Operating and Financial Review

Economic Environment

Global economic growth has slowed again in the second quarter of 2012 and is approximately back to the growth levels seen in the fourth quarter 2011. Results of the purchasing manager surveys reflect this development, as their assessment grew increasingly pessimistic over the course of the second quarter and in June reached the lowest level in three years. This is partly attributable to the waning effects of monetary policy measures and increased uncertainty regarding developments in the European sovereign debt crisis. The tense situation in the eurozone is reflected in risk premiums on Spanish and Italian government bonds, which rose in the first quarter and were in the second quarter at levels similar to those at the end of 2011.

Nevertheless, there continues to be marked differences in growth across the regions of the world. While economic output in the eurozone stagnated in the first quarter of 2012, it has declined in the second quarter. After a strong first quarter, German GDP was likely close to stagnant while in France economic output fell. The southern economies of the EU in recession have contracted again noticeably due to the consolidation of public and private finances and the high level of uncertainty in these countries. Economic output in the U.S. is likely to have grown at an annualized rate of approximately 2 % and at roughly the same pace as in the first quarter. However, the U.S. purchasing managers’ assessment deteriorated significantly in June and the labor market recovery remained stagnant. Although the pace of growth in the emerging markets and developing countries is still high, it is likely to have also slowed primarily as a result of the falling demand for emerging markets goods from the U.S. and Europe.

The banking sector environment in Europe deteriorated in the second quarter of 2012 following a good start to the year, due to a return of worries about the European economy and the sovereign debt crisis. The liquidity support measures of the European Central Bank (ECB) only had a temporary positive effect on European banks’ funding situation, while the performance of almost all operating businesses may have been weaker both year-over-year and quarter-over-quarter. Loan losses are rising particularly in the southern European countries which have fallen back into recession. In the eurozone as a whole, lending volumes may have contracted (despite continuing expansion in the more robust economies such as Germany). Similarly to the second half of 2011, bank funding in capital markets largely dried up in the second quarter of 2012, although in the short run this did not pose a serious problem for most banks which have made abundant use of ECB liquidity.

The recovery of the U.S. banking industry continued in the past few months. Loan volumes in corporate and retail banking may have risen moderately, and loan losses may have declined further. In addition, the negative impact of the European debt crisis on U.S. banks has so far been limited; sometimes U.S. banks have been able to take advantage of their competitors’ weakness to reinforce their own position in the domestic market by pursuing (add-on) acquisitions.

At the same time and following a similar rise in the first three months of the year, European banks have probably been able to strengthen capital levels again in the second quarter, mostly by retaining earnings and reducing risk-weighted assets. According to the European Banking Authority, the vast majority of institutions that had participated in the capital exercise have met the target Core Tier 1 capital ratio of 9 % by June 30, 2012. In more critical cases particularly in Spain and Cyprus, discussions are continuing about government support which seems likely to be necessary.

Investment banking operations in general suffered again from investors’ elevated risk aversion in the second quarter; issuance volumes in particular, but often also trading activity, were below the levels of a year ago. In asset and wealth management, banks especially in those countries of the eurozone with the soundest finances recorded further capital inflows; overall, however, lower market valuations had a negative impact on fee and commission revenues.

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Deutsche Bank Interim Report as of June 30, 2012