Nontrading Market Risk

Nontrading market risk arises from market movements, primarily outside the activities of our trading units, in our banking book and from off-balance sheet items. Significant market risk factors the bank is exposed to and are overseen by risk management groups in that area are:

  • Interest rate risk (including model risk from embedded optionality and from modeling behavioral assumptions for certain product types), credit spread risk, foreign exchange risk, equity risk (including investments in public and private equity as well as real estate, infrastructure and fund assets).
  • Market risks from off-balance sheet items such as pension schemes and guarantees as well as structural foreign exchange risk and equity compensation risk.

The market risk component of our nontrading activities is overseen by dedicated groups within our risk management organization. Due to the variety of businesses and initiatives subject to nontrading market risk exposure, coverage is split into three main areas:

  • Market Risk Management – covering market risks arising in the business units PBC, GTB, DeAWM and Treasury and NCOU activities, such as structural foreign exchange risks & equity compensation risks, as well as pension risks.
  • CRM Principal Investments – specializing in the risk-related aspects of our nontrading alternative asset activities and performing regular reviews of the risk profile of the banks alternative asset portfolios.
  • Asset Management Risk – specializing in the fiduciary risk related aspects of our asset and fund management business in the DeAWM Corporate Division. Key risks in this area arise from operational and/or principal guarantees and reputational risk related to managing client funds.

The Risk Executive Committee and the Capital and Risk Committee oversee nontrading market risk exposures. Investment proposals for strategic investments are analyzed by the Group Investment Committee. Depending on the size, strategic investments may require approval from the Group Investment Committee, the Management Board or the Supervisory Board. The development of strategic investments is monitored by the Group Investment Committee on a regular basis. Multiple members of the Capital and Risk Committee & Risk Executive Committee are also members of the Group Investment Committee, establishing a close link between these committees.

An independent team in Risk validates the models for nontrading market risk. In general the validation includes a review of the appropriateness of risk factors, parameters, parameter calibration and model assumptions. Validation results are presented to senior management and appropriate remediating actions are taken by Market Risk Management Methodology to improve the specific model used for the various risk types.

Assessment of Market Risk in Nontrading Portfolios

The majority of market risk in our nontrading portfolios is quantified through the use of stress testing procedures. We use stress tests that are specific to each risk class and which consider, among other factors, large historically observed market moves, the liquidity of each asset class, and changes in client behavior in relation to deposit products. This assessment forms the basis of the economic capital calculations which enable us to monitor, aggregate and manage our nontrading market risk exposure.

Interest Rate Risk in the Banking Book

The majority of our interest rate risk arising from nontrading asset and liability positions, with the exception of some entities and portfolios, has been transferred through internal transactions to the CB&S division. This internally transferred interest rate risk is managed on the basis of value-at-risk, as reflected in trading portfolio figures. The treatment of interest rate risk in our trading portfolios and the application of the value-at-risk model is discussed in the “Trading Market Risk” section of this document.

The most notable exceptions from the aforementioned paragraph are in the PBC Corporate Division in Germany including Postbank and the DeAWM mortgage business in the U.S. Unit. These entities manage interest rate risk separately through dedicated Asset and Liability Management departments subject to banking book value-at-risk limits set and monitored by Market Risk Management. The measurement and reporting of interest rate risk managed by these dedicated Asset and Liability functions is performed daily in the PBC division and on a weekly basis for DeAWM. The global interest rate in the banking book is reported on a monthly basis.

The changes of present values of the banking book positions when applying the regulatory required parallel yield curve shifts of (200) and +200 basis points was below 1 % of our total regulatory capital at December 31, 2013. Consequently, outright interest rate risk in the banking book is considered immaterial for us.

Our PBC, GTB and DeAWM businesses are subject to model risk with regard to client deposits as well as savings and loan products. Measuring interest rate risks for these product types in the banking book is based upon assumptions with respect to client behavior, future availability of deposit balances and sensitivities of deposit rates versus market interest rates resulting in a longer than contractual effective duration. Those parameters are subject to stress testing within our Economic Capital framework. Additionally, consideration is made regarding early prepayment behavior for loan products. The parameters are based on historical observations, statistical analyzes and expert assessments. If the future evolution of balances, rates or client behavior differs from these assumptions, then this could have an impact on our interest rate risks in the banking book.

Foreign Exchange Risk

Foreign exchange risk arises from our nontrading asset and liability positions, denominated in currencies other than the functional currency of the respective entity. The majority of this foreign exchange risk is transferred through internal hedges to trading books within CB&S and is therefore reflected and managed via the value-at-risk figures in the trading books. The remaining foreign exchange risks that have not been transferred are mitigated through match funding the investment in the same currency, therefore only residual risk remains in the portfolios. Small exceptions to above approach follow the general MRM monitoring and reporting process, as outlined for the trading portfolio.

The bulk of nontrading foreign exchange risk is related to unhedged structural foreign exchange exposure, mainly in our U.S., U.K. and China entities. Structural foreign exchange exposure arises from local capital (including retained earnings) held in the Bank’s consolidated subsidiaries and branches and from investments accounted for at equity. Change in foreign exchange rates of the underlying functional currencies result in revaluation of capital and retained earnings and are recognized in other comprehensive income booked as Currency Translation Adjustments (“CTA”).

The primary objective for managing our structural foreign exchange exposure is to stabilize consolidated capital ratios from the effects of fluctuations in exchange rates. Therefore the exposure remains unhedged for a number of core currencies with considerable amounts of risk-weighted assets denominated in that currency in order to avoid volatility in the capital ratio for the specific entity and the Group as a whole.

Investment Risk

Nontrading market risk from investment exposure is predominantly the equity risk arising from our non-consolidated investment holdings in the banking book categorized into strategic and alternative investment assets.

Strategic investments typically relate to acquisitions made by us to support our business franchise and are undertaken with a medium to long-term investment horizon. Alternative assets are comprised of principal investments and other non-strategic investment assets. Principal investments are direct investments in private equity (including leveraged buy-out fund commitments and equity bridge commitments), real estate (including mezzanine debt) and venture capital, undertaken for capital appreciation. In addition, principal investments are made in hedge funds and mutual funds in order to establish a track record for sale to external clients. Other non-strategic investment assets comprise of assets recovered in the workout of distressed positions or other legacy investment assets in private equity and real estate of a non-strategic nature. The majority of the non-strategic investment portfolio has been moved to the NCOU and its mandate to achieve accelerated de-risking and capital relief.

Pension Risk

Deutsche Bank is exposed to market risk from a number of defined benefit pension schemes for past and current employees. The ability of the pension schemes to meet the projected pension payments, is maintained through investments and ongoing plan contributions. Market risk materializes due to a potential decline in the market value of the assets or an increase in the liability of each of the pension plans. Market Risk Management monitors and reports all market risks both on the asset and liability side of our defined benefit pension plans including interest rate risk, inflation risk, credit spread risk, equity risk and longevity risk. For details on our defined benefit pension obligation see additional Note 35 “Employee Benefits”.

Other Risks

In addition to the above risks, Market Risk Management has the mandate to monitor and manage market risks that arise from capital and liquidity risk management activities of our treasury department. Besides the structural foreign exchange capital hedging process this includes market risks arising from our equity compensation plans.

Market risks in our asset management activities in DeAWM, primarily results from principal guaranteed funds, but also from co-investments in our funds.

Economic Capital Usage for Our Nontrading Market Risk Portfolios per Business Area

Economic Capital Usage of Nontrading Portfolios by Business Division

 

 

 

2013 increase (decrease) from 2012

in € m.

Dec 31, 2013

Dec 31, 2012

in € m.

in %

Corporate Banking & Securities

333

818

(485)

(59)

Global Transaction Banking

143

136

7

5

Deutsche Asset & Wealth Management

1,295

1,235

60

5

Private & Business Clients

2,964

3,162

(198)

(6)

Non-Core Operations Unit

1,362

2,336

(974)

(42)

Consolidation & Adjustments

2,444

808

1,636

202

Total

8,541

8,495

46

1

Nontrading market risk economic capital usage totaled € 8,541 million as of December 31, 2013, which is € 46 million, or 0.5 %, above our economic capital usage at year-end 2012.

Increases in economic capital usage were largely driven by the implementation of a more conservative methodology for structural foreign exchange risk and pension risk with regards to applied liquidity horizon and treatment of longevity risk offset by substantial decrease in exposures for banking books with material credit spread risk.

The decrease in economic capital usage for CB&S was mainly driven by guaranteed funds risk caused by a transfer of assets to DeAWM and lower interest rate risk exposure. At DeAWM the economic capital usage further decreased following decreased interest rate risk due to risk mitigation positions. The reduction of credit spread risks mainly caused the economic capital movement in PBC and NCOU. Both the large increase in structural foreign exchange risk and the increase in pension risk are reflected in Consolidation & Adjustments.

Carrying Value and Economic Capital Usage for Nontrading Market Risk Portfolios

Carrying Value and Economic Capital Usage for Nontrading Portfolios

 

Carrying value

Economic capital usage

in € m.

Dec 31, 2013

Dec 31, 2012

Dec 31, 2013

Dec 31, 2012

1

N/A – Indicates that the risk is mostly related to off-balance sheet and liabilities items.

Strategic investments

3,257

3,015

1,277

1,230

Alternative assets

4,761

5,666

1,722

1,966

Principal investments

1,526

2,061

718

898

Other nonstrategic investment assets

3,234

3,605

1,004

1,068

Other nontrading market risks1

N/A

N/A

5,542

5,299

thereof:

 

 

 

 

Interest rate risk

N/A

N/A

1,557

1,390

Credit spread risk

N/A

N/A

444

1,636

Equity compensation risk

N/A

N/A

(262)

(303)

Pension risk

N/A

N/A

734

340

Structural foreign exchange risk

N/A

N/A

2,037

828

Guaranteed funds risk

N/A

N/A

988

1,364

Total nontrading market risk portfolios

8,018

8,681

8,541

8,495

The total economic capital figures for nontrading market risk currently do not take into account diversification benefits between the different asset categories except for those of banking book interest rate & credit spread risks, equity compensation risk, pension risk and structural foreign exchange risk.

  • Strategic investments. Economic capital usage was mainly driven by our participation in Hua Xia Bank Company Limited.
  • Alternative assets. The nontrading market risk economic capital decreased during 2013 mainly driven from further de-risking initiatives within the alternative assets portfolio, valuations and foreign exchange effects.
  • Other nontrading market risks:
    • Interest rate risk. Besides the allocation of economic capital to residual outright interest rate risk in the nontrading market risk portfolio, a main component in this category is the maturity transformation of contractually short term deposits. The effective duration of contractually short term deposits is based upon observable client behavior, elasticity of deposit rates to market interest rates (“DRE”), volatility of deposit balances and Deutsche Bank’s own credit spread. Economic capital is derived by stressing modelling assumptions in particular the DRE – for the effective duration of overnight deposits. Behavioral and economic characteristics are taken into account when calculating the effective duration and optional exposures from our mortgages businesses. In total the economic capital usage for December  31, 2013 was € 1,557 million, versus € 1,390 million for December 31, 2012, predominantly driven by PBC including Postbank, BHW and Deutsche Bank Bauspar.
    • Credit spread risk. Economic capital charge for portfolios in the banking book subject to material credit spread risk. Economic capital usage was € 444 million as of December 31, 2013, versus € 1,636 million as of December 31, 2012. The decrease in economic capital usage was driven by a substantial reduction in exposure due to de-risking activities and the alignment of the calculation methodology with the traded market risk methodology leading to increased diversification benefits.
    • Equity compensation risk. Risk arising from structural short position in our own share price arising from restricted equity units. The economic capital usage was € (262) million as of December 31, 2013 on a diversified basis, compared with € (303) million as of December 31, 2012. The negative contribution to our diversified economic capital was derived from the fact that a reduction of our share price in a downside scenario as expressed by economic capital calculation methodology would reduce the negative impact on our capital position from the equity compensation liabilities.
    • Pension risk. Risk arising from our defined benefit obligations, including interest rate risk and inflation risk, credit spread risk, equity risk and longevity risk. The economic capital usage was € 734 million and € 340 million as of December 31, 2013 and December 31, 2012 respectively. The increase was predominantly due to a more conservative treatment of longevity risk in the model and a decrease of diversification benefit after alignment of the calculation methodology with the traded market risk economic capital calculation.
    • Structural foreign exchange risk. Our foreign exchange exposure arising from unhedged capital and retained earnings in non-euro currencies in certain subsidiaries. Our economic capital usage was € 2,037 million as of December 31, 2013 on a diversified basis versus € 828 million as of December 31, 2012. The increase is largely due to the implementation of a more conservative liquidity horizon for deriving the foreign exchange shock in the economic capital positions, reflecting the long term strategic nature of this position.
    • Guaranteed funds risk. The decrease in economic capital usage to € 988 million as of December 31, 2013 was triggered predominately by lower interest rate risk due to risk mitigating positions. As of December 31, 2012 the economic capital amounted to € 1,364 million.