Regulators Stunned By Deutsche Bank’s Spectacular, 12x VaR Trading Blowup

Most banks were well under VaR as they should.

Courtesy of Zero Hedge

Until recently, Deustche Bank was best known for being the worst managed megabank in the world, for having attempted rigging and manipulating virtually every single market and getting caught doing it, for having been "secretly" added to the Fed's "troubled bank" watchlist, for having been told by the ECB to simulate a "crisis scenario", for "accidentally" transferring €28 billion to an outside account, and of course, for having some $50 trillion in gross notional derivatives on its books.

As of today it is also known for having reckless traders on "full tilt" who go all in, bet the house, and lose.

As first noticed by Bloomberg, and disclosed publicly in a May 7 Federal Financial Institution filing, unknown Deutsche Bank traders suffered a staggering one-day loss in the first quarter that was almost 12x VaR, or 12 times what DB's risk officers have estimated for regulatory purposes it might lose on a typical day.

"Even a loss of two or three times VaR on a given day is unlikely. Twelve times VaR is extraordinarily unlikely," MIT finance professor Andrew Lo told Bloomberg.

This loss, which is unrivaled in either Deutsche Bank history, or in other banks’ first quarter reports – was oddly left out of Deutsche Bank’s earnings report, and as BBG notes, "raises questions about U.S. regulators’ ability to have an accurate picture of a foreign bank’s operations if metrics such as value-at-risk, or VaR, show only a fraction of potential trading exposure." It also confirms that the Fed has ample reasons to be worried about a bank which is willing to not only gamble the house on some wild trade, but also lose as a result.

The staggering, record Q1 loss is more than 6x greater than the next largest disclosed VaR exception, that of BNP Paribas. Most banks were well under VaR as they should.

"Such a high trading loss is off the charts," said Gregor Weiss, a professor at Leipzig University and an expert in financial risk management. "It’s definitely something a supervisor will look into."

And they did: the issue of the giant loss, and subsequent attempted cover up (or at least lack of disclosure) is particularly stark at Deutsche Bank, which has increased capital levels at its U.S. business after multiple failed stress tests and cease-and-desist orders. More from Bloomberg:

Multiple U.S. regulators, including the Federal Reserve, inquired about the outsized loss, according to a person with knowledge of the discussions. Eric Kollig, a Fed spokesman, and Richard Loconte, a spokesman for New York’s Department of Financial Services, which supervises part of Deutsche Bank’s U.S. business, declined to comment

While Deutsche Bank didn’t disclose the size of the loss, one can back into it based on the disclosed average regulatory value-at-risk during the period which was was $30.8 million, which would imply that the total loss was roughly $400 million, although as Bloomberg caveats, because daily variations in the figure aren’t disclosed, it’s impossible to know what the exact loss was.

And since the gargantuan one-day loss took place in a quarter in which DB reported trading revenue of negative $64 million, indicating losses on trading positions - while the Barclays and Credit Suisse each reported more than $100 million of positive revenue – we can be further assured that this was indeed some spectacular trading blow.

According to Bloomberg calculations, the extreme day was one of four in the first quarter in which Deutsche Bank’s U.S. traders had a loss that surpassed the firm’s regulatory VaR estimate, however it is unlikely that any of the other three came even remotely close to 12x VaR.

Others did much better:

no other bank required to file quarterly reports with the Fed detailing significant trading activities had more than two such days, and none had a daily loss that even doubled its estimate, according to a review of the 33 filings from U.S. lenders and the local units of foreign firms. Deutsche Bank had just one such day all of last year. Exceeding the estimate too often causes a bank’s capital requirements to rise.

Needless to say, it’s been a tumultuous year for Frankfurt-based Deutsche Bank, which following a series of unfortunate events, reported the latest abysmal quarter. Days after the quarter closed, Deutsche Bank named Christian Sewing – previously its deputy chief of risk – to take over as chief executive officer.

If only more risk managers were at the bank at the time its traders were taking on 12x VaR risk positions, the quarter may not have been that terrible.

As for the consequences… "The firm finished a months-long strategy review shortly thereafter, announcing U.S. operations would significantly shrink as part of a global overhaul."

Some 10,000 workers are expected to be fired; it is unclear just how much of a factor that spectacular trading loss was in the CEO's decision to cut headcount by 10%.

As Bloomberg concludes, "a number of leaders and dealmakers in the U.S. have left the bank amid the shakeup. In a letter to staff this month, Sewing said the firm has taken steps to reorganize its business, bolster capital and reduce risks."

"Many of you are sick and tired of bad news," he admitted.

And now there's more.

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