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Exclusive: Deutsche's radical revamp foiled by ECB stress test

Anshu Jain (R) and Juergen Fitschen, co-CEOs of Deutsche Bank, speak at a news conference in Frankfurt, Germany, April 27, 2015. REUTERS/Kai Pfaffenbach

By Thomas Atkins and Kathrin Jones

FRANKFURT (Reuters) - A radical plan for Deutsche Bank (DBKGn.DE) to become a pure investment bank and corporate lender was dropped after stress tests demanded by the European Central Bank concluded the model would not withstand a severe financial crisis, sources said. 

Deutsche Bank, Germany's biggest lender, has spent much of this year looking at ways of reconfiguring its business to boost returns and had narrowed the choice to two possible models.

The bank's co-chief executives, Anshu Jain and Juergen Fitschen, originally favored shedding its entire retail business and becoming Europe's answer to Goldman Sachs (GS.N), sources familiar with internal discussions told Reuters.

But they and other decision-makers later changed their view in the wake of the stress tests and a raft of demands by trade unions and political interests in Berlin. The bank instead chose a less ambitious solution, selling only its Postbank (DPPBGn.DE) retail arm, cutting investment bank assets and investing more in equities trading and wealth management.

During Deutsche Bank's strategic review, the ECB, directly responsible for supervising the lender since the euro zone centralized banking oversight last year, asked it to test different structures to see if they could withstand a crisis.

Stripped of its retail arm's rich seam of deposits, the proposal - codenamed Model 5 during the process - failed because its funding dried up and its cost of capital rose in the stressed scenario, the sources familiar with the process said.

The result was that Model 5, which was already opposed by a trade union fearing mass layoffs and politicians who instinctively disliked the idea of Germany's flagship bank abandoning its retail customers, was no longer viable.

The ECB declined to comment.

This left Deutsche Bank with no option but to present a less radical plan, coded Model 2, to its investors on Monday after getting supervisory board approval for it on Friday. Postbank will be sold via a stock market listing and Deutsche will cut around 150 billion euros in investment bank assets.

Bank insiders said following the decision that they believed Model 5 would have gained more acceptance from investors who wanted to see Deutsche abandon its expensive universal model, offering everything from home loans to complex derivatives, while rivals such as UBS (UBSN.VX) specialize.

But the inherent risks, which were revealed as a result of carrying out the ECB's tests, showed it to be not resilient enough to survive a hard market downturn, sources said.

Jain, in announcing the new plan, said regulators played a large role in shaping it.

”A lot of our caution - when we think of our future - stems from what we think the future shape of regulation situation will look like,” he told journalists.

Deutsche's share price slid nearly 6 percent on Monday after Model 2 was unveiled under its official title, "Strategy 2020."  

Part of the drop was due to investor frustration at the lack of information on the pace of restructuring costs and targets. Deutsche was forced to rush out Strategy 2020 after leaks and has promised to provide more details in the next 90 days.

Those within Deutsche in favor of the more radical Model 5 depicted a bank dragged down by its sprawling retail operations, which include some 700 branches flying the blue Deutsche Bank banner, some 1,100 branches under the yellow flag of Postbank, and some 800 more abroad in countries such as Italy and Spain.

That, they argued, bloated the group's balance sheet and forced it to set aside billions of euros in capital to meet regulatory demands while making little profit in the overbanked German market, sources familiar with the bank's internal discussions told Reuters on condition of anonymity.

Despite their preference for Model 5, getting it done would have been high risk for Jain and Fitschen as it would have involved fully merging Postbank with Deutsche's own retail brand and bringing the combined entity to market.

“The breakup would have been the more courageous model, but it would have taken up so much bandwidth,” said one person close to the talks. “And the integration of Postbank into Deutsche Bank didn’t work in the past years. Why was it going to be different this time?”

Trade unions representing Postbank preferred a spin-off because that would protect the most jobs.

Regulator Bafin said a complete retail exit was undesirable because retail banking made Deutsche safer by diversifying its income. Ratings agencies said retail made the group more robust than a standalone investment bank.

Berlin also played a big role, supporting a strong, international German bank to serve the country's exporters. Jain and Fitschen met with German Finance Minister Wolfgang Schaeuble on Monday evening to reassure him.

(Additional reporting by John O'Donnell and Jonathan Gould; Writing by Carmel Crimmins. Editing by Alexander Smith)