What it means
Ackermann began his career in Swiss banking and rose through Credit Suisse before joining Deutsche Bank's management board in the mid-1990s. He built his reputation in investment banking, the part of a bank that trades securities and advises companies on deals, and later became the face of the bank's expansion into global markets.
As chief executive he pushed the bank towards higher profits and a stronger international presence. He publicly set a target of a 25% return on equity before tax, a level that few banks had delivered consistently.
The number became a headline because it was so ambitious. Return on equity (ROE) measures how much profit a company earns for each dollar of shareholders' money.
A bank can raise its ROE in two ways: by earning more on its assets or by using more borrowed money relative to its own capital. Targets as high as 25% usually require a mix of both, which is why critics worried they encouraged risk.
The global financial crisis tested these ideas. Banks across the world had high leverage (a large amount of borrowing compared with their own capital), so losses on investments could quickly wipe out their thin cushion of equity.
Regulators later required banks to hold more capital, which makes very high ROE figures harder to reach. For managers outside banking, the Ackermann story is a lesson in target setting.
A single headline number can steer behaviour in unintended ways, since staff chase the metric rather than the underlying health of the business. Good targets are paired with limits on risk, such as capital ratios and loss limits.
It is also worth being careful when judging individuals. Large banks are run by many people and are shaped by regulators, markets and history.
A fair summary credits Ackermann with building a global business and acknowledges that the sector as a whole had to reassess its risk-taking after the crisis.
In practice
Real-world examples.
Example
A bank analyst compares two lenders that both report a 20% return on equity. One reaches it with an equity multiplier of 10 and the other with a multiplier of 30. She concludes that the second bank is taking far more risk to get the same figure.
Example
A founder reads about Ackermann's 25% target while setting goals for his sales team. He decides to pair the revenue target with limits on discounts and customer credit, so that the team cannot hit the number by taking on risky deals.
Example
A business student in a corporate finance class is asked to explain why regulators raised bank capital requirements after the crisis. She uses the ROE formula to show that more equity lowers the multiplier and therefore lowers ROE, but also makes the bank safer.
Formula
Calculation
Return on equity = Profit / Shareholders' equity
Return on equity can also be split into two parts: ROE = Return on assets x Equity multiplier, where the equity multiplier is total assets divided by equity.
Suppose a bank earns a pre-tax profit of $2,500,000,000 on shareholders' equity of $10,000,000,000.
ROE = $2,500,000,000 / $10,000,000,000 = 0.25, or 25%
Now look at it another way. If the bank has total assets of $300,000,000,000, the equity multiplier is $300,000,000,000 / $10,000,000,000 = 30. A return on assets of 0.8% then gives ROE = 0.8% x 30 = 24%. A modest return on assets becomes a large return on equity only because the bank is highly leveraged.Case study
Seen in the real world.
This is a fictional illustration. Meridian Continental Bank, an invented lender, announced a target of 25% return on equity to impress investors.
To reach it, managers increased lending against thin capital and expanded trading positions. Profits rose quickly for two years and the bonus pool grew. Then a downturn caused losses on trading assets, and the equity cushion was almost wiped out.
The new chief executive, Dr Lindqvist, replaced the single headline target with a range for return on equity and strict limits on leverage. The board accepted lower profits in good years in exchange for protection in bad years, showing that a target is only useful when risk is managed alongside it.
Watch out
Common mistakes.
- Treating a high return on equity as proof of strong management. It may simply reflect heavy borrowing.
- Judging bank leaders by one number. Profit, capital strength, funding and risk controls all matter.
- Assuming the crisis was caused by one executive. It involved the whole financial system, including regulators and markets.
Questions
People also ask.
Who is Josef Ackermann?
He is a Swiss banker who was chief executive of Deutsche Bank from 2002 to 2012.
Why was the 25% target controversial?
It encouraged a focus on high returns, which critics said could push banks to take too much risk or use too much leverage.
How can a bank raise its return on equity?
It can earn more on its assets, cut costs or use more debt relative to equity, though the last option increases risk.
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