Deutsche capital boost puts banks' models in spotlight

The sharp improvement in Deutsche Bank's capital ratio has revived debate about the role banks' own risk models play in deciding whether or not they have sufficient reserves.

Germany's largest lender, one of Europe's most weakly capitalized major banks, beat expectations on Thursday when it reported an 8 percent core tier one capital ratio for the end of 2012, helping to drive its share price close to one-year highs.

This compared to a target of 7.2 percent and 8.5 percent by the end of this quarter.

But on a conference call after the results, analysts questioned the way Deutsche had arrived at the 8 percent figure, in particular, they way the model changes helped them cut their Risk Weighed Assets (RWA) by 55 billion euros ($74.7 billion) in the fourth quarter.

"They're already one of the most aggressive users of internal models. For them to do that again (in the fourth quarter) really stretches credibility," said Andrew Lim, a London-based analyst at Espirito Santo, which has a "sell" recommendation on the German bank.

Deutsche's finance chief Stefan Krause defended the bank's methodology on the analyst call and said the bank's models would hold up amid moves to harmonize RWAs globally.

He said he was very comfortable with how the bank would stack up against its peers when international regulators examine approaches to risk weighting.

"They (the results) will prove that these accusations to Deutsche Bank's reliance on modeling might not be as true, and that maybe some of our other competitors are more exposed to this than we are," he said.

Banks, with the approval of regulators, can use their own models to assess how risky their assets are and assign a 'risk weighting' to various categories of loans and bonds.

These RWAs are used as a yardstick for the bank's capital, since capital demands are capital as a percentage of RWAs.

Krause said banks got lower risk charges by taking a more "granular" look at their books.

"Don't forget also that it takes a long time and a continuous proof between standardized and our individual models to make sure that our modeling of risk corresponds," he told analysts.

Analysts at Credit Suisse estimated that 41 billion euros of the fourth-quarter drop in Deutsche's RWAs was due to changes in Deutsche's modeling and warned that some of those cuts may have to be reversed if regulators harmonize how banks assess their own riskiness.

Banks have been cutting RWAs in a bid to hit Basel III capital targets, which are being phased in from 2014, with ratings agency telling Reuters last week that commercial banks' RWAs had fallen from 65 percent of total assets in 2007 to 35 percent by June 2012.

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At Deutsche, after the latest round of model changes, risk weighted assets have fallen to about 19 percent of the bank's total assets, as measured under the incoming Basel III system.

Under the old Basel 2.5 system, they came in at just under 18 percent.

That compares with Royal Bank of Scotland , whose RWAs equaled 35 percent of the bank's total assets in September, and Barclay's , whose RWAs equaled 24 percent at the same point, based on Basel 2.5.

At Credit Suisse , RWAs were about 23 percent of total assets by September. At BNP Paribas' , the figure came in at 29 percent at the half year point.

Although Switzerland's UBS had RWAs equal to just 15 percent of total assets in September it is Deutsche which appears to be taking the heaviest flak.

This partly reflects the candid disclosure Deutsche has made on its RWAs.

Institutions aren't required to disclose what drives changes in risk weighted assets, but Deutsche has done so anyway, telling investors how much of the reduction was due to asset sales and how much of it was due to model changes.

"The bottom line is we can only go on what they have given us," said Chris Wheeler, analyst at Mediobanca.

(Additional reporting Carmel Crimmins; Editing by Mike Nesbit)