demand etc. Other things being equal, this measure works. The most dangerous situation is where there is a decline that should be substituted with growth or, at least, stopped, and, simultaneously, there is a high inflation rate that also depends upon money supply. Increased money supply can give additional momentum to GDP; this measure is most likely to be bring positive results, but, at the same time, it definitely accelerates inflation. This design is very dangerous, and Russia's economy has come very close to it. But the Russian Central Bank has avoided the dangerous area after it identified that the high inflation rate was the weakest component. The primary goal of Russia's monetary policy should be to reduce inflation rather than to seek to boost GDP. It is a low (or, at least, relatively low) inflation rate that acts as the backbone to prevent domestic economy from collapsing.

The Central Bank has successfully attained this goal.

They have to continue their efforts in this very delicate area because, to repeat myself, our resources are limited and have to be used with great caution. Error is not an option, and the Central Bank has managed to avoid those so far. I am very happy with that.

There is a whole range of alternative theories announced in the public space, which are supported by well-known and, in some cases, very important people. But the current policy of the Russian Central Bank seems more coherent to me.
Money intervention would cause an inflation spike, while it is receding now. 
It is possible that it will be even lower next year.

You said in public recently that Russian financial laws were being localized, which results, in particular, in domestic laws beginning to conflict with EU laws (specifically, in the area of finance). May we discuss how it is going on?

Localization of financial markets is also a global trend,
No matter how we would like the financial market to become increasingly global, the trends move in the opposite direction because many countries cannot afford their own banking system due to a negligible size of their national economy. That is why they delegate the relevant authorities, whether in part or in full, to some external party. This happens in the EU, for example, where few countries can afford their own banking system (that includes, among other things, a banking regulator). So they outsource that function (a fundamentally governmental one) to the supranational level, for example, to the European Central Bank. By accessing exchanging markets to trade in securities or commodities, some European countries also outsource regulatory functions to the relevant supranational agencies of the European Union. A number of Asian countries are attracted to other financial centers, be in Singapore or Hong Kong. The Americas are traditionally attracted to New York, and Middle East begins to lean towards Dubai. And these processes are going on.

Russia is one of the few ex-USSR countries that can afford its own banking system and its own banking regulator. Our country has been fighting quite tough battles for this right for about 25 years with many different adversaries. Let me remind you that as part of the negotiations on Russia's WTO membership an option for foreign banks to open their branch offices was a major requirement. Russian strongly opposed that and argued that foreign banks could only have subsidiary entities in the country, which were governed by a Russian regulator, and would not accept any other option. The same thing happened with insurance companies and pension funds. As result, Russian has managed to maintain its financial independence, which was a difficult thing to do.

This happened in the early 2000-s.

This was followed by the formulation of Russia's financial laws: banking, pension, stock exchange, insurance, anti-money laundering etc. In this respect, the behavior of Russian regulators (and now the mega regulator) is similar to the behavior of comparable foreign agencies.

Naturally, the more evolved our national laws are, the more distinctive and different from other countries they are. At the same time, Chinese financial laws are taking shape. For example, both China and Japan have their own systems that are different from both the Russian system and American system or the continental system. In this context, many countries are following the localization path. National statutory requirements are becoming more specific and focused.

For example, we say that every Russian financial institution should have its own risk management policy, which does not sound unusual. But in actual fact, multiple options are possible because risks can also be managed from the outside. But the Russian regulator requires a respective expert to exist within the framework of the financial institution itself. He/she should be properly qualified and engaged in operations on an ongoing basis. If the Central Bank has any questions, then this particular expert should answer those. All those details are being gradually fine-tuned. The simple statement that risks should be managed is filled with specific content, and such details become more and more focused, specific and tangible. Clearly, each such initiative implies additional costs and certain expenses. Therefore, a banking license becomes increasingly expensive. Participants that consider such expenses to be unacceptable are withdrawing from the market. This process is going on.

Western institutions are revaluating their costs, too, including their portfolios of Russian businesses and their product lines, just because the risk to return ratio becomes unobvious for their parent entities at some point. Something was profitable before, but it is no longer profitable today. This is a global trend rather than a Russia-specific situation.

A single global environment can only exist in theory simply because a single global environment should have a single global regulator, i.e. a mega central bank. Naturally, hardly any participant wants such entity to emerge.

Where all are equal somebody has to be more equal than others, and this is a bit of a problem.

It is sufficient to see just how many claims are currently raised against the International Monetary Fund, and why.

If alternative centers are inevitable, how can they interact?

Currently, interaction is governed by the Basel Committee where representatives of the major regulators work together. There is proper dialog going on, and this is sufficient in this situation.

However, localization is a global trend. The stronger an economy, the more influential the country, the more the national authorities want to lay down the markers for its independence, including in the financial area: create a national payment system, a national rating agency etc. Quite intelligent people are moving this way, and they have their sound reasons.

In the mid-term, what can the world's financial configuration look like in terms of multiple centers?

Firstly, each reserve currency lays claims to its own center. Today's reserve currencies are US dollar, Euro, Yen, Swiss frank, and Pound sterling. Chinese Yuan was added recently. In other words, there are at least six centers. As one can see, Ruble is not there yet.



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