Journal of Risk and Governance

Volume 3, Number 2

ISSN: 1939-5922
2014 Nova Science Publishers, Inc.

STRATEGIC RISK MANAGEMENT - A TALE OF TWO

STRATEGIES

Patrick McConnell
Honorary Fellow, Macquarie University Applied Finance Centre
at Macquarie University, Sydney, NSW, Australia

ABSTRACT
2012 was a tumultuous year for international investment banks, not least because of
the emergence of the LIBOR scandal, just as the worlds largest banks were emerging from
the turmoil of the Global Financial Crisis (GFC). For two banks that had survived the GFC
fairly well, Barclays and Deutsche Bank, the year was momentous as both experienced
significant changes to the composition of their Boards and top management. In 2012, with
some fanfare, both banks announced new Corporate Strategies: Barclays with its so-called
Go To strategy and Deutsche with its Deutsche 2015+ strategy.
Following the failure of a number of high profile banks during the GFC as a direct
result of their flawed strategies, banking regulators around the world have recognized the
risks to the financial system that can arise from a too big to fail bank embarking on a
significant new strategy. These so-called strategic risks can be considerable but the
process of managing such risks is not well-developed. This paper compares and contrasts
the way in which these two banks disclosed how they developed their different strategies
and how strategic risks were identified and managed. The paper concludes that for
Deutsche, strategic risks were identified as part of the development process and an attempt
was made to measure, and to set capital to offset, potential losses due to strategic risks. On
the other hand, the Barclays strategy is little more than an aspirational vision with few
strategic objectives that can be independently monitored and, from their shareholder
disclosures, no apparent attempt was made to assess and manage the not inconsiderable
risks in the strategy that the bank was committing to.

Keywords: Strategy, Strategic Risk, Conduct Risk, Barclays Bank, Deutsche Bank, Banking
Regulation

E Mail: pjmcconnell@gmail.com

Patrick McConnell

INTRODUCTION
In their 2013 semi-annual Risk Perspective, the regulator of Large and Complex
Financial Institutions (LCFI) in the USA, the Office of the Comptroller of the Currency
(OCC), noted large banks are grappling with the need for fundamental changes to their
business models as a result of weakening revenue growth, including shifts in trading,
securitization, and consumer fee income (OCC 2013). The regulator also warned, as a key
theme, that strategic risk continues to increase and remains high for many banks as
management searches for ways to generate acceptable returns because of a challenging
operating environment, which is leading many banks to re-evaluate their overall strategies and
business models (OCC 2013). This is hardly surprising as banks, world-wide, come to terms
with the new economic and regulatory realities of the global banking system, in the wake of
the Global Financial Crisis (GFC).
Prior to the GFC, regulators tended to monitor the outcomes of the corporate strategies of
the banks that they supervised, rarely questioning the strategies themselves. In evidence to the
UK Parliament on the crisis, Lord Turner, last head of the UK banking regulator, the Financial
Services Authority (FSA), pointed out that before the GFC, "it was not the function of the
regulator to cast questions over the overall business strategy of firms" and there was an
approach to the "global philosophy of regulation which was based upon too extreme a form of
confidence in markets and confidence in the ideas that markets were self-correcting. This in
turn had led to a belief that firms themselves could be left to make fundamentally sensible
decisions [emphasis added]" (Treasury Committee 2009).
Official inquiries into some of the spectacular failures during the GFC, such as the Royal
Bank of Scotland (FSA 2011), Halifax/Bank of Scotland (FSA 2012), Washington Mutual
(FCIC 2011), Lehman Brothers (Valukas 2010), and Anglo Irish Bank (Nyberg 2011), all
concluded that these banks failed, in large part, because their corporate strategies were
inherently flawed. In learning the lessons of the failure of Royal Bank of Scotland (RBS, the
FSA noted that, in future,
"Supervisors needed to undertake a detailed analysis, assessment and challenge of a
firms business strategy to confirm that all risks had been identified and adequate
mitigation put in place Where the boards of high impact firms could not demonstrate
that they have adequately considered risks when setting their strategy, supervisors needed
to subject the firm to additional supervisory scrutiny and challenge [emphasis added]"
(FSA 2011).

In 2013, the UK banking regulator, the FSA, was split into two separate regulators, the
Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) both of
which recognized the need to investigate the risks posed to the financial systems by failed
corporate strategies. For example the FCA warned that in response to post-financial crisis
stresses and regulatory reforms, firms are adjusting their business models and strategies to adapt
to current and future conditions. These adjustments may create risks if not carried out with
appropriate governance and controls (FCA 2013) and the PRA noted that
The PRA has a variety of formal powers available to it under the [new] Act, which it
can use in the course of its supervision, if deemed necessary to reduce risks. For example,
it may vary a firms permission or impose a requirement to prevent or curtail a firm
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Strategic Risk Management - A Tale of Two Strategies

undertaking certain regulated activities, which may require a change to a firms

business model or future strategy. It may also, as noted above, use its powers to require
information from firms [emphasis added] (PRA 2013).

In effect, these new regulations are a charter for regulators to examine and scrutinize the
risks in the strategies of the banks that they supervise and also for regulated firms to identify
and assess risks to future viability, i.e. to manage strategic risks. It is possible, with hindsight,
to identify flaws in the development of a particular corporate strategy and the failure of the
Board and management of a failed firm to properly manage the risks that arose from such as
strategy (McConnell 2012). However, it is more difficult to provide guidelines for firms
embarking on such a potentially hazardous undertaking. This paper attempts to compare and
contrast the development of new strategies by two of the largest and most successful banks in
the world - Barclays and Deutsche. These banks are similar in size and business model with
both banks being classified as Global Systemically Important Banks (G-SIBs) by the Financial
Stability Board (FSB 2012). In this Too Big To Fail (TBTF) classification, Deutsche was
placed in the highest risk bucket (i.e. bucket 4) requiring an additional 2.5% of capital buffer
for loss absorbency, and Barclays close behind in bucket 3 , which requires an additional
2% capital buffer (FSB 2012).
In 2012, both of these banks developed new corporate strategies and, with some fanfare,
communicated their new strategic objectives to shareholders, regulators and staff (Barclays
Strategy 2013, Deutsche Strategy 2012). The long-term corporate strategies of these banking
giants are of interest not only to their shareholders, but also regulators, because of the strategic
risks involved and by governments and taxpayers because of the cost of bailing-out such
important banks, if their strategies were to fail. This paper first discusses the development of
corporate strategy in general and, from the firms own disclosures, the development for the new
corporate strategies for the two banks. The paper then describes how the articulation of any
strategy leads inexorably to the surfacing of risks to that strategy, and describes the very
different approaches taken by the Boards and management of these two firms to recognizing
and managing so-called Strategic Risks. It is possible to meaningfully compare these two
strategies because (a) by chance, the Boards and management of these two banks decided to
announce new strategies within a few months of the each other, in the same economic and
regulatory climate; (b) unlike other banks, such for example Royal Bank of Scotland, the
Boards were not compelled by government or shareholders to develop new strategies but chose
to do so themselves; and (c) the two banks are comparable, having almost identical business
models, and both considered as the highest levels of G-SIBs. Finally the paper discusses some
the regulatory initiatives in the new discipline of Strategic Risk Management (SRM) and makes
some suggestions to regulators and banks as to how they might improve Strategic Risk
Management in the future.

Text Removed

Patrick McConnell

Comparison of the Two Strategies

The table below summarizes the differences between the two strategies.
Table 1. Comparison of the Two Strategies Strategic Objectives

Strategic Positioning
Geographic Focus
Market Focus
New Focus
Strategic Withdrawal

Strategic Objectives
Capital
RWA reduction
Operational
Income
Return on Equity
Cost/Income
Headcount Reduction
Strategic Execution
Cost reduction
Culture

Deutsche 2015+
Universal Bank
Germany plus new focus on
Asia/Pacific
Global Transaction
Asset & Wealth Management
Create Non-Core Unit (135
billion in assets)

Barclays Go-To
Universal Bank
United Kingdom and Africa

Meet Basel III through Organic

Growth & Reducing RWA
> 45 billion over non-core
Cost Reduction
Targets by business line
>12%
< 65%
Not specified

Meet Basel III through

Reducing RWA
> 30 billion over legacy
Strategic Cost Management

Annual savings 4.5 billion at

cost of 4 billion
Lead Culture Change

Annual Savings 1.7 billion

at cost of > 2.7 billion
Become the Go-To bank

Investment Bank
Structured Capital Markets

> Cost of Equity

Mid 50s
Approx. 3,700

At first glance, the table appears to show that there is little difference between the strategies
(other than specific objectives) and there is indeed little difference in the medium term (to
2015). However, the table does not show the lack of specific objectives for the Go-To strategy
espoused by Barclays for which NO specific objectives have been provided. In summary, the
Deutsche 2015+ strategy has a detailed plan and objectives that can be measured as the strategy
is implemented, but Barclays long-term strategy is lacking in measurable objectives and
detailed plan.

Text Removed

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Strategic Risk Management - A Tale of Two Strategies

Comparison of Strategic Risk Management

The table below summarizes the differences between the two banks as regards Strategic
Risk Management.
Table 2. Comparison of the two Approaches to Strategic Risk Management

Strategic Risk
Definition
Measurement
Methodology
Capital Estimated
Strategic Risk
Management
Board

Executive
Strategic Risk
Management

Deutsche 2015+

Barclays Go-To

Yes, subset of Business Risk

Yes not disclosed

No partial - Conduct Risk

No - To be developed

Yes - 1.4 billion

No

Supervisory Board Risk

Committee

Board Conduct, Reputation

and Operational Risk
Committee
Management Committee to
focus on Conduct Risk
Not disclosed probably
Chief Risk Officer

Management Board Capital

and Risk Committee
Deputy CRO heads up
Strategic Risk and Enterprisewide Risk Management

From the table it can be seen that Deutsche has developed a methodology for measuring,
and a governance structure for managing, its Strategic Risks. On the other hand, aside from the
sub-set of Conduct Risk, Barclays has not set up the governance structures to manage the risks
to its Go-To strategy and had yet to develop methodologies for measuring any of the associated
risks.

Text Removed

Patrick McConnell

CONCLUSION
This paper considered the development, in 2012, of new corporate strategies by two of the
worlds Systemically Important Banks (SIBs): Deutsche and Barclays. The Boards of these two
huge banks decided to develop new strategies whenever their senior management changed. In
the case of Barclays the changes were necessitated by the resignation of senior executives
following the LIBOR scandal. In the case of Deutsche, it was triggered by the retirement of the
long-term CEO.
The strategies of the two banks are quite different. Deutsche banks Strategy 2015+ is
described as a strategy to win in a changed environment and is designed to adapt the bank to
new economic realities, post-GFC, and to cope with so-called megatrends, such as the ageing
population. On the other hand, Barclays strategy to become the Go-To bank for all of their
stakeholders, i.e. customers, staff, regulators and shareholders.
The paper first looks at the concept of strategy and the role of the Board and management
in determining the development of strategy and the strategic positioning of the firm. The paper
then describes the development of the two strategies and the strategic objectives set by the
respective Boards. The paper concludes that the Deutsche strategy is a not overly ambitious
attempt to change direction for one of the largest banks in the world, with non-trivial but at
least outwardly achievable objectives. On the other hand, Barclays Go-To strategy is a mix
of a medium-term strategy to repair the banks fortunes, battered by the LIBOR scandal, and a
longer term strategy to transform the culture of the bank. However, this longer-term strategy
is lacking in measurable, strategic objectives and, although worthy, is little more than a vague
aspiration.
Strategies involve, sometime considerable, risks. The paper then describes the concept of
strategic risk and analyzes the strategies developed by the banks as to the management of
these risks. The paper concludes that Deutsche, in a new initiative, has, by setting aside
economic capital to cover strategic risks, at least recognized the possibility that their strategy
may fail. On the other hand, Barclays has not yet recognized that possibility or, if it has,
management have not communicated that to shareholders. Nor, unlike Deutsche, has Barclays
created the organizational structures to manage the full range of strategic risks.
The strategies of Systemically Important Banks are important to regulators as, if overambitious or managed ineptly, the banks may require regulatory, even government, intervention
in future. Following the GFC, regulators have recognized the need to understand, and if
necessary inhibit, the strategies of Too Big To Fail banks. The paper discusses the regulatory
thinking in this important area. Finally, the paper makes some suggestions as to how Strategic
Risk Management may be strengthened in firms and how banking regulation may be enhanced
to consider how firms may better manage risky strategies. Strategic journeys take time and,
over time, it is possible to see risks to stated strategic objectives emerge and be addressed by
bank management. The paper sets the scene for monitoring the strategies of two Systemically
Important Banks, over their strategic horizons of the next 3-5 years.

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