Germany
Financial Sector Assessment Program-Financial System Stability Assessment
Author:
International Monetary Fund. Monetary and Capital Markets Department
Search for other papers by International Monetary Fund. Monetary and Capital Markets Department in
Current site
Google Scholar Close
Publication Date:
29 Jun 2016
eISBN:
9781475577730
Language:
English
Keywords:
ISCR; CR; interest rate; banking system; private sector; central bank; coverage ratio
Download PDF (2.2 MB)

This paper evaluates the risks and vulnerabilities of the German financial system and reviews both the German regulatory and supervisory framework and implementation of the common European framework insofar as it is relevant for Germany. The country is home to two global systemically important financial institutions, Deutsche Bank AG and Allianz SE. The system is also very heterogeneous, with a range of business models and a large number of smaller banks and insurers. The regulatory landscape has changed profoundly with strengthened solvency and liquidity regulations for banks (the EU Capital Requirements Regulation and Directive IV), and the introduction of macroprudential tools.

Abstract

This paper evaluates the risks and vulnerabilities of the German financial system and reviews both the German regulatory and supervisory framework and implementation of the common European framework insofar as it is relevant for Germany. The country is home to two global systemically important financial institutions, Deutsche Bank AG and Allianz SE. The system is also very heterogeneous, with a range of business models and a large number of smaller banks and insurers. The regulatory landscape has changed profoundly with strengthened solvency and liquidity regulations for banks (the EU Capital Requirements Regulation and Directive IV), and the introduction of macroprudential tools.

Executive Summary

Germany’s financial sector plays a key role in the global economy. The country is home to two global systemically important financial institutions, Deutsche Bank AG and Allianz SE, as well as to one of the largest global central counterparties (CCP), Eurex Clearing AG. The system is also very heterogeneous, with a range of business models and a large number of smaller banks and insurers. Its asset management industry is the third largest in the European Union (EU), while its sovereign bond market is a safe haven and benchmark for fixed income instruments globally. Consequently, Germany’s contribution to ensuring the success of the new European financial stability architecture is crucial for fostering its domestic financial stability and the success of the European reform agenda.

The resilience of the German financial sector is bolstered by major financial sector reforms, driven by EU-wide and global developments, which are now nearing completion. The regulatory landscape has changed profoundly with strengthened solvency and liquidity regulations for banks (the EU Capital Requirements Regulation (CRR) and Directive IV (CRD IV)), and the introduction of macroprudential tools. The establishment of the Single Supervisory Mechanism (SSM) has positively impacted the supervision of the banking system as a whole, while the bank resolution regime has been significantly strengthened following the implementation of the EU Bank Recovery and Resolution Directive (BRRD). Introduction of Solvency II enhanced the regulatory and supervisory regime for insurance, leading to a more risk-based approach. The framework for Financial Markets Infrastructure (FMIs) has been strengthened by the European Market Infrastructure Regulation (EMIR). Germany is making progress towards compliance with the new EU Directives on Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Fund Managers (AIFMD). Overall, there is welcome emphasis on quantitative analysis to augment the traditional qualitative and relationship-based supervision.

The key risks facing the financial system reflect euro area (EA) and global developments as well as characteristics unique to the domestic financial architecture:

  • The ongoing transition to the new supervisory and resolution architecture may give rise to decision-making and implementation frictions. The newly established European recovery and resolution framework entails a major cultural change. Its complex decision-making process still needs to be tested. The coordination of the European and domestic authorities to handle a systemic crisis is being set up. While the SSM supervisory practices are evolving quickly, the SRB—in charge of resolution measures for significant German banks—is still in a startup mode. This constitutes a transition risk until the EA level authority is fully operational.

  • Low profitability, rooted in banks’ and insurers’ business models, is exacerbated by the low interest rates. The low interest rates are helping to boost credit demand and stimulate growth. However, prevailing business models make banks and life insurers particularly vulnerable to the associated adverse side-effects of unconventional monetary policy. Banks faced with falling net interest margins may be tempted to adopt risky search-for-yield strategies, and bank equity prices have been dropping markedly. Low profitability of life insurers hampers their ability to pay guaranteed yields to policyholders. Real estate assets, while currently broadly in line with fundamentals, could become overvalued.

  • A global growth shock, sharp downturn in emerging markets (EMs), or renewed tensions in the EA could lead to a rapid hike in global risk premia and asset price volatility. This may give rise to domestic financial risks and second round adverse spillovers because of the globally interconnected financial sector and the importance of German G-SIFIs for shock transmission. The uncertainties associated with the possibility of British exit from the EU weigh on the outlook.

Although long-standing challenges remain, the financial system as a whole appears resilient to these risks:

  • Households’ and corporate balance-sheets are strong. Deleveraging has progressed steadily, and mortgage-related debt-service is largely insensitive to rapid changes in interest rates.

  • Risk-based bank solvency measures indicate substantial capital buffers, and non-performing loans (NPLs) are generally low and declining, although bank profitability is low and leverage is high in some institutions. While banks have continued to consolidate and reduce costs, mainly through branch reductions and increased IT services, further progress is needed.

  • Notwithstanding severe challenges from low interest rates and Solvency II implementation, life insurers generally retain significant loss absorption capacity. Large insurers enjoy diversification benefits from multiple business lines and an international presence, while many small insurers are less affected by the low interest rates owing to their business mix. Some medium-sized insurers do not have such clear strengths.

  • Eurex Clearing CCP has a comprehensive risk management framework. Preliminary results of the EU-wide stress test indicate that the CCP could withstand an extreme but plausible shock scenario, covering losses with pre-funded resources.

At this juncture, the German authorities, in close collaboration with their European partners, should keep their focus on finalizing the agenda and, crucially, ensuring that the new architecture is effective in practice. In this context, the following priorities are highlighted:

  • Rapidly completing the processes to facilitate the resolvability of German financial firms while safeguarding taxpayer resources, and building capacity to implement the new resolution regime.

  • Expanding further the capacity to monitor financial stability risks and cross-sector spillovers, by collecting comprehensive and granular data and completing the macroprudential toolkit.

  • Continuing to integrate quantitative analysis into ongoing supervisory monitoring and promoting sound risk management practices in banks, including on strengthening the oversight role of supervisory boards, internal control and audit, related party exposures, and operational risk.

Key FSAP recommendations are summarized in Table 1.

Table 1.

Germany: FSAP Key Recommendations

article image

Near term is one year. Medium term is 2–3 years.

Macrofinancial Setting

1. The German economy is growing at a steady pace. Strengthening domestic demand, bolstered by robust labor market developments, higher public expenditures and lower oil prices (Table 2) offset a weaker foreign environment in 2015.

Table 2.

Selected Economic Indicators, 2013–17

January 2016 Projections

article image
Sources: Deutsche Bundesbank, Eurostat, Federal Statistical Office, Haver Analytics, and IMF staff.

Reflects Germany’s contribution to M3 of the euro area.

2. Private sector balance sheets continue to strengthen as monetary conditions ease and house prices increase (Figure 1, Tables 3 and 4). Households’ (HH) and non-financial corporations’ (NFC) debt and interest expenses have declined in relation to income. HH debt service is largely insensitive to rapid rises in interest rates with most mortgage rates being fixed for a 10–15 year period. Following more than a decade-long correction, house prices have risen rapidly since 2010, though still broadly in line with fundamentals. Recent real estate developments warrant monitoring as pockets of vulnerability may be emerging (Box 1).

Figure 1.
Figure 1.

Germany: Real Estate and Shipping Developments

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Table 3.

Financial Soundness Indicators for the Household Sector, 2006–15

(Billions of euro, end of period, unless otherwise noted)

article image
Sources: BulwienGesa, Bundesbank, Destatis, ECB, Hypoport, OECD, and IMF Staff Calculations.

Source: Hypoport.

Nominal house prices to rent prices, index based in 2010. Source: OECD.

Total house price; trend from 1975-2014. Source: BulwienGesa.

Table 4.

Financial Soundness Indicators for the Corporate Sector, 2006–14

(Billions of euro, unless otherwise indicated)

article image
Source: Bundesbank, Capital IQ, Deutsche Bourse, and IMF staff calculations.

Data is the median value of the top 50 companies by assets, IMF/MCM.

Index: December 30, 1987 = 1000.

3. The authorities have made progress in addressing the 2011 FSAP recommendations (Annex I). The financial oversight framework has been strengthened. The restructuring of the Landesbanken is under way but with only a limited progress to reduce non-commercial influences. Improvements are evident in the intensity of banking and insurance supervision and the adoption of analytical tools to support system-wide monitoring. The crisis management framework has been reformed owing to the EU-wide developments. Government support to banks is being wound down.

4. The financial system is dominated by banks and is generally domestically oriented and robust to shocks—a relatively unchanged financial structure since the last FSAP (Figures 2 and 3, Table 5). The banking system, with assets equivalent to 245 percent of GDP, is structured around three pillars and has gone through a sustained period of consolidation (Annexes II and III).1 Bank funding, in aggregate, is more reliant on deposits compared to other advanced economies. Banks’ foreign exposures are a fifth of total assets, with only small exposure to vulnerable emerging markets and Central and Eastern Europe. Approximately half of the claims are against the foreign non-bank private sector, followed by banks and the public sector. Germany’s insurance sector is smaller than its peers as a share of GDP, with guaranteed return life products playing a dominant role. The asset management sector is the third-largest in Europe as measured by assets under management, and comprises a broad range of management companies and funds. Financial infrastructures are fewer than in other financial centers, but are interconnected with G-SIBs.

Figure 2.
Figure 2.

Germany: Financial System Structure

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Figure 3.
Figure 3.

Germany: Banking Sector

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

*EA Peers includes: Austria, Germany, Italy, France, Netherlands, Portugal, and Spain.
Table 5.

Financial Soundness Indicators, 2008–14

(In percent, unless otherwise indicated)

article image
Source: Deutsche Bundesbank.

Spread in basis points.

Trends in Residential Real Estate

For the fourth consecutive year, house price increases in 2015 exceeded the growth in nominal income, but with important regional differences. While apartment price increases in the largest and most dynamic German cities (Berlin, Munich, and Hannover) reached double-digits in 2015H2, sustained East-West migration continues to weigh on residential prices in former East Germany.

The positive trend in real house prices that started in 2010 broadly reflects fundamentals. Following the post-reunification fiscally-triggered excesses of the early nineties, real estate prices declined, reaching a trough in 2009–10. Since then, higher income growth, immigration, supply bottlenecks, declining inventories, higher construction costs, and record-low interest rates contributed to the positive price trend. In real terms, house prices have reached a level consistent with measures of long-term equilibrium in 2015, as confirmed by price-to-rent and price-to-income ratios as well as the Bundesbank’s internal valuation models. As households take advantage of record-low interest rates to lock-in new mortgage debt, mortgage credit growth has also been trending up, but at a moderate pace with largely unchanged credit standards.1

However, recent developments warrant closer monitoring. Despite a pickup in construction activity, supply continues to fall short of demand in selected areas fueling higher prices. The Ministry for the Environment estimates that around 400,000 new residential units per year are needed to keep up with current demand, or about 100,000 more units than are currently put on the market each year. Absent a rise in mortgage interest rates or a sudden burst in house supply—both rather unlikely in the next couple of years—house prices should continue to rise quickly in the most dynamic regions. The arrival of refugees will put additional pressure on vacancy rates and boost house prices in the next few years.

Pockets of vulnerability may be emerging. While the financial stability assessment has been hampered by the lack of granular loan-by-loan data, survey evidence suggests that for a notable part of mortgage loans in the largest urban areas, loan-to-value ratios may exceed prudent levels.2 Future mortgage developments therefore warrant close supervisory monitoring. Authorities should address administrative housing supply bottlenecks and ready the macroprudential toolkit.

1 The acceleration in 2015 may have been partially driven by the renewals of a large number of loans granted in 2005 in anticipation of the abolishment of the home owners’ subsidy. 2 Surveys in selected urban areas suggest that about a third of mortgages have a loan-to-value ratio (LTV) of more than 100 percent based on the German sustainable LTV (Beleihungsauslauf) – a conservative measure that applies a prudential haircut to the value of properties. Also, debt service exceeds 40 percent of income for about 10–15 percent of indebted households (about 8 percent due to mortgage).
A01ufig1

Germany: Cross-Border Banking Exposures

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Sources: BIS Consolidated Banking Statistics, IMF Staff Calculations.

5. Intermediation is concentrated between HHs and financial institutions, while NFCs rely less on banks and more on intra-segment financing. HHs are closely interlinked with banks (via loans; deposits, bank bonds and equity holdings) and insurance companies (via claims on insurance reserves). NFC financing by households mainly constitutes payments to corporate pension funds. Insurance companies and investment funds are expanding their claims to investment funds via debt securities, which have almost doubled since 2008.

A01ufig2

Germany: Sectoral Interlinkages, June 2015

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: FSAP team model and estimation based on Bundesbank data, using the Reingold-Tilford network algorithm Note: The category “banks” includes all monetary financial institutions as defined by the ECB. All financial instruments for which comprehensive debtor/creditor relationships exist are taken into account (deposits, debt securities, loans, listed shares, investment fund shares and claims on insurance corporations and pension funds). The arrows show the direction of interlinkages (from who to whom) and their thickness indicates strength of interlinkages. The size of the node the interconnectedness within a sector.

Risks, Resilience, and spillovers

A. Key Risks Facing the German Financial System

6. The FSAP analyzed three macrofinancial scenarios using a number of quantitative techniques (Table 6):

  • A global stress with recessions in advanced economies, triggered by a tightening of global financial conditions and credit cycle downturns in emerging economies (EMs): German exporters would be hit, and both investment and consumption would drop as confidence deteriorates. A sharp correction of asset prices, paired with strong foreign exchange rate movements, would affect unhedged market positions and hit banks’ trading income.

  • The return of the EA crisis: Sovereign yields in highly indebted EA countries would increase sharply. Flight-to-quality effects would diminish and the ‘core’ countries would see their refinancing conditions deteriorate, albeit to a lesser extent. Investor sentiment would deteriorate, and the EA would enter a deflationary phase. The uncertainties associated with the possibility of a British exit from the EU could usher in a heightened macroeconomic uncertainty and financial market volatility.

  • Excessive risk-taking associated with the protracted low interest rate environment: Banks and insurers may be tempted to adopt risky search-for-yield strategies against the backdrop of squeezed profitability and persistent structural weakness. Banks are key beneficiaries of the unconventional monetary policy in the EA through improved growth prospects and borrower credit worthiness, among other. However, prevailing business models of German banks and insurers may make them particularly vulnerable to the associated adverse side effects.2 Separately, lower market liquidity fuels asset price volatility. Banks could see a drop in deposit funding, and institutional investors could channel funds towards higher-yield investments.

Table 6.

Germany: Risk Assessment Matrix (RAM)

article image
article image

7. The overall stability assessment paints a mixed picture. While reported risk-based bank solvency indicators point to substantial capital buffers across all pillars, the risk-weighted assets (RWA) density (at 30 percent on average for large banks) is among the lowest in Europe. Capital ratios may, therefore, understate risks as leverage remains high for some banks. Bank profitability is low and cost-to-income ratios are high, reflecting banks’ cost-intensive business model. NPLs are low and falling on aggregate, although asset quality and provisioning in Landesbanken are below average. Commercial (and large) banks, Landesbanken, and the regional institutions of credit cooperatives appear more liquid compared to local savings and cooperative banks, in part owing to an intra-pillar distribution of liquidity.

Germany: Financial Statement Indicators for Different Types of Banks

(End-2014 data or last available year)

article image
Source: Bankscope, Bundesbanks and IMF staff calculations. Notes: Unless otherwise noted, numbers are in percent.

Return on average equity (assets).

Loan loss reserves to impaired loans.

Net interbank lending; money lent to money borrowed. Numbers above (below) 100 percent indicate net liquidity provision (consumption).

8. A legacy of the crisis has been a shift in the availability and form of funding and subdued credit growth (Figures 4 and 5). Loose monetary conditions are prominent on the domestic risk map. The crisis exposed weaknesses in bank funding practices, and precipitated ongoing restructuring. Short-term markets contracted significantly, while longer-term markets became more domestically focused. Funding flows across the banking pillars continue to be concentrated among a few key financial institutions, which themselves receive significant amounts of intra-pillar financing. The ECB liquidity injections are ensuring a high level of liquidity in the system, but markets will face further challenges as they adapt to new bank liquidity and leverage regulations. While the new regulatory regime may result in improved sectoral resilience, it may also result in higher volatility. Measures to facilitate the transfer of excess liquidity within and across the banking pillars, and elimination of barriers to competition and consolidation among banks, particularly within the savings banks and credit cooperatives sectors, could help promote efficient intermediation of excess savings.3

Figure 4.
Figure 4.

Germany: Bank Liability Structure by Segment

(In EUR billion, September 2015)

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

1/Other liabilities include bearer debt securities, capital and reserves, and other liabilities.Source: Deutsche Bundesbank
Figure 5.
Figure 5.

Germany: Systemic Risk Indicators

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

9. The banking system faces structural headwinds and will need to adapt. Financial technology innovation is introducing new competitive pressures while the post-crisis regulatory reforms have raised the bar with respect to capital and liquidity requirements. The Landesbanken have generally become more efficient, but the risk of inefficient use of public resources in some institutions remains. For some Landesbanken, viable restructuring may require further downsizing, opening of capital to private investors and further reform of governance structure. Chronic overcapacity in the context of slowing international trade has put the shipping industry under intense pressure. Further provisioning related to shipping may become necessary in banks with large shipping exposures.4

10. Consolidation is ongoing, albeit gradually. Banks have been reducing costs mainly through reduction of branch networks and introduction of IT-based services. Among the largest banks, Deutsche Bank announced a major shift in strategy, while Commerzbank is dealing with legacy commercial real estate and shipping assets.5 A merger of DZ Bank AG and WGZ Bank AG, two central institutions for cooperative banks, will be effective in 2016 creating the country’s third-largest bank by total assets and should lead to improved efficiency.

B. Financial System Resilience6

Banking Solvency Tests

11. Solvency tests covering all banks operating in Germany were performed to evaluate the stability of the German banking system (Figures 6 and 7, Annex IV). The analysis covered 1776 institutions operating in Germany and assessed banks’ resilience to credit and market risk, including foreign exchange rate and sovereign risk, equity price, and house price risk, in the baseline based on the October 2015 World Economic Outlook and two stressed scenarios.

Figure 6.
Figure 6.

Germany: Macroeconomic Scenarios—Key Variables

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: IMF Staff Calculations.
Figure 7.
Figure 7.

Germany: Solvency Stress Test

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: IMF Staff Calculations.Note: The top panel shows the evolution of CET1 ratio under the three scenarios. Capital shortfalls to regulatory hurdles are shown as bars in the panel below, together with the share of total assets that the banks dropping below hurdle rates correspond with (markers, rhs). The drivers are expressed in terms of percentage points of the CET1 ratio. For example, the credit risk losses experienced by large banks in the Global Stress Scenario equal 2.3 percentage points of the CET1 ratio.

12. The German banking system would remain broadly stable under the baseline scenario.7 Banks are relatively well capitalized, with CET1 ratios around 15 percent, on average, and found to be resilient, with an improvement in their solvency levels under the baseline. For both large banks (also known as significant institutions or SIs) and small and medium-sized banks (less significant institutions or LSIs), interest revenue would continue to deteriorate, albeit more or less offset by lower interest expenses. Nevertheless, in the current low interest rate environment, business models concentrating on maturity transformation continue to weigh on bank profitability.8

13. Under the adverse scenarios, banks would see an increase in loan losses, while adverse market price movements take a toll on trading income and the value of sovereign bonds. The credit risk model implies that loan losses would rise by up to 80 percent, as a result of a rise in default probabilities. Banks’ annual credit impairment needs would almost double, albeit from a very low level, in part because of the impact of house prices stress on mortgage collateral values. SIs would suffer a 40 percent drop in trading income, while LSIs with very little trading exposure and open foreign exchange (FX) positions would be affected much less. The direction of net FX positions varies across banks and, on average, the impact is not large. Some SIs are affected by credit risk and sovereign bond valuation losses. LSIs mainly suffer from continuously falling net interest income, and structurally high costs.

  • Under the Global Stress Scenario, the CET1 ratio of SIs would drop by 2.6 percentage points, but remain above 10 percent. On aggregate, capital shortfalls amount to EUR 6.0 billion, or 0.2 percent of annual GDP. LSIs appear more resilient, and that group as a whole would experience a drop in CET1 ratio of only around 0.3 percentage points against the fully-loaded CET1 hurdle. The CET1 capital shortfall amounts to around EUR 450 million. Only 32 banks out of 1,755 in this bucket would see their CET1 capital ratios drop below fully-loaded regulatory hurdle rates in 2018.

  • The EA Crisis Scenario would cause the average CET1 ratio to drop by 2.2 percentage points, to 12.7 percent in 2018 for SIs, corresponding to a capital shortfall of EUR 4.2 billion, or 0.1 percent of annual GDP. LSIs would see CET1 ratio eventually rising 0.6 percentage points above the current level, after a 0.2 percentage point drop, against the fully-loaded CET1 hurdle, including buffers. The aggregate CET1 capital shortfall stands at around EUR 450 million, with 30 small and medium-sized banks breaching the regulatory hurdles.9

14. Sensitivity analysis shows that the persistently low interest rates weigh significantly on the profitability of LSIs (Figure 8).10 Under banks’ own interest rate projections, profitability is expected to decline by around 25 percent by 2019. Should the low interest rates persist, operating profit could slump by 50 percent, on average. If the interest rate were to fall by a further 100 basis points, the operating profit of LSIs could decline by 60 percent or 75 percent, under a dynamic or static balance sheet assumption, respectively.

Figure 8.
Figure 8.

Germany: Low Interest Rates and Bank Profitability

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: BundesbankNote: The charts show, for five different tests, the evolution of operating profit to total assets for some 1500 LSIs. The top-left chart gives weighted averages for each scenario tested, while the other charts show the median and the 5th/95th percentile of individual banks’ operating profit. Details about methodology, scenarios, and samples can be found in the Stress Test Matrix in the Annex IV.

15. Sovereign risk analysis shows diversity across banks (Figure 9). While noticeable in some banks, valuation losses from sovereign exposures tend to be rather low overall. Banks usually keep more risky securities in the held-to-maturity portfolio, which is not being marked to market.11 Also, duration differs considerably across portfolios and banks. Banks with higher sovereign risk index values hold longer-term or riskier paper, or try to generate profit from market movements in yields.

Figure 9.
Figure 9.

Germany: Sovereign Exposures, Risk Index, and Valuation Losses under Stress

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: IMF Staff Calculations using EBA 2015Q2 data.Note: The sovereign risk index gives for each bank the valuation loss (VL) with the gross volume of sovereign bond exposures held (Exp), relative to the total sampleIdx=VLiΣj=1nVLj/ExpiΣj=1nExpjIf the index value is 1, the valuation loss corresponds to the total sovereign exposure held by the bank, signaling average risk from sovereign exposures. If the value is above 1, the bank’s valuation loss is disproportionally higher than its holdings would imply, indicating that the sovereign bond portfolio has relatively more risk (and vice versa). Index values are determined by (i) the issuer’s risk as expressed by the sovereign yield and its volatility of time, (ii) average maturity of the bonds in the portfolio together with (iii) the bank’s accounting of that exposure (HTM, AFS, FVO, HFT).

Bank liquidity tests

16. Tests based on the LCR show that the banks would be able to withstand market and funding liquidity shocks (Figure 10). Almost all banks show ratios above 70 percent, and most banks already today have LCR ratios above 100 percent, with foreign banks showing the lowest dispersion.

Figure 10.
Figure 10.

Germany: LCR Estimates

(In percent)

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: Bundesbank.Note: Results were estimated from reporting data through a matching with CRD IV asset and liability categorization (i.e., net outflows and liquid assets). The Whisker plots give the lower and upper quartile, the median (black line inside the box), and the lower and upper 5 percent percentile. The orange line is the current (2016) regulatory minimum of 70 percent, while the dashed line shows the fully phased-in hurdle rate of 100 percent. Outliers are not shown. Results for the four big banks are not shown, as individual LCRs could be identified. However, they are all above 70 percent regulatory minimum. The big bank group includes Commerzbank, Deutsche Bank, Deutsche Postbank, and UniCredit.

17. Banks have been increasing both the LCR and the Net Stable Funding Ratio (NSFR), and larger banks appear to be managing their ratios more efficiently (Figure 11). Analysis of detailed Basel Committee’s (BCBS) Quantitative Impact Study (QIS) results, reported by participating banks, shows a general improvement in ratios since 2011, and the variation across banks’ LCRs has also reduced over time.

Figure 11.
Figure 11.

Germany: LCR and NSFR Reported by German Banks in the BCBS QIS

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: BundesbankNote: Results as reported by banks participating in BCBS QIS. The box gives the lower and upper quartile, the median is shown as black line separating the box, the weighted average as orange circle, and whiskers are at the 5th and 95th percentile. For the LCR, the orange line marks the 2016 regulatory minimum of 70 percent, while the dotted line gives the fully phased-in 2019 minimum of 100 percent. For the NSFR, the dotted orange line marks the future expected regulatory minimum of 100 percent, to be introduced in 2018. Whiskers extending above the vertical axis’ range are removed.

Insurance solvency tests

18. Low interest rates pose particular challenges to life insurers over the medium- to long-term, reflecting the predominance of traditional products with high guaranteed rates of return (Figure 12). Capital adequacy ratios have been showing a downward trend in recent years. Since 2016, Solvency II has created new pressures on life insurers to recognize the impact of low interest rates in a forward-looking assessment of solvency. Some evidence of search for yield has been emerging.12 Health, property and casualty, and reinsurance companies appear to be more robust, reflecting lower dependence on investment returns.

Figure 12.
Figure 12.

Germany: Insurance Earnings, Solvency, and Risk Analysis

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: BaFin, Bundesbank, EIOPA, Insurer disclosures (Allianz, Munich Re, AXA and Generali), Assekurata, IMF Staff Calculations.

19. Stress tests analyzed the impact of low interest rates under Solvency II (Annex V). The scenarios covered major market shocks, while sensitivity analysis assessed the potential impact of other insurance-specific risks, such as longevity and lapse risks. A majority of life insurers (93 percent of the sector by assets) were covered. The methodology reflected the significance of policyholder participation in traditional life insurance and the scope for insurers to reduce future policyholders’ profit participation in a stressed situation.13

20. The results are stated with respect to the Solvency II Capital Requirement (SCR) ratio, with and without transitional measures (Figure 13). Based on EU law, the so-called transitional measures allow insurers, on BaFin’s approval, to mitigate material Solvency II impacts arising from lower interest rates over the 16-year long phase-in period. Both ratios—with and without transitional measures—will be published in 2017, the stress tests apply the two hurdle rates.

Figure 13.
Figure 13.

Germany: Insurance Stress Testing Results

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: BaFin and IMF staff calculations

21. With transitional measures, insurers’ capital levels appear generally sufficient, although a minority would have difficulties in meeting the SCR under stress. Life insurers maintain SCR ratios above 100 percent even under stress, although the weighted average SCR ratio drops from 372 percent to 236 percent. No firm would have negative capital after the shocks, but for 13 firms (out of 75) the SCR ratio would fall below 100 percent. The total capital shortfall by value would be small.

22. Without the transitional measures, a majority of life insurers would have difficulties in meeting the SCR. The weighted average SCR ratio would fall from 126 percent to 48 percent under stress. Thirty-four firms and 58 firms (out of 75) would fall below the 100 percent SCR ratio before and after the shocks, respectively. Eight firms and 27 firms would have negative capital before and after the shocks, respectively. The total capital shortfall would be EUR 12 billion (0.4 percent of GDP) before shocks and would increase to EUR 39 billion (1.3 percent of GDP) after the shocks.

23. The business model is a significant determinant of insurers’ relative resilience. The tests were conducted at the legal entity level. Individual large insurers are generally more resilient than others, as many are part of wider groups and benefit from diversification across business lines and geographically. Many small firms have focused on protection-type business, where profitability is less affected by the low interest rate environment and thus have exceptionally high SCR ratios, and appear resilient to investment-side interest rate and other market shocks. However, some medium-size life insurers are more vulnerable to the low interest rate environment and additional market shocks. Features such as business mix, the amount of unrealized gains, future discretionary policyholders’ bonuses, and average guaranteed rates are the most important risk drivers.14

C. Systemic Risk and Spillovers15

24. Domestically, the largest German banks and insurance companies are highly interconnected (Figure 14). The highest degree of interconnectedness can be found between Allianz, Munich Re, Hannover Re, Deutsche Bank, Commerzbank and Aareal bank, with Allianz being the largest contributor to systemic risks among the publicly-traded German financials.16 Both Deutsche Bank and Commerzbank are the source of outward spillovers to most other publicly-listed banks and insurers. Given the likelihood of distress spillovers between banks and life insurers, close monitoring and continued systemic risk analysis by authorities is warranted.

Figure 14.
Figure 14.

Germany: Financial Sector Interconnectedness

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: IMF Staff Calculations. Results are based on the Espinoza-Vega and Sole (2010) approach and BIS Consolidated Banking Statistics for 2015Q1.

25. Notwithstanding moderate cross-border exposures on aggregate, the banking sector is a potential source of outward spillovers. Network analysis suggests a higher degree of outward spillovers from the German banking sector than inward spillovers.17 In particular, Germany, France, the U.K. and the U.S. have the highest degree of outward spillovers as measured by the average percentage of capital loss of other banking systems due to banking sector shock in the source country. Reflecting solid aggregate capital buffers, the impact of inward spillovers on the German banking sector is considerably more moderate, as measured by the percentage of capital loss in the banking system due to the default of all exposures.

26. Among the G-SIBs, Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse (Figure 15). In turn, Commerzbank, while an important player in Germany, does not appear to be a contributor to systemic risks globally. In general, Commerzbank tends to be the recipient of inward spillover from U.S. and European G-SIBs. The relative importance of Deutsche Bank underscores the importance of risk management, intense supervision of G-SIBs and the close monitoring of their cross-border exposures, as well as rapidly completing capacity to implement the new resolution regime.

Figure 15.
Figure 15.

Global Systemic Risk

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: IMF Staff Calculations based on the Diebold and Yilmaz (2014) methodology using daily equity returns from 11 October 2007 to 26 February 2016. Lower chart constructed with NodeXL.Note: The GSIB list follows the November 2015 update by the FSB. Commerzbank is included in the analysis, Groupe BPCE and the Agricultural Bank of China (ABC) are excluded due to the data limitations. The blue, purple and green nodes denote European, US and Asian banks, respectively. The thickness of the arrows capture total linkages (both inward and outward), and the arrow captures the direction of net spillover. The size of the nodes reflects asset size.

27. In light of its systemic importance in the financial system and cross-sectoral activities, Eurex Clearing AG can become a source of domestic and cross-border spillovers. Eurex Clearing AG is one of the largest global CCPs, with interlinkages to over 180 clearing members in 17 countries. Its clearing members include 24 G-SIBs, creating potential contagion channels through interbank markets and memberships of these G-SIBs in other CCPs around the world.

28. Eurex Clearing could withstand an extreme but plausible market shock scenario, covering losses with pre-funded resources. The EU-wide stress test exercise initiated by the European Securities and Markets Authority (ESMA) was ongoing during the FSAP mission. The objective was to test the resilience of EU CCPs to historical and hypothetical adverse market developments, including market participant’s defaults across CCPs. The preliminary results for 2014 data for Eurex Clearing indicate sufficient buffers to withstand market shock scenarios.

Macro- and Microprudential Oversight

A. Macroprudential Policy Framework

29. Germany has revamped its macroprudential policy framework. The Financial Stability Act, adopted in late 2012, created the Financial Stability Committee (FSC) with a central role in macroprudential oversight, and set out additional financial stability responsibilities for the Bundesbank.18 These reforms have taken place in the context of EU-wide macroprudential policy reforms. Notably, the European Systemic Risk Board (ESRB) was created in December 2010, and the Single Supervisory Mechanism (SSM) was established in November 2014, the latter sharing macroprudential powers with the respective national authorities.

30. The new German framework appears broadly appropriate for effective macroprudential policy. Although too early to make a full effectiveness assessment, the mandate, accountability, and tasks are reasonably clear and set out in the Financial Stability Act and elaborated in the FSC’s macroprudential policy strategy. Furthermore, Germany has recently established a macroprudential policy tool-kit that became operational on January 1, 2016, including: a countercyclical capital buffer (CCB); capital buffers for G-SIBs and for other systemically important institutions; and the systemic risk buffer. Also, a liquidity coverage ratio is being phased in, as in other EU countries.

31. Still, there is scope to strengthen the framework, including with regards to:

  • Macroprudential tools. As the real estate sector is often a source of systemic financial risk, macroprudential tools, such as loan-to-value caps, debt-service-to income limits, debt-to-income ceiling, and amortization requirements, can be very useful. Though the German real estate market does not show an imminent risk of a bubble, the authorities should create such real estate-related tools, as recommended by the FSC in June 2015 to close an important gap in the macroprudential policy framework. International experience is that such tools should be deployed early to be most effective.

  • Data. Macroprudential analysis and policy are highly data-dependent. The real estate tools, in particular, require access to granular information on household incomes, debt data on a loan-by-loan basis and real estate prices. To strengthen macroprudential and financial sector risk analysis, the authorities should give priority to obtaining the required data. It could also consider amending the Federal Data Protection Law to allow judicious use of data already collected for other purposes, while maintaining adequate privacy protection.

  • Transparency and accountability. The main accountability mechanism is the FSC’s Annual Report to the Bundestag. To give more visibility to macroprudential policy issues, the FSC should consider publishing a record of the discussions at each FSC meeting and creating a dedicated FSC website with access to all relevant information, broadly similar to the practice in many other advanced economies.

B. Microprudential Oversight

Banking regulation and supervision

32. German banking supervision has undergone profound changes with the approval of the CRD IV/CRR framework, the establishment of the European Banking Authority (EBA) and the creation of the SSM. The legal framework has been amended to transpose the CRD IV, while the CRR and the regulatory technical standards developed by EBA and issued by the European Commission became directly applicable. Additionally, the ECB took over direct supervision of 21 of Germany’s largest banks, including one G-SIB.

33. Overall, the FSAP found good compliance with international best practices when accounting for the more stringent 2012 BCP standards, proportionality considerations and the impact of SSM integration.19 The legal framework for banking supervision is well established by German laws with effective division of responsibilities between BaFin and Bundesbank. Banks are required to conduct regular stress testing using both standardized and bespoke scenarios. Interest rate risk in the banking book (IRRBB) features as a key priority for both SIs and LSIs. Supervisors have also stepped up the frequency and intensity of interaction with banks regarding management of liquidity risk, contingency funding plans and compliance with the new Basel III liquidity requirements (LCR and NSFR). A range of supervisory initiatives to mitigate cyber risk, which constitutes growing stability threat, is welcome (Box 2).

Cyber Risk and Financial Stability in Germany

The complexity and interconnectedness of banks’ digital technology is growing, increasing the technology-related operational risk. The changing distribution channels and nature of cyber-related incidents require the regulations and supervisory approach to adapt to a rapidly changing risk profile. Effective management of technology-related operational risk is a fundamental element of a bank’s risk management.

Authorities have established industry-wide initiatives on the availability, integrity, and confidentiality of IT-infrastructure by passing the IT-Security Act.1 The Act focuses on providers of critical infrastructure required to implement and maintain appropriate organizational and technical security standards in order to ensure its proper operation and permanent availability. A range of financial institutions is covered, while measures include the need for a contact point; measures to protect infrastructure; and reporting.

Risk management standards for IT-related operational risk are established by MaRisk.2 Banks are required to have in place an effective operational risk management framework across the entire enterprise, subject to ongoing testing and enhancements to keep pace with the scale, complexity and risk profile of the business. In addition, banks are required to adhere to established industry standards for IT security, such as ISO/EC 27 of the International Standards Organization and the IT-Grundschutz Catalogues.

Strengthening IT resilience and cyber security is a key strategic priority for bank supervisors. Several initiatives have been implemented:

  • Strengthened dedicated IT risk specialist teams to support supervision processes;

  • Annual meetings with IT security professionals to raise awareness of IT-related security issues;

  • Cyber risk questionnaire involving all SIs to survey good practices and areas of weaknesses; and

  • Targeted IT onsite examinations conducted across the banking system.

Further work is planned in 2016, including:

  • Development of specific requirements for banks’ IT risk management;

  • Targeted onsite examinations to test and assess IT resiliency; and

  • Thematic review of Significant Institutions (SIs).

Robust surveillance techniques are needed to keep pace with evolving cyber threats. Regular board and management engagement and intrusive inspection are key planks in the supervisory approach. Supervisors need to verify that banks are appropriately incentivized to increase security and IT resilience by raising risk management standards, and to leverage collective strengths through greater global coordination. Achieving consistent industry standards at each layer of the service point will be necessary.

1 https://www.orrick.com/Events-and-Publications/Pages/German-Parliaments-IT-Security-Act-Covers-Critical-Infrastructure.aspx. 2 Minimum requirements for risk management (Mindestanforderungen an das Risikomanagement - MaRisk).

34. Notwithstanding the extensive legal and regulatory framework, important gaps exist. While the Banking Act establishes fit-and-proper standards for supervisory and management board members and defines the oversight function of the supervisory board, in practice the focus of governance is placed on the management board. The oversight by the supervisory board is very light. The independence of internal audit and compliance is compromised as they report to the management board with no independent reporting channel to the supervisory board. The lack of comprehensive and granular supervisory data negatively affects all aspects of financial supervision and risk monitoring. In the absence of supervisory approval of investments, acquisitions may occur that increase the risk to the banking group without ex ante prudential review. There is still no sound framework regarding management and supervision of related-party risk. More attention is also needed to monitoring of the effective implementation of operational risk management frameworks.

35. The establishment of the SSM has fundamentally changed the supervision of German banks, both large and small. For the SIs, day-to-day supervision is conducted by Joint Supervisory Teams led by ECB staff and supported by supervisors from supervisory agencies from all member states where banks have operations, involving supervisors with different backgrounds, supervisory cultures, and languages. The coordination of these teams presents operational and motivational challenges, which will need to be addressed by the SSM in the long run. For the two largest German SIs, the introduction of SSM allows for a welcome benchmarking of supervisory practices with other large banks and G-SIBs. However, the timeliness of the supervisory response seems to have been reduced given the need to develop consistent policies and the complex ECB decision making procedures. For the smaller German SIs, the shift from local supervision to the SSM framework represents a deep change in terms of reporting, minimum level of engagement with supervisors, intrusiveness, and supervisory requirements—including capital add-ons resulting from the Supervisory Review and Evaluation Process (SREP) process.

36. Over 1500 LSIs remain under the direct supervision of BaFin and the Bundesbank, under the general guidance and oversight of the ECB. The ECB has designated some LSIs as High Priority for which enhanced supervisory monitoring and reporting have been adopted, and is developing joint standards to ensure elements of the SSM supervisory manual are also applied to LSIs. BaFin and the Bundesbank have traditionally put a great emphasis on processes for risk management and controls, counting on the work of external auditors for the verification of compliance, while supervisors conduct the risk assessment using this and other information obtained through onsite inspections, reports, and direct contact with banks. The greater emphasis on reporting and SREP, in particular on a more direct assessment of credit risk valuation, is welcome. As a consequence, LSI supervision is changing from a more qualitative and relationship-based approach to a more quantitative approach. However, the increased reporting and monitoring requirements for LSIs need to be proportional to their systemic importance and available resources. For the very small entities, it is also important that sufficient resources in the national competent authorities (NCAs) continue to be dedicated to meeting supervisory objectives.

37. Most of the tasks assigned to the SSM must be executed according to national legislation, and all decisions need to be approved by the ECB’s Governing Council resulting in a time-consuming and cumbersome decision making process. Every supervisory decision, after consideration and approval by the Supervisory Board, is raised to the ECB’s Governing Council for approval under a no-objection procedure. In addition, for LSIs and SIs alike, the ECB needs to apply local legislation in each member state. For instance, licensing applications must be filed with national authorities in compliance with national legislation, and then submitted for analysis and decision by the ECB. All fit and proper authorizations of SIs are assessed against national fit and proper criteria and then submitted to the ECB. Enforcement and sanctioning powers of the ECB are also largely based on what is available under national legislation, and although the ECB has some direct enforcement powers, it mostly needs to act by giving instructions to BaFin on measures to be taken under German legislation. It is crucial that decision making processes in the day-to-day supervision are streamlined to the extent possible so that timely supervisory response is not hindered further in this already complex legal framework.

38. As the supervisory landscape evolves, it is crucial that supervisors communicate their expectations to banks and develop guidelines and regulations that can be used to substantiate enforceable measures. All aspects that are not harmonized within the EU—or on which EU or German regulatory framework is silent—need to be developed into guidelines or regulations that can both inform the banks of supervisory expectations and substantiate supervisory action. In the German framework some of that is done through circulars, ordinances and guidelines. Through the implementation of the SSM, harmonized standards are being introduced for SIs and the good practices and process engrained in the internal SSM procedures should be made public in instruments which can help substantiate supervisory measures. This is particularly relevant for guidance related to loan portfolio management (on setting loan classification parameters and provisioning, collateral valuation considerations, and elements of effective credit risk management), concentration risk, country and transfer risk, related party risk, and operational risk. The coverage and granularity of supervisory data needs to be improved rapidly.

Withdrawal of correspondent banking relationships

39. Some major German banks are withdrawing from correspondent relationships in a number of countries. These decisions appear to be driven mainly by business and risk-return considerations, lower risk appetite and implementation of a risk-based approach to international standards. Not unique to German banks, they could entail disruptions to the affected countries’ economic activity. The authorities should encourage banks to assess the risks that they face in specific situations and apply risk mitigation tailored to the risks of a specific customer or product, with a view to preventing unnecessary curtailment of legitimate financial activities. Greater cooperation among national supervisors is also needed, including to clarify regulatory expectations, harmonize regulatory frameworks and facilitate cross-border information sharing on customer due diligence.

Financial market infrastructures—Eurex Clearing20

40. Eurex Clearing is licensed both as a CCP and a credit institution resulting in a number of financial stability safeguards. It is authorized by BaFin as a clearing house in accordance with EMIR and at the national level licensed also as a credit institution. The banking license allows it to take deposits, and provide lending while acting as a CCP. As a member of TARGET 2, Eurex Clearing settles the cash leg of its euro transactions in central bank money, using its account at the Bundesbank. It also settles the Swiss franc transactions at the Swiss National Bank (SNB). It has access to the intraday and overnight credit facility of the Bundesbank and may have access to further liquidity assistance at the discretion of the relevant central bank, subject to applicable legal restrictions.

41. Eurex Clearing has coped well with volatile markets and strengthened international standards. It has already developed a recovery plan in accordance with the Recovery and Resolution Act. Eurex Clearing has been recognized by the Swiss authorities as a systemically important FMI to the Swiss market and approved by the U.S. Commodity Futures Trading Commission (CFTC) as a registered derivatives clearing organization to offer proprietary OTC clearing services to clearing members domiciled in the U.S. However, it would benefit from strengthening its liquidity stress tests and ensuring effective business continuity arrangement by upgrading the secondary site with appropriate staffing arrangements. While the regulatory, supervisory, and oversight framework is effective, the legal basis for the Bundesbank’s oversight warrants strengthening, its tasks and powers should be made explicit in the law and intensity of on-site inspections increased.

42. Potential spillover risks related to Eurex Clearing are well contained; authorities are encouraged to monitor global and domestic interdependencies. As the G20 regulatory reforms lead to increased central clearing volumes,21 Eurex Clearing’s sound risk management is critical to minimize global spillovers from disruption of its operations. German authorities should monitor interdependencies, for example through network analysis and stress testing, and are encouraged to continue leading the international effort to increase robustness of CCPs, further enhance recovery and resolution standards for FMIs, analyze and monitor their interconnectedness and coordinate FMI recovery planning with other key global players in the relevant international fora.22

Insurance regulation and supervision23

43. Since the last FSAP, the authorities have acted to mitigate the impact of low interest rates on the insurance sector; nonetheless, vulnerabilities persist. Actions taken include the introduction, as early as 2011, of requirements on life insurers to build reserves for future commitments (the so-called ZZR);24 legislative changes regarding distribution of unrealized investment gains to departing policyholders; and the use of transitional measures under Solvency II to mitigate the material impact of the new valuation basis. Insurers themselves have been changing their product mix, and reducing guarantees on new products. Nonetheless, financial strains at individual companies are possible, particularly those concentrating on traditional life insurance, reflecting large accumulated books of business written over many years.

44. The regulatory and supervisory regime has been substantially bolstered by Solvency II implementation. BaFin is taking a more risk-based approach to evaluating supervisory risks and allocating resources. There is an increased focus on groups in the regulatory and reporting requirements, improved cross-border cooperation through colleges of supervisors, and enhanced monitoring of insurers’ investment activities, including regular stress testing. After a large increase, BaFin’s supervisory resources appear appropriate, while the transition to Solvency II has involved extensive retraining of staff and application of more principles-based approaches to governance and risk management. However, many new regulatory tools (including a prudent person principle for investments) are still under implementation and their effectiveness remains to be tested.

45. BaFin has identified life insurers under strain that are now subject to close oversight. The continuing importance of national Generally Accepted Accounting Principles (GAAP) in relation to policyholder profit participation, which is a central feature of German life insurance, makes Solvency II implementation particularly complex in Germany. While BaFin is monitoring companies’ positions and has conducted surveys on the impact of Solvency II, uncertainty remains regarding market reactions to the publication of new solvency indicators. The array of measures of financial strength may hamper interpretation.25 Given this multiplicity and high transparency of measures to be published in 2017 regarding the reliance on transitional measures, a communication strategy should be formulated with high priority to improve public understanding.

46. BaFin’s intervention and policy framework should be reinforced. BaFin should communicate supervisory expectations based on the Own Risk and Solvency Assessment (ORSA) review more systematically, and make full use of the provisions in the supervisory legislation to require capital add-ons in the circumstances envisaged in Solvency II. BaFin should consider applying aspects of its G-SII approach, on a risk-based basis, to other large insurance groups, including large reinsurers with global reach. BaFin should continue to develop its crisis management planning, including the acceleration of recovery planning (now applied only to the G-SII) and keep under review the adequacy and flexibility of safety net arrangements, in particular transferability of complex businesses with derivatives and reinsurance transactions. The authorities should continue to improve the stress testing methodologies and conduct regular stress tests on an industry-wide basis.

47. BaFin should require action plans where companies face difficulties in meeting Solvency II requirements. Where companies are relying on transitional measures, insurers should have robust and credible plans for meeting the full requirements, including under stress conditions that may occur in the long transitional period, and by the end of the period. BaFin should take action to restrict business or withdraw approval of transitional measures, where necessary.

Asset Management and Collective Investment Schemes26

48. Germany’s regulatory framework for asset management sector is strong and comprehensive. Full account is taken of the requirements set out in EU legislation and the standards and principles developed by International Organization of Securities Commissions (IOSCO), with some adjustments to reflect the specificities of the German market and priorities of the main supervisor of the sector, BaFin.

49. The authorities have increased their supervisory engagement in recent years. BaFin is sufficiently well-resourced that it can maintain close contact with asset managers and depositaries, which could be intensified even further through a program of more frequent on-site inspections. This should include BaFin staff accompanying external audits on a more regular basis. In addition, BaFin should take into account a broader range of factors, such as the leverage employed by fund managers and the level of interconnectedness, in its risk classification of supervised entities.

50. German asset managers and funds are subject to detailed rules on the valuation of assets and net asset value (NAV) calculation, but additional macroprudential measures could be considered. With respect to liquidity risk management, appropriate safeguards were put in place to prevent a recurrence of problems experienced by certain open-ended real estate funds following the financial crisis. Nevertheless, additional measures could further ensure stability—and should be considered in tandem with other EA supervisors—for instance, the introduction of mechanisms, such as swing pricing, to reduce the first-mover advantage that can exist in single-priced funds. BaFin should also monitor the need for more detailed guidelines on the use of these tools, with a view to contributing to relevant EU and international standard-setting work. The authorities should also consider allowing for a broader range of tools to deal with situations of market illiquidity that could have an impact on the ability of funds to meet redemption requests. Finally, the treatment of material pricing of investment funds and associated rules on investor compensation merit stronger oversight.

51. BaFin is able to monitor developments in the asset management sector by having access to an extensive set of data shared by the Bundesbank. Individual exposures can be identified accurately, allowing supervisory intervention where needed. BaFin’s oversight of the sector using quantitative data will be further enhanced as the reporting under the AIFMD becomes more reliable. Pending the establishment of a system for the collection and exchange of data by ESMA, BaFin should ensure it has its own system in place to assess the reported information and flag issues to other EU supervisory authorities as necessary. BaFin should also contribute to discussions at the European and international levels on the development of a single method of calculating leverage.

AML/CFT27

52. In recent years, Germany has introduced significant reforms to enhance its AML/CFT regime. It notably criminalized self-laundering and immobilized bearer shares, enhanced domestic cooperation, improved the supervisory framework for designated non-financial business and professions (DNFBPs) and the risk analysis model applied by BaFin for AML/CFT supervision. Onsite visits to financial institutions and DNFBPs have increased. Germany is currently conducting a national assessment of its money laundering (ML) and terrorist financing (TF) risks.

53. Overall, the AML/CFT framework appears strong, with enhancements warranted in some areas. Germany should consider expanding the range of predicate offenses to ML so as to include offenses—in particular tax offenses—not only when aggravating circumstances are met but also in their absence, when the offense generates significant amounts of proceeds. Significant sanctions by foreign regulators for non-compliance with their national AML/CFT provisions imposed on some banks suggest the need for stronger implementation of AML/CFT obligations. Germany should enhance AML/CFT supervision of banks with cross-border operations, and as a priority, give additional attention to the supervision and audit review of banks’ risk assessments and control measures. More streamlined information flow and cooperation between BaFin, ECB and the Bundesbank would also strengthen BaFin’s AML/CFT supervision of banks’ group-wide risk management policies and controls at the parent level. Current staffing levels at BaFin’s Department of Money Laundering Prevention warrant strengthening. Finally, Germany should take further measures to facilitate timely access to beneficial ownership information of legal persons.

Financial Safety Nets28

Scope and inst itutional landscape for bank resolution and crisis management

54. The transposition of the EU BRRD into German law has significantly strengthened the existing resolution regime in Germany. The BRRD establishes uniform rules within the EU for recovery and resolution of banks and investment firms that are closely aligned with the FSB’s Key Attributes for Effective Resolution Regimes (KAs).29 Preexisting broad German powers and tools have been further enhanced by, inter alia, the introduction of bail-in, though the authorities did not transpose the BRRD’s extraordinary government financial stabilization tools (temporary public equity support and temporary public ownership), thus constraining their toolkit in the event of a systemic crisis. This new framework now needs to be operationalized.

55. Institutional arrangements have undergone fundamental change with the implementation of the Single Resolution Mechanism (SRM). In 2016, the SRB has assumed responsibility for ensuring effective resolution of SIs along with other German banks with cross-border operations in other EU jurisdictions. A Single Resolution Fund (SRF) was created to fund resolution measures, and will be used for banks resolved in all SRM member states after the national compartments of the SRF have been fully mutualized in eight years’ time. While the SSM has established a track record over more than a year in operation, the SRM is still in a start-up phase. The SRM decision-making structure is complex. Its efficiency should be reviewed and streamlined.

56. While the institutional framework for bank resolutions has been put in place, a coordination mechanism for addressing a systemic crisis remains less formalized. A formal coordination framework involving the German authorities, ECB and SRB should be developed along with contingency plans for management of a systemic crisis in cooperation between the German and European authorities. These plans should be tested via crisis simulation exercises.

Recovery and resolution planning

57. Authorities are making significant progress in recovery and resolution planning. Since 2013, large domestic banks have been required to have recovery plans. This requirement is now being rolled out for additional banks, including high priority LSIs and small banks, by 2017. Similarly, resolution planning and resolvability assessments are ongoing in all significant banks.

58. Authorities intend to rely largely on bail-in to resolve systemic banks. The EU minimum requirement for eligible liabilities (MREL) is formally in place since 2016 and will be applied on an institution specific basis and phased-in over time.30 The framework for bail-in is strict and only allows exemptions in limited cases. Building adequate buffers may take years in some banks. This might constrain policy options in a systemic crisis during the transition. The authorities’ policy options are also constrained by the non-transposition of the BRRD’s provisions on government stabilization tools in the SRM regulation and German legislation. Based on a number of surveys, the authorities believe that most potentially systemic banks have already issued a sufficient volume of debt that would allow for bail-in. The authorities should continue to monitor that the available bail-inable liabilities are adequate for large banks. Recent German legislation clarifying the subordination of certain unsecured debt from 2017 onwards will facilitate implementation of bail-in.

59. Operationalization of resolution plans and ensuring funding of a bank in resolution is a high priority. The authorities have identified operational challenges (e.g., the timely valuation of assets to be transferred, continued access to financial market infrastructures) and are working to surmount them. In some cases, actions to effect resolution may require a number of days to implement, and the authorities should ensure they can maintain control over the bank during this period, including by using their powers to impose a more general moratorium for a specific bank.31 Authorities also need to ensure adequate funding to support banks in, and subsequent to, a resolution decision. The available funding should be assessed during resolution planning and in the preparation of a resolution decision. Such funding needs should preferably be covered by private sector funding, or by public sector backstop facilities. While the resolution framework legally precludes assuming access to ELA (which is subject to ECB approval above specified thresholds) as part of resolution planning, the Bundesbank should consider liaising with the resolution authorities during the preparatory phase to assess potential post resolution liquidity needs.

60. Completing a common European backstop to the SRF remains a medium term priority. Currently, the German Loan Facility Arrangement with the SRB provides a backstop for the national compartment in the SRF. In addition, the SRF allows for limited recourse to the SRF’s other national compartments during the transition phase. There is no agreement yet on a common European backstop. The EU Economic and Financial Affairs Council (ECOFIN) ministers have committed to agreeing on this issue by the end of the SRF transitional period, i.e., 2023. A common European backstop remains necessary to ensure that the SRF will have sufficient resources at its disposal to fund resolution measures.

Cross-border cooperation

61. Contrary to the requirements of the Key Attributes of Effective Resolution regimes, the resolution framework limits the participation of third country authorities in Resolution Colleges to the role of observers. Their access to confidential information is conditional upon their domestic regimes compliance with the required confidentiality and data secrecy provisions. In practice, the German authorities have developed a good track record of coordination with countries outside of the EU in Crisis Management Groups (CMGs). The authorities should continue efforts to foster cooperation with non-EU countries, despite gaps regarding confidentiality in the European framework.

62. Similarly, the resolution framework requires the resolution authority to take into account the effects of a resolution decision in other EU Member States, but not the effects in third countries. Aforementioned cooperation in Resolution Colleges and CMGs will also address these effects. The authorities should continue their efforts to develop cooperation with third country authorities, and, in the longer term, to pursue legislative changes—with other EU member states—to foster cross-border cooperation at the European level.

Deposit insurance

63. Funding and transparency of the deposit guarantee schemes (DGS) has been enhanced. Deposit insurance follows the three-pillar model of the German banking sector. In the event of a bank failure, depositors have a legal claim for reimbursement of their covered deposits up to EUR 100,000 (in specific situations, up to a higher amount). In addition to the two statutory DGSs (one for private banks and one for public banks), there are also two Institutional Protection Schemes (IPS), which are formally recognized as DGSs; one covers savings banks and Landesbanken and another cooperative banks. Legislation requires banks be able to provide information on insured depositors with respect to their claims and for reimbursement by a statutory DGS within seven working days. While important progress has been made, EA jurisdictions have not yet reached agreement on an EA-wide deposit insurance scheme.

64. IPSs play important monitoring and stabilization roles for their members, but the uneven playing field for DGSs may result in competitive disadvantages for private banks and hinder consolidation across sectors. The IPSs have risk monitoring systems in place, and can provide funding to restructure and resolve individual failing members as part of private sector measures. In a systemic crisis situation, they may potentially propagate contagion within the respective banking pillars. However, the members of IPSs do not have a legal claim on such funding by the IPS. In the absence of IPS support, as an appropriate safeguard, covered deposits will be paid out to the maximum of EUR 100,000 and the troubled bank will be dealt with under the general resolution regime.

Annex I. Germany: Implementation Status of 2011 FSAP Recommendations

article image
article image
article image
article image

Annex II. Structure of the German Banking System

The system is structured around three pillars and comprises 1,776 institutions. The consolidation in the last five years mainly took place at local savings and cooperative banks levels and the number of institutions has declined by more than 100 since the last FSAP.

The first pillar, 273 private commercial banks (of which 107 are branches of foreign banks), represents the largest segment of the banking sector, accounting for 39 percent of assets. Among the private commercial banks, the four big banks cover retail, corporate banking and investment banking business, both domestically and internationally, and act as the principal banking partners of Germany’s major industrial enterprises.1 Some large commercial banks have undergone major cost cutting exercise and reduced the exposure to non-core business.

The second pillar, public savings banks, includes seven independent regional Landesbanken and 425 savings banks, covering about 27 percent of banking system assets. The savings banks operate under a regional principle, providing a range of banking services to households and small- and medium- enterprises (SMEs). While local savings banks weathered the 2008 financial crisis relatively well, Landesbanken, their central institutions, endured large losses due to their involvement in structured finance and derivative products. A number of Landesbanken have undergone major consolidation since 2011 FSAP. Asset quality remains below system average, with an NPL ratio at 6.7 percent. Moreover, the provisioning of NPLs is relatively low compared with other pillars.

The third pillar, cooperative banks, includes more than 1000 financial institutions, accounting for about 14 percent of the banking assets. The cooperative banks are owned by their members, who tend to be their depositors and borrowers, and usually offer core banking services to their customers. The cooperative banks have the highest net interest margins across different pillars, and undertook considerable consolidation since the last FSAP, in part, responding to the low interest rate environment. The number of local credit cooperatives reduced by about 100 since end-2010, and the two central institutions for cooperative banks, DZ Bank AG and WGZ Bank AG will be merged effective August 1, 2016.2

The remaining 20 percent of the German banking sector comprises 57 mortgage banks, building and loan associations and special purpose banks. Mortgage banks suffered losses during the financial crisis, and subsequently went through restructuring and resolution. Their asset size has declined to under five percent of the banking system in 2015.

Annex III. Landesbanken—Recent Developments

The need for reform of the public banking sector in Germany, and specifically the Landesbanken, intensified after the financial crisis.1 Such reform was one of the principal recommendations of the 2011 FSAP. Several institutions had to be rescued by the government. Pressure increased for reforms in ownership, governance, and business models of the sector.

The sector has seen important consolidation since the financial crisis began. There are now only seven independent Landesbanken, excluding Dekabank, the central asset manager of the sector. The ownership structure varies, and will evolve further in the next few years (Table A1). The sector deleveraged, as banks have refocused on core businesses (Annex Figure 1). Non-core assets and participations have been reduced, foreign offices have been closed, and a number of subsidiaries have been sold. Foreign currency activities and refinancing risks have been cut back. Dependence on wholesale market financing has declined.

Annex Table 1.

Germany: Ownership Structure of Landesbanken, 2015

article image
Source: Association of German Public Banks

Private sector investors

NordLB.

Under the March 2016 agreement with the EC, HSH Nordbank will be privatized by end-August 2018 at the latest or wound down.

Annex Figure 1.
Annex Figure 1.

Germany: Risk-Weighted Assets of Landesbanken, 2007–15

(In EUR billion)

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Source: Association of German Public Bonks

Business models are changing. Some banks are focusing on developing customer lending business in the corporate and/or retail sectors, sometimes concentrating on specific industries. Others are taking a broader approach, including the development of investment banking activities. Financing patterns vary, with some banks able to rely on customer deposits for at least part of their funding, while others continue to be supported by loans from regional savings banks and wholesale borrowing. The result is a diversified sector with institutions of varying sizes and ranges of business activity (Table A2).

Annex Table 2.

Germany: Business Models of Landesbanken, 2015

article image
Source: Association of German Public Banks.

Notwithstanding this progress, the sector still faces considerable challenges. The Landesbanken in general are more efficient than before, but with large differences across individual banks. Business models are evolving and have not yet been fully tested, and profitability continues to be low even when adjusted for risk. Viable restructuring for some institutions is likely to require further downsizing, opening of capital to private investors and further reform of governance structures.

Annex IV. Stress Test Matrix (STeM) for the Banking Sector

article image
article image
article image
article image
article image
article image
article image
article image
article image

Annex V. Stress Test Matrix (STeM) for the Insurance Sector

article image
article image

Annex VI. Stress Test Matrix (STeM) for Systemic Risk Analysis

article image

Annex VII. Methodology for Systemic Risk and Spillover Analysis

Contagion risks and interconnectedness are assessed using two different approaches. The first approach applies the Espinoza-Vega and Sole (2010) methodology to examine cross-border bank exposures, using BIS consolidated Banking Statistics. The second approach uses the Diebold and Yilmaz (2014) methodology with daily equity returns data to examine the contagion between publicly traded banks and insurance companies in Germany, and the spillover among Deutsche Bank, Commerzbank and GSIBs.

Network Analysis Framework (Espinoza-Vega and Sole, 2010)

The analysis based on the network framework of Espinoza-Vega and Sole (2010) considers both credit and funding shocks to the banking systems:

Credit shock: “Failure” of banking system A will incur credit losses to system B that has claims against A. The credit loss rate assumption controls for the severity of credit cost upon failure. A loss given default rate of 100 percent is assumed to capture the impact of an extreme credit shock.1

  • Funding shock: “Failure” of banking system A will force system B (that has claims against A) to find alternative sources of funding. This may result in the fire sale of liquid assets by system B to fill the funding gap. The fraction of lost funding that is not replaceable is assumed to be 35 percent (65 percent rollover) and the haircut in the fire sale is assumed to be 50 percent.2

The sample consists of 16 BIS reporting countries including those with the highest banking sector exposure to Germany.3 Cross-border banking exposure data are based on BIS consolidated statistics on ultimate risk basis. Tier 1 regulatory data are taken from IMF’s FSI Statistics. The analysis is based on 2015Q1 data.

An initial negative credit or funding shock to a country’s financial system could be propagated through the network of bilateral claims across countries (based on the BIS consolidated banking statistics), and could distress banking systems in other countries beyond the direct losses from the initial shocks.

If any banking system incurs losses larger than their total Tier 1 capital, the system “fails.” This failure can subsequently cause some other banking system to fail, triggering domino effects, where a failure of a banking system in a network transmits to other banking systems.

Two sets of simulations are considered in the analysis. The first simulation applies to reporting banks’ exposure to foreign banks, and the second one applies to the total exposure of the banking sector.

Spillover Analysis with Market Data (Diebold and Yilmaz, 2014)

The spillover analysis using the Diebold and Yilmaz (2014) methodology first estimates a Vector Autoregression (VAR) model with market data. The interconnectedness measure is then derived from the Generalized Variance Decomposition (Pesaran and Shin, 1998) of the underlying VAR. In contrast to the traditional Cholesky and other structural identification strategies, the Generalized Variance Decomposition (GVD) does not impose any assumptions on the order of variables, instead, it relies on a largely data-based identification scheme (“let the data speak”).

Two sets of simulations are conducted as part of the market-based spillover analysis. The first set of simulations examines the interconnectedness between publically traded banks and insurers in Germany, while the second studies the spillover and the contribution to systemic risks among GSIBs. Daily equity returns, as constructed as the log difference of equity prices are used in both exercises. The sample spans from 16 July 2015 to 23 February 2016 for the German bank-insurer analysis, and from 11 October 2007 to 26 February 2016 for the GSIB analysis.4

The FSAP team derives a set of pair-wise directional connectedness measure between financial firms, based on the Generalized Variance Decompositions. On aggregate, the from-degree measure captures exposures of individual firms to systemic shocks from the network (inward spillover), in a fashion analogous to Marginal Expected Shortfalls (MES). The to-degree measure captures contributions of individual firms to systemic network events (outward spillover), in a fashion analogous to Delta CoVaR (see Diebold and Yilmaz, 2014). In addition, the net-degree measure (the difference between to- and from- measures) describes the relative contribution to systemic risks from each financial firm.

The results are based on rolling window estimations and the relative importance of each institution’s contribution to systemic risks (the net-degree measure) is broadly stable and robust over time. The following charts present the net contribution to systemic risks in the German financial sector (among publically traded firms) and among GSIBs. For space considerations, only select firms with a positive net contribution to systemic risks are presented.

Annex Figure 2.
Annex Figure 2.

Net Contributions to the Systemic Risk

Citation: IMF Staff Country Reports 2016, 189; 10.5089/9781475577730.002.A001

Appendix I. Report on the Observance of Standards and Codes (ROSCs)—Summary Assessments

Basel Core Principles for Effective Banking Supervision

A. Introduction

At the request of the German authorities, this assessment of the current state of the implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in Germany was completed as a part of the Financial Sector Assessment Program (FSAP) mission undertaken by the International Monetary Fund (IMF) during March of 2016.1 It reflects the regulatory and supervisory framework in place as of the date of the completion of the assessment. It is not intended to represent an analysis of the state of the banking sector or crisis management framework, which are addressed in other parts of the FSAP.

An assessment of the effectiveness of banking supervision requires a review of the legal framework, and detailed examination of the policies and practices of the institutions responsible for banking regulation and supervision. In line with the BCP methodology, the assessment focused on BaFin, the Deutsche Bundesbank (BBk) and the European Central Bank as the joint supervisors of the banking system, and did not cover the specificities of regulation and supervision of other financial intermediaries. It is important to note, however, that to the extent that BaFin is a unified supervisor responsible for other entities of the financial sector, the assessment of banking supervision in Germany may provide a useful picture of current supervisory processes applicable to other financial institutions supervised by it.

B. Information and Methodology Used for Assessment

Germany requested to be assessed according to the Revised Core Principles (BCP) Methodology issued by the BCBS (Basel Committee of Banking Supervision) in September 2012. The current assessment was performed according to a revised content and methodological basis as compared with the previous BCP assessment in 2011. Importantly, that the two assessments will not be directly comparable, as the revised BCPs have heightened focus on corporate governance and risk management and its practice by supervised institutions and its assessment by the supervisory authority, raising the bar to measure the effectiveness of a supervisory.

The German authorities chose to be assessed against the highest standards of supervision and regulation, choosing to be assessed and rated against both the Essential Criteria and the Additional Criteria. To assess compliance, the BCP Methodology uses a set of essential and additional assessment criteria for each principle. The essential criteria (EC) were usually the only elements on which to gauge full compliance with a Core Principle (CP). The additional criteria (AC) are recommended best practices against which the authorities of some more complex financial systems may agree to be assessed and rated. The assessment of compliance with each principle is made on a qualitative basis. A four-part grading system is used: compliant; largely compliant; materially noncompliant; and noncompliant. The assessment of compliance with each CP is made on a qualitative basis to allow a judgment on whether the criteria are fulfilled in practice. Effective application of relevant laws and regulations is essential to provide indication that the criteria are met.

The assessment team reviewed the framework of laws, rules, and guidance and held extensive meetings with officials of BaFin, the Bundesbank and ECB supervision, and additional meetings with auditing firms and banking sector participants. The authorities provided a self-assessment of the CPs rich in quality and comprehensiveness, as well as detailed responses to additional questionnaires, and facilitated access to supervisory documents and files, staff and systems.

The team appreciated the very high quality of cooperation received from the authorities. The team extends its thanks to staff of the authorities who provided excellent cooperation, including extensive provision of documentation and access, at a time when staff was burdened by many initiatives related to the European and global regulatory changes, and still adapting to the new European supervisory framework.

The standards were evaluated in the context of the German financial system’s structure and complexity. The CPs must be capable of application to a wide range of jurisdictions whose banking sectors will inevitably include a broad spectrum of banks. To accommodate this breadth of application, a proportionate approach is adopted, both in terms of the expectations on supervisors for the discharge of their functions and in terms of the standards that supervisors impose on banks. An assessment of a country must recognize that its supervisory practices should be commensurate with the complexity, interconnectedness, size, risk profile and cross-border operation of the banks being supervised. In other words, the assessment must consider the context in which the supervisory practices are applied. The concept of proportionality underpins all assessment criteria. For these reasons, an assessment of one jurisdiction will not be directly comparable to that of another.

An assessment of compliance with the BCPs is not, and is not intended to be, an exact science. Reaching conclusions required judgments by the assessment team. The team assessed the supervisory and regulatory framework in the midst of great changes, and the assessment should reflect the transition phase in which it took place. Nevertheless, the assessment of the current legal and regulatory framework and supervisory practices against a common, agreed methodology should provide the supervisors of German banks with an internationally consistent measure of the quality of its banking supervision in relation to the CPs, which are internationally acknowledged as minimum standards, and point the way forward.

C. Preconditions for Effective Banking Supervision2

The macroeconomic environment has been stable in recent years. Borrower-related credit risk and stock of nonperforming loans are low, particularly when compared to other European countries. Results of the Bundesbank Bank Lending Survey suggest that lending policies were stable in recent years. With interest margins stable so far, banks active in the traditional banking business extended their balance sheets and maturity transformation risk. If the low interest environment prevails, the shrinking interest rate margin will force banks to look for alternative business opportunities potentially raising new risks.

The Financial Stability Act provides the legal framework for the FSC, Germany’s macroprudential institution. The FSC discusses the factors that are key to financial stability, strengthens cooperation between the institutions represented on it, advises on the handling of warnings and recommendations issued by the ESRB and reports annually to the lower house of Parliament. The FSC can issue warnings and recommendations to all public bodies in Germany in order to promptly combat any adverse developments which may cause risks to financial stability. The addressees of these recommendations must adhere to a “comply or explain” mechanism.

As the German credit market is dominated saving and co-operative banks which typically conduct business with retail customers and SMEs, the credit culture is traditional and collateralization, e.g., by mortgages, prevails. More recently one can see the tendency of larger corporates, the typical clients of the bigger banks, to fund themselves directly on the capital market. This might be driven by an increased willingness of investors to take these risks while funding costs of larger banks went up due to rating downgrades.

Germany has a well-developed public infrastructure, including a comprehensive legal system covering in particular areas relevant for the banking system. These laws relate, for example, to corporate law setting out the requirements regarding the setting up and winding down/liquidating of joint stock companies, limited companies, partnerships, and cooperatives, their internal governance structures, detailed accounting provisions as well as rules regarding mergers and acquisitions.

The financial sector regulation covers all relevant areas. As a member state of the EU, large parts of the German framework are rooted in the transposition or implementation of EU directives and directly applicable EU regulations. Specific national rules exist where topics considered relevant are not regulated by EU law or where EU law leaves room for additional national rules. Furthermore, BaFin as an integrated supervisory authority is member of the European Supervisory Authorities (EBA, ESMA and EIOPA). In this context, BaFin is obliged to cooperate with and support the work of the ESAs. This also includes the implementation of ESA guidelines and recommendations. The same applies to the cooperation of BaFin and ECB within the SSM.

Germany enjoys a system of independent external audits and comprehensive accounting principles and rules that are contained in the German Commercial Code (HGB). All German public accountants are organized in the Chamber of Public Accountants (WPK), a corporation under public law. The requirements on the profession of a certified public accountant are stringent. The Auditor Oversight Commission (AOC), comprised entirely of persons independent from the profession, carries out public oversight on the Chamber of Public Accountants (WPK), and all auditors associated in the WPK.

Terms and conditions of contracts are, in general, not regulated in supervisory law but in civil law. The Civil Code (Bürgerliches Gesetzbuch - BGB) for example sets legal framework for consumer credits including consumer protection regulations and the act on insurance contracts (Versicherungsvertragsgesetz - VVG) also stipulates consumer protection regulations. Recently the German legislator adopted a new law to improve the protection of retail investors (“Kleinanlegerschutzgesetz”). Moreover BaFin supervises compliance of financial market players with consumer protecting provisions in supervisory laws, e.g., German Banking Act (Kreditwesengesetz – KWG), Insurance Supervision Act (Versicherungsaufsichts-gesetz – VAG) and Securities Trading Act (Wertpapierhandelsgesetz - WpHG).

Germany has transposed the European directive on deposit guarantee schemes (DGSD) into national law (Einlagensicherungsgesetz-EinSiG). Under the Directive, all credit institutions have to be allocated to a statutory guarantee scheme or an institutional protection scheme that is officially recognized as a deposit guarantee scheme. Customers of all institutions have a legal claim to compensation for their covered deposits up to an amount of EUR 100,000.

The German Act for Recovery and Resolution of Institutions and Financial Groups (SAG) spells out the different responsibilities and tools available in crisis management and for bank resolution which complement the powers and measures granted by the Banking Act (KWG). The Federal Agency for Financial Market Stabilization (FMSA) was appointed as resolution authority on a national level. The supervisory authority reviews and assesses the recovery plan in consultation with the Bundesbank. Banks that are deposit taking institutions as defined in section 1 (3d) first sentence KWG also have to be members of a deposit insurance scheme which further bolsters public confidence in the stability of the financial system.

D. Main Findings
Responsibility, Objectives, Powers, Independence, Accountability (CPs 1-2)

The legal framework for banking supervision is well established by German laws and regulations, directly applicable EU regulation, and Single Supervisory Mechanism Regulation (SSMR). While the division of responsibilities between BaFin and the Bundesbank regarding LSI supervision is well established, the framework for the SSM is evolving and there are still uncertainties regarding the specific operational roles of each agency in the new environment. These uncertainties reflect the complex legal and operational framework but do not to affect the overall understanding of responsibilities by the market or authorities. The three supervisory agencies enjoy operational independence, in the sense that there is no government or industry interference in individual supervisory decisions. However, there is potential for indirect influence of government and industry in the execution of BaFin’s supervisory objectives through the budget approval process and the mandatory approval of BaFin’s internal organization and structure by the MoF. The decision making process at the ECB is complex and does not foster effectiveness and timeliness of day-to-day supervisory decisions (although there are processes in place for emergency decisions).

Ownership, Licensing, and Structure (CPs 4-7)

The ECB is the licensing authority, who makes decisions on the basis of applicable German and EU laws. While criteria and procedures are well established, in general, the financial suitability of shareholders is limited to the availability of the initial capital, and the assessment of the supervisory board does not play a relevant role in the licensing process, although assessors noted these elements are gradually being incorporated in the licensing process. In addition, there is no requirement for the bank to notify the supervisor when they become aware of events that may cause a significant shareholder to no longer be fit-and-proper. The review of fit-and-proper qualification would benefit from expanded requirements and standards. The team welcomes the new guidelines issued by BaFin in January 2016, which emphasize the prudential importance of the professional qualification of the Board.

There is no need for prior supervisor approval of investments below a 10 percent threshold, other than investments in other German institutions (significant holdings regime). This may create situations where acquisitions occur that increase the risk to the banking group beyond management skills and have a negative impact on the group that greatly the amount of the investment. While the regulator requires higher capital or may be able to force the bank to unwind the investment, it is more prudent to require ex-ante review.

Methods of Ongoing Supervision (CPs 8-10)

The transition to the SSM for SIs has had many benefits, although some aspects of the supervision methodology are still undergoing implementation. Much has been achieved in a short space of time and the supervision framework lays the foundation for a risk-based approach with the SREP as the core element. Elements of the framework are still being implemented and will take time to mature and be applied consistently across banks.

The supervisory approach for LSIs is established but evolving and scope exists for greater verification of compliance with regulations. Onsite examinations verify adherence with MaRisk and are undertaken by the Bundesbank and BaFin through testing and interviews of management. The MaRisk Inspection Guide used by LSI supervisors lays the foundation for a consistent examination process and the use of the external auditor is also a key aspect of the supervision architecture to confirm compliance. Annual meetings with the Management Board, analysis of the Internal Capital Adequacy Assessment Process (ICAAP) and the risk profile form core elements of a sound framework. However, much reliance is placed on the external audit long form report and while rich in detail, greater emphasis is needed to verify the reliability, accuracy, and integrity of the information used for risk assessments as inputs into a forward looking view of risk.

Supervisory reporting is not sufficiently granular to support offsite supervision. Not all data needs are covered by EBA ITS reporting. To fill the gaps, short-term exercises and surveys are used, such as for concentration, liquidity, and IRRBB. While the data contributes to the risk assessment process, using peer group analysis and benchmarks is not systematic. Currently, supervisors are challenged by differences between reporting based on the national GAAP and IFRS data which complicates systematic and consistent comparisons between different account treatments. Technical work is underway to address this issue. Timely and accurate data is fundamental to effective supervision and the issues with data need to be addressed as a matter of priority.

Corrective and Sanctioning Powers of Supervisors (CP 11)

German law and SSMR provide a broad range of actions that can be taken by supervisors in their respective responsibilities. Direct enforcement powers and sanctions of ECB are limited; however the ECB can make use of the enforcement and sanction powers available to BaFin. Assessors had access to evidence of such indirect actions, however the complex legal framework may make it operationally difficult and time consuming for ECB to impose enforcement actions. The actual use of formal powers by both BaFin and the ECB in practice is not intensive.

Cooperation, Consolidated and Cross-Border Banking Supervision (CPs 3-12-13)

The collaboration and coordination framework with domestic and cross-border supervisors is highly developed. The EU has adopted a supervisory coordination process that is based on joint supervision through the SSM, colleges of supervisors led by the home country coordinator and signed MOUs with third country supervisors and nonbanking sector regulators.

A consolidated supervisory approach is in place at both the SI and LSI levels. A detailed planning approach is in place through supervisory colleges and MOUs that result in a comprehensive review for the consolidated group. Additionally, ring-fencing powers are available to ensure that the group can be insulated from related companies that may adversely impact the group. Banking groups may be required to close reorganize to correct a non-transparent structure.

Corporate Governance (CP 14)

The role of supervisory boards is weak and passive with most policy, and risk management duties and responsibilities placed on the management board. In the past few years there has been some evolution in supervisors focus on the supervisory board within the SREP process, and a thematic review on Risk Governance has been conducted that resulted in recommendations addressed to banks aimed at making the supervisory board involvement more robust. Additionally, MaRisk is being amended and will include code of conduct requirements.

Supervisory guidance should clearly delineate that ultimate responsibility for establishing the risk culture, developing business plans and risk appetite statement rests with the supervisory board. The fit-and-proper process is streamlined for supervisory board members as are technical knowledge requirements. As established by KWG, the primary responsibility for internal controls, governance, business strategy, and internal audit is assigned to the management board.

Prudential Requirements, Regulatory Framework, Accounting and Disclosure (CPs 15-29)

While risk management standards are generally sound, the reporting line between the internal risk control function and the Supervisory Board should be strengthened. Reporting of risk management is through the Management Board and the CEO which is responsible for setting the business plan and risk taking. The risk function does not report directly to the Supervisory Board but to the Management Board and therefore the CEO. This approach may weaken the independence of the risk management function and the CRO to raise issues as also highlighted by the SSM methodology. In particular, the reporting line to the management body (with supervisory and management function) was a topic assessed within the thematic review on Risk Governance and Risk Appetite. While banks had in place formal “whistle-blowing” processes, the structure may inhibit the independence of the CRO and the risk function to report weaknesses in the RMF. This is further aggravated by the ex-post notification of removal of the CRO by the management board which is the prescribed minimum of MaRisk.

Banks are well-capitalized and supervisors have the powers to impose additional requirements. The deviations of the EU capital framework in relation to the Basel standards regarding the definition of capital do not appear material for German banks in general, although some may be for specific banks (such as deduction of participation in insurance). Regarding the calculation of risk weighted assets, a few elements for which the RCAP found deviations may be significant for Germany, such as sovereign exposures under the permanent and temporary partial use, lower risk weights for covered bonds, and the counterparty credit risk framework. Assessors observed some cases where these deficiencies were being addressed by banks’ internal capital adequacy assessments and supervisory action, and it is impossible to determine that that existing framework is not in general resulting in overstated CET1 ratios. Both the ECB and BaFin can require banks to hold capital in excess of the minima under Pillar 2. However, the practice was not commonly used by German authorities. The ECB has only concluded one SREP cycle so far, in which some banks were required to implement Pillar 2 add-ons. Leverage is specifically taken into account in the SSM SREP methodology, while BaFin has not systematically incorporated it in the analysis yet.

Supervisors have not provided guidance on loan portfolio management expectations. For example, broad guidelines on general characteristics of various loan risk buckets; definitions of non-performing, restructured, forborne and cured loans. Granularity of credit portfolio data is limited.

The role of the supervisors in loan classification and supervision primarily involves a review of policy and procedures. The focus of supervision is to provide bank management with considerations when setting loan classification parameters and provisioning such as items to consider for residential mortgages and commercial real estate classification triggers. Collateral valuation considerations, such as, conservative valuations of realizable net values are important.

Loan classification and provisioning have been viewed as an accounting issue; however, supervisors recently conducted a thematic review of loan valuation and impairment. To implement a supervisory approach that asks supervision staff to review loan files and value loans and determine adequacy of provisions in a market where the practice was not present, ex-ante discussions with bankers and accountants should take place and supervisor expectations on loan valuation and provisioning communicated. It is also important to provide supervisory staff with training and support to be able to challenge management valuation of collateral or failure to rate an asset as impaired. The process of developing the capacity of supervisors to challenge bank management valuation of loans has started.

Market risk management standards are generally sound and supervisors take an active approach. MaRisk establish the requirements for banks to implement effective risk management frameworks to measure and manage market risk. For the larger more systemic banks with a trading bias, greater supervisory intensiveness and intrusiveness takes place. Market risk has been a focus of the supervisors during 2014 and 2015. In addition, a targeted review of banks’ internal models is planned. Supervisors periodically review banks to assess that their market risk management processes are consistent with the risk bearing capacity and the market risk management framework. Banks with the largest trading books are subject to enhanced focus, while the remaining banks are on a normal cycle based upon their SREP score and risk profile. Assessors observed supervisory practice for both SIs and LSIs and verified compliance with the core principle.

IRRBB has received a significant amount of the supervisor’s attention during the last several years and features as a key priority for both SIs and LSIs. Banks are required to measure, calculate and report their exposure to IRRBB on a quarterly basis. Banks are also required to conduct regular stress testing using both standardized and bespoke scenarios, especially for those banks with more complex business models and optionality in the portfolio. Supervisors make an assessment of IRRBB through the SREP process as well as a key topic in discussions with bank senior management. The German authorities have also conducted short term data collection exercises in the last several years to deepen the understanding of the systems exposure.

Concentration risk and country risk treatment warrant enhancement. The definition of concentration risk is limited to credit exposures, and not in a broader sense including different types of exposures. The expectations of the supervisors with respect to concentration risk and country risk management are not clearly communicated to the banks. There is no requirement that all material concentrations to be regularly reviewed and reported to the bank’s supervisory board. Reporting and monitoring of country risk and concentrations can be improved, and their inclusion in banks’ stress tests specifically required.

The framework for transactions with related parties is weak, although the definition of related parties is wide and detailed. The framework covers loans in a broad definition that includes off-balance sheet exposures and leasing operations, albeit not dealings such as service contracts, asset purchases and sales, and construction contracts. Related party loans must be granted on market terms, but there is no requirement that individuals with conflict of interest are excluded from the whole process of granting and managing such exposures. There is no requirement that related party exposures are monitored and controlled separately or in aggregate. There is no regular reporting of exposures to related parties. Supervision of related party risk is mostly carried out to external auditors, whose analysis of related party risk is very limited. No limits on related party are imposed by laws, regulation, or the supervisor.

Supervisors have stepped up the frequency and intensity of interaction with credit institutions regarding their management of liquidity risk, contingency plans and funding requirements. Supervisors have built-up in-depth understanding of liquidity funding risks at individual institutions, they periodically meet with treasury staff and receive monthly monitoring of LCR data. Funding plans and results of stress testing are reported and evaluated periodically. The LCR adopted in EU has a number of elements that are less stringent than the Basel agreed rule, most notably wider definition of HQLA. German banks make use of the wider definition of HQLA, mainly of covered bonds included as Level 1 assets. Guidance for assessing Internal Liquidity Adequacy Assessment Processes (ILAAP) will be implemented for 2016 which will help strengthen the assessment of liquidity risk management as part of the SREP. To this regard, SSM issued a letter in the beginning of the year on Supervisory expectations on ILAAP and harmonized information collection on ILAAP to enhance the analysis of ILAAP and its integration in the SREP. Benchmarks for liquidity risk indicators will be developed during 2016.

While operational risk has undergone several enhancements since the last FSAP, more attention is needed to ongoing monitoring of the effective implementation of operational risk management frameworks. Dedicated IT risk specialists mainly conduct onsite examinations but also develop supervision approaches for IT risk more generally. This team has been successful at deepening the institutional knowledge of IT risks and vulnerabilities and identifying where standards need to be raised. The most recent example is in the area of data centers where IT risk specialists have attended DR testing for several of the larger LSIs.

The independence of the internal audit and compliance is undermined as they report to the management board. The internal audit function, as an instrument of the management board, is under its direct control and has to report to management board members. The internal auditor can also be subject to the direct control of one management board member, who should, if possible, be the chairperson. Additionally, the supervisory board is only informed of a replacement of the internal auditor, compliance officer and risk officer ex-post.

Banking supervisors do not have legal power to access external auditors’ work papers. Although this is not an essential requirement, Germany chose to be assessed against the best international practices, and given the heavy reliance on external auditors for reviewing not only the reliability of financial statements but also reporting on whether the banks comply with all risk management guidelines, this gap should be addressed.

Overall, the AML/CFT framework appears strong, but some weaknesses remain, mainly in supervisory practices. BaFin has established a risk-based framework to discriminate banks’ risk profiles and exposure to risks from AML/CFT. The framework is designed to help identify those institutions where enhanced monitoring and attention is required. While the framework should help focus supervisory attention on the highest risk institutions, inputs into the process need to be refined to be fully risk-based. The framework is heavily reliant on the EA report to identify deficiencies or weaknesses in risk management. Ongoing monitoring of banks’ compliance with the regulations needs to be more systematic through the ongoing receipt of a range of inputs. Lastly, coverage of the banking sector through onsite examinations needs to be expanded.

Appendix Table 1 offers a principle-by-principle summary of the assessment results, while recommendations to improve compliance with the BCPs are summarized in Appendix Table 2.

Appendix Table 1.

Summary Compliance with the BCPs

article image
article image
article image
article image
article image
article image
Appendix Table 2.

Recommendations to Improve Compliance with the BCPs

article image
article image
E. Authorities’ Response to the BCP Assessment
a) German Authorities’ Response

The German authorities wish to express their appreciation to the IMF and its assessment teams for this assessment since they strongly support the Financial Sector Assessment Program, which promotes the soundness of financial systems in IMF-member countries and contributes to improving supervisory practices around the world.

The German authorities appreciate the assessment in general. Some clearly unsatisfactory ratings are considered as an encouragement to critically reflect current supervisory practices and to make changes and adjustments where appropriate.

However, there are a number of recommendations where the German authorities believe that the current regime effectively fulfils the IMF’s requirements. These are set out below:

The following comments are ordered in the sequence of the DAR text (factual corrections):

Licensing, qualifying holdings and major acquisitions (CPs 5-7)

Regarding Principle 5 the German authorities want to point out, that although the assessment of the members of the supervisory board is not explicitly a part of the licensing procedure the appointment of any member of the supervisory board undergoes an assessment process by the competent supervisor. According to section 25d (1) of the German Banking Act [Kreditwesengesetz – KWG], the members of the supervisory board of an institution, a financial holding company or a mixed financial holding company must be trustworthy, have the necessary expertise to fulfil their control function as well as to assess and monitor the business of the undertaking, and devote sufficient time to performing their duties. Pursuant to section 36 (3) sentence 1 KWG BaFin is entitled to force a bank to withdraw a member of the supervisory board which does not fulfil these standards. According to section 25d (2) KWG the supervisory board as a whole shall have the necessary knowledge, skills and experience to fulfil its control function as well as to assess and monitor the management board of the institution, group of institutions or financial holding group, financial holding company or mixed financial holding company.

Regarding Principle 5 and 6 the authorities want to point out that BaFin has published Guidelines regarding the licensing procedures, qualifying holding procedures and the assessment of managing directors and members of the supervisory board. The Guidelines regarding the licensing procedures that were published in 2007 and especially the Guidelines regarding the assessment of the managing directors and the members of the supervisory board which were published for the first time in 2012 and 2013 contain passages regarding the term “trustworthiness” and provide an overview of the standards applied by BaFin in so far. The Guidelines regarding the assessment of managing directors and members of the supervisory board which were revised in 2016 will be published in English shortly as well.

Regarding Principle 7 the authorities are convinced that although German legislation does not provide for the authority to ex ante review and (dis)approve such participations the qualification as materially non-compliant is not justified. Firstly, Article 89 Capital Requirements Regulation [CRR] is directly applicable in Germany and in so far Germany does not see the possibility to apply a stricter approach than the one set out in directly applicable Union law. Secondly, in our view the acquisition of participating interests outside the financial sector is a business decision in which the supervisor should not intervene. The potential risks stemming from an institutions’ acquisition and investment policies are sufficiently limited by quantitative limits and by the fact that the institutions’ managers are responsible and accountable for the handling and monitoring of the institutions’ risks which includes acquisitions and investments. The managers’ performance in turn is subject to review by auditors and supervisory interventions in case the requirements are breached. Thirdly, the qualifying holding procedures also apply for significant participations in insurance companies according to section 17 of the German Act on the Supervision of Insurance companies [Versicherungsaufsichtsgesetz - VAG] and other financial services institutions (i.e. investment firms) according to section 1 (1a), (2) KWG. The requirement of a pre-approval by the competent supervisor for any significant participation in one of these regulated entities also applies if the proposed acquirer is a bank.

Supervisory reporting (CP 10)

The authorities cannot agree with the overall assessment. Taking into account their entire supervisory environment, their experience with the information available and their capacity to react if necessary promptly on banks’ situations which are not satisfactory the isolated assessment of Principle 10 is too harsh and should be upgraded. Moreover, we would like to emphasize that the assessment does not take future developments into account. According to the ECB regulation 534/2015 which further elaborates Regulation (EU) 680/2014 the required information will be available next year.

Corporate Governance (CP 14)

On Principle 14, Corporate Governance, on basis of its findings the IMF concludes that the following actions are needed to strengthen the role of the supervisory board:

  • Supervisory guidance should clearly state that ultimate responsibility for establishing the risk culture, developing business plans and risk appetite statement rests with the supervisory board.

  • Supervisory enforcement and sanctioning programs should explicitly address supervisory board member liability.

  • The knowledge/experience requirements for supervisory board members should be commensurate with the complexity of the bank.

  • Reporting to the board should be frequent and with sufficient detail to enable the board members to challenge management.

  • Banking supervisors should continue to increase dialogue and discussions with the supervisory board on results of supervisory activities and concerns.

Reference has been made to BCP standards, requiring increased emphasis on the role of the supervisory board’s oversight of management and the institution. According to paragraph 6, page 2, of the Basel Principles for enhancing corporate governance of October 2010, insufficient board oversight of senior management, inadequate risk management and unduly complex or opaque bank organizational structures and activities failures and lapses were one of the reasons for the financial crisis that began in mid-2007. For this reason, Principle 1 of the Basel Principles for enhancing corporate governance of October 2010 states, that “The board has overall responsibility for the bank, including approving and overseeing the implementation of the bank’s strategic objectives, risk strategy, corporate governance and corporate values. The board is also responsible for providing oversight of senior management.”

Also Principle 1 of the Basel Corporate Governance Principles for banks, published July 2015, requires that “the board has overall responsibility for the bank, including approving and overseeing management’s implementation of the bank’s strategic objectives, governance framework and corporate culture.”

However, neither the above cited guidelines nor the BCP address the “supervisory board” in specific but the “board” in general, which is defined, according to Basel Corporate Governance Principles for banks of July 2015 as,

“The body that supervises management. The structure of the board differs among countries. The use of “board” throughout this paper encompasses the different national models that exist and should be interpreted in accordance with applicable law within each jurisdiction.”

Footnote 27, page 25 of BCP states that the BCP” […] refers to a governance structure composed of a board and senior management. The Committee recognizes that there are significant differences in the legislative and regulatory frameworks across countries regarding these functions. Some countries use a two-tier board structure, where the supervisory function of the board is performed by a separate entity known as a supervisory board, which has no executive functions. Other countries, in contrast, use a one-tier board structure in which the board has a broader role. Owing to these differences, this document does not advocate a specific board structure. Consequently, in this document, the terms “board” and “senior management” are only used as a way to refer to the oversight function and the management function in general and should be interpreted throughout the document in accordance with the applicable law within each jurisdiction.”

Also, paragraph 7 of the Basel Principles for enhancing Corporate Governance of October 2010 points out that “the application of corporate governance standards in any jurisdiction is naturally expected to be pursued in a manner consistent with applicable national laws, regulations and codes.” Paragraph 15 of the Basel Corporate Governance Principles for banks of July 2015 states that the Principles are “intended to guide the actions of board members, senior managers, control function heads and supervisors of a diverse range of banks in a number of countries with varying legal and regulatory systems, including both Committee member and non-member jurisdictions. The Committee recognizes that there are significant differences in the legislative and regulatory frameworks across countries which may restrict the application of certain principles or provisions therein. Each jurisdiction should apply the provisions as the national authorities see fit. In some cases, this may involve legal change. In other cases, a principle may require slight modification in order to be implemented.”

Against this background we would like to point out that the German two tier structure differs from the one tier structure. However, the abovementioned Basel principles in general and especially the BCP 14 requirements have been fulfilled.

As regards the responsibilities of both boards, it seems that the interaction between the management board and the supervisory boards and the full range of the supervisory board’s tasks and powers in German banks have not been made sufficiently clear yet.

The German two-tier system allocates the board’s responsibilities in two institutionally independent bodies, the management board, which has the direct responsibility for the management of the company, including the exercise of management control over the lower hierarchical levels, and the supervisory board, which in turn supervises the management activities of the management board. The basic idea is to separate the supervision in an own body, which is staffed and functionally separate from the management board, namely the supervisory board. The aim of this separation of responsibilities is not only to prevent that management responsibilities become so extensive that there is not enough room for the monitoring responsibilities, but also to avoid an involvement of the supervisory board members in management decision-making and accordingly as a final consequence the need to monitor themselves with all resulting potential conflicts of interest. The clear separation of management and supervisory responsibilities as well as the independence of the supervisory board members are major advantages of this system. Requiring an ultimate responsibility for establishing the risk culture, developing business plans and risk appetite statement rests with the supervisory board would contravene this separation.

The role of both, the management board and the supervisory board, is not only governed by supervisory law, i.e. the KWG, but to a large extent subject to the respective company law. In order to facilitate a better understanding of the German two-tier structure and especially the role of the supervisory board, the main responsibilities and powers are outlined below (where governed by company law, using the public limited company (Aktiengesellschaft) as an example).

With respect to the management board, we firstly refer to our explanations in the Preliminary remarks of the German specific part of the Detailed Self-Assessment on BCP 14. Furthermore, we would like to emphasize the fact that due to corporate law it is the management board which has to manage the company on its own responsibility (sec. 76 German Stock Corporation Act [Aktiengesetz – AktG]). This means on the one hand performing the management tasks - or in other words the leadership tasks - and on the other hand bearing the ultimate management responsibility. In its leadership function, the management board is not limited to performing day-to-day management, but also responsible for developing the corporate strategy as well as determining the corporate policy and ensuring their implementation (cf. sec. 4.1 of the German Corporate Governance Code (GCGC); cf. also sec. 25c KWG). The tasks of the management board also encompass the exercise of management control in the sense of ongoing and subsequent monitoring of the performance and success of delegated management tasks. Concerning the latter, the main responsibility of the supervisory board is normally to assess whether such delegation is appropriately organized, e.g., whether the responsible individuals are properly selected and sufficiently monitored by the management board.

With regard to the qualifications of the supervisory board members, we would like to refer to BCP 14, EC 4, German specific part, and to highlight the fact that, when assessing whether a member of the supervisory board has the necessary expertise, the scope and complexity of the business conducted by the institution, group of institutions or financial holding group, financial holding company or mixed financial holding company has to be taken into account (sec. 25d para. 1 sentence 2 KWG). We also refer once more to BCP 14, EC 9, German specific part, with special regard to corrective measures against supervisory board members.

As already said in the preliminary remarks of the German specific part of the Detailed Self-Assessment on BCP 14, the main responsibility of the supervisory board is the supervision of the management board. For credit institutions, sec. 25d para. 6 KWG specifies that the supervisory board shall oversee the management board, also with regard to its adherence to the applicable prudential supervisory requirements, and shall devote sufficient time to the discussion of strategies, risks and remuneration systems for management board members and employees. Credit institution specific responsibilities also follow from sec. 25d para. 7-12 KWG, where the tasks of the supervisory board’s committees are laid down.

For the purpose of supervising the management board, the supervisory board has quite significant powers:

  • The supervisory board is responsible for the appointment and dismissal of members of the management board (sec. 84 AktG), including the service agreement and its termination, the compensation of each management board member (cf. sec. 25d (12) KWG in accordance with sec. 3 (2) Remuneration Ordinance for Institutions [Institutsvergütungsverordnung – InstitutsvergVO]) as well as the representation of the company vis-à-vis the members of the management board (sec. 112 AktG). Where necessary, the supervisory board has to consider and to pursue claims for damages against members of the management board (cf. sec. 116, 93 AktG). Corresponding to the liability of the members of the management board, supervisory board members can also be held liable personally for damages in case of infringements of their duty of care (sec. 116 AktG).

  • The management board is subject to comprehensive regular and case-specific reporting obligations vis-à-vis the supervisory board (sec. 90 AktG). In addition, the supervisory board may require at any time further reports from the management board on the affairs of the company (sec. 90 para. 3 AktG). It may also inspect and examine the books and records of the company as well as the assets of the company, in particular cash, securities and merchandise (sec. 111 para. 2 AktG). A specificity for all credit institutions is the right of the chairs of the risk committee and the audit committee, or, if such committees have not been established, the chair of the supervisory board, to make direct enquiries to both the head of the internal audit function and the head of the risk control unit (sec. 25d para. 8 and 9 KWG). Correspondingly, the chair of the remuneration committee (or the chair of the supervisory board) may make direct enquiries to both the head of the internal audit function and the heads of the organisational units responsible for the structure of the remuneration systems (sec. 25d para. 12 KWG).

  • Within the scope of its supervising function, the task of the supervisory board is also to advise the management board in the management of the enterprise regularly. The supervisory board must be involved in decisions of fundamental importance to the enterprise. (cf. sec. 5.1.1 GCGC)

  • The supervisory board shall instruct the auditor as to the annual financial statements and consolidated financial statements according to sec. 290 of the Commercial Code (sec. 111 para. 2 sentence 3 AktG). It shall itself examine the annual financial statements, the annual report and the proposal for appropriation of distributable profit and shall report on the results of its examination in writing to the shareholders’ meeting (sec. 171 AktG). The annual financial statements shall be deemed to have been approved, upon approval thereof by the supervisory board, unless the management board and the supervisory board resolve that the annual financial statements are to be approved by the shareholders’ meeting (sec. 172 AktG).

  • While it is explicitly stipulated that management responsibilities may not be conferred on the supervisory board, the articles of association or the supervisory board have to determine that specific types of transactions may be entered into only with the consent of the supervisory board (sec. 111 para. 4 AktG).

  • The supervisory board shall call a shareholders’ meeting whenever the interests of the company so require (sec. 111 para. 3 AktG), e.g. to achieve a vote of no confidence by the shareholders’ meeting in order to revoke the appointment of a member of the management board.

  • The strategies and, where applicable, adjustments to the strategies shall be brought to the attention of and discussed with the institution’s supervisory board (guidance provided by AT 4.2 para. 5 Minimum Requirement for Risk Management [MaRisk], an administrative regulation issued by BaFin).

  • Risk management creates a basis for the proper performance of the supervisory board’s monitoring functions and thus shall also include the adequate involvement of the supervisory board (guidance provided by AT 1 para. 1 MaRisk).

Against this background, we would like to emphasize that the management board is the right body regarding the reporting lines of the control functions. All control functions are instruments of the management board due to its responsibility to manage the company on its own responsibility. Therefore, the control functions report directly to the management board. The management board, then again, is obliged to report to supervisory board. This reporting line does not mean that risk reporting to the supervisory board is influenced in an unduly manner. Firstly, the control functions are clearly (up to and including management board level) segregated from the operational functions (front office) to enable the control functions to monitor and report on risk issues independently from divisions where risks may arise. Secondly, it is not up to the management board members to decide about form and extent of the information provided by the control functions. German supervisors have the clear expectation that reports to the supervisory function are identical or at least coextensive to those that are provided to the management board in order to ensure the same level of information for the supervisory board and the management board (please see also responses to BCP 15).

However, to a certain extent reporting lines of the control functions to the supervisory board are also in place. As already mentioned above, the supervisory board has direct access to the heads of control functions, namely the CRO and the head of internal audit. According to sec, 25d (8) KWG), the chair of the risk committee, and if no risk committee has been established, the chair of the supervisory board, may make direct inquiries to the head of internal audit function and the head of risk control unit. The management board shall be informed thereof. The same applies to the chair of the audit committee and the head of supervisory board if an audit committee has not been established, according to sec. 25d (9) KWG.

Specific guidance regarding reporting requirements to the supervisory board are also laid down in the MaRisk. According to the guidance provided by AT 4.4.2 para. 6 MaRisk, the reports of the compliance function shall (next to the primary reporting line to the management board) additionally be passed to the supervisory board. Additionally, according to the guidance provided by BT 2.4 para. 4 of MaRisk’s amended version, the Internal Audit function has to write an overall report on its performed audits on a quarterly basis and provide them to both, the management board and the supervisory board. Regarding the reporting obligation of the risk management function, please see the comments regarding the preliminary assessment of BCP 15.

Regarding remuneration topics, the chair of remuneration committee or, if a remuneration committee has not been established, the chair of the supervisory board may make direct inquiries to the head of the internal audit function and the heads of the organizational units responsible for the structure of the remuneration systems. The management board shall be informed thereof according to sec. 25d (12) KWG.

In this regard, it is important to point out, that all members of the respective committees are only supervisory board members; no management board member is included.

Regarding the assessment that “Banking supervisors should continue to increase dialogue and discussions with the supervisory board on results of supervisory activities and concerns” we do not understand on which basis this assessment has been made. We believe that the dialogue between the German banking supervisors and the respective institution’s bodies is commensurate with the role of each board.

Consequently, we do not think that the findings made by the IMF are sufficiently justified. Considering the content of the Basel Core Principles, we are convinced that the requirements relating to the “board” are addressed correctly against the background of the German two-tier system.

Therefore, we are convinced that the German system is compliant with the requirements of Principle 14.

Prudential Requirements, Regulatory Framework, Accounting and Disclosure (CPs 15-29)

Comment on the Assessment of BCP 15 Risk management process: We do not share the view of the IMF that the existing dual system of the legal structure in German companies and banks (strict separation of the management board and the supervisory board) and the resulting implications for their tasks in Germany leads to a weakening of independence of the control functions (risk management function, compliance function, internal audit function) within the institutions in general and with regard to the risk management function in particular. The responsibility of the supervisory board according to German company law is clear: it is in the responsibility of the supervisory board to observe and monitor the business management of the management board. Furthermore, the supervisory board must not perform business management tasks. This fact implies some modifications concerning the reporting requirements (reporting lines) and the organisational and operational structure in which the risk management function is embedded. For more details concerning the specific role of the supervisory board and the resulting implications see response to BCP 14.

To begin with, it has to be emphasized that all control functions, including risk management function, are instruments of the management board (due to their responsibility for the business management) and therefore organizationally subordinated to the management board. This is why the risk management function reports initially to the management board. The fact that it is in the responsibility of the management board (not automatically the CEO but usually the CRO – when the CRO is member of the management board, as it is the case in the most largest institutions in Germany – or the management board member where the risk management function is subordinated) to report to the supervisory board (at least quarterly) does not mean (and should not lead to the conclusion) that risk reporting to the supervisory board could be influenced in an unduly manner. Two facts in this context are particularly important: Firstly the risk management function is clearly (up to and including management board level) segregated from the operational function (front office) to enable this function to monitor and report on risk issues independent from those divisions of the institution where risks arise. Secondly, it is not left to the discretion of the management board members in what form and to what extent risk related information is reported to the supervisory board. German supervisors have the clear expectation (and review if these expectations are met by institutions, especially in the context of onsite inspections) that risk reports to the supervisory function to be identical or at least coextensive to those which are presented to the management board in order to ensure the same level of information for the supervisory board and the management board. The compliance with this requirement are reviewed during ongoing supervision and on-site inspections.

In addition, the chair of the supervisory board (or the chair of the audit committee if such a committee exists, see also section 25d (9) KWG in connection with section 25d (7) KWG) has direct access to the head of the risk management function and can call for further information. The fact that the management board shall be previously informed is a direct implication of the organisational and disciplinary subordination of those staff members and does not imply that the chair of the supervisory board cannot discuss with the head of risk management in confidence (without presence of a management board member). Please note that large institutions are required to implement the head of risk management function exclusively on management board level (“CRO”). In those cases the CRO has always the access to supervisory board (and vice versa) at all times.

For these reasons it is sufficiently ensured that the risk management can act independently and can provide both management board and supervisory board with risk information without any influence of the management board.

With regard to the required notification of the supervisory board in cases where the head of the risk management function is removed (for removals of the head of compliance and head of internal audit there are identical requirements; see guidance provided by AT 4.4.1, AT 4.4.2, AT 4.4.3 MaRisk) we would like to point out that this notification is not only required ex-post but a sufficient time before the removal in order to enable the supervisory board to discuss those issues with the management board. German supervisors have addressed this topic in the draft of a revised version of the MaRisk (consultation process was opened in February 18th 2016) and will amend the respective sections of the MaRisk to make clear that the notification has to be given due in advance and under specification of the reasons of the removal.

Comment on Assessment of Principle 18: Based on the experience and the results of AQR from 2014, BaFin is aware that there has to be a stronger focus on questions in terms of valuation. For that reason, BaFin established a new division, BA 53, Financial Accounting and Valuation Practices, with the task to get a better understanding of the institutions’ valuation practices, the underlying assumptions and the calculation of provisions.

In this way, BaFin aims for a deeper insight into the institutions’ processes and their valuation methods to discuss the institutions’ appraisals in terms of a prudential perspective. Based on the various banking practices, a guidance for the supervisor might be a helpful tool. Nevertheless, a conflict with existing accounting legislation should be avoided. In this regard, the new division will explore a possible balanced way forward. Nevertheless, we expect that challenging the institutions results and comparisons might lead to an increase of quality of valuation methods and its results.

Additionally BaFin and BBK implemented a supervisory approach for LSI in 2015 (PAAR – Prudential Assessment of Adequate Risk-Provisioning) and set up a supervisory training program which was enrolled in 2015. Regarding that it is a completely new inspection approach for BBK there are no public issued guidelines yet, however there are comprehensive internal guidelines for inspectors available. This safeguards to keep room for adjustments in this early stage of this new inspection approach.

On SSM-level there is an on-site methodology for credit risk available and detailed information for loan valuation and provisioning are yet to be finished.

Regarding Principle 19 we would like to point out that the CEBS Guidelines on the management of concentration risk under SREP (GL 31) still are applicable and establish a framework on the EU level which relates to Art. 81 Capital Requirements Directive [CRD]. Without explicit mentioning the definition of these Guidelines, all aspects referred to in the Core Principle as footnote are covered. At the same time, the definition is congruent with the guidance provided by the MaRisk (see AT 2.2, para Annotations).

Furthermore, the MaRisk definition of intra-risk concentrations includes market-risks aspects (market, currencies) as well as funding risk concentrations. The requirement to analyse regularly the access to relevant refinancing - even in the event of tight markets - clearly points in this direction (BTR 3.1. Tz. 4).

Regarding the regular review of all material concentrations by a bank’s supervisory board we cannot agree with the statement that there is no such requirement: MaRisk do require a special reporting about risk concentrations and their potential consequences (see AT 4.3.2., para 4). Besides, according to AT 4.3.3 para 1 stress tests have to be extended on risk concentrations. The results of the stress tests have to be reported as well and shall therefore cover the assumed risk concentrations additionally.

According to the guidance provided by BTR 1 para 7a MaRisk the risk report on credit risk has to contain information regarding the development of the credit portfolio. Risk concentrations as well as large exposures (Para 7b) have to be considered. The risk reports are generally sent via the management board in identical or at least coextensive form to the supervisory board so it is ensured that the supervisory board gets the same information as the management board in a timely manner.

Regarding Principle 20 the statement that there is no regular reporting of exposures to related parties is correct, but it doesn’t mean that German supervisors never obtain information on loans to related parties. According to section 34 (2) No. 4 of the Audit Report Regulation [Prüfungsberichtsverordnung – PrüfbV], stricter (single-loan-based) reporting requirements apply where loans to related parties must be regarded as noteworthy because of their size or the way they are structured or because indications of conflicts of interests occur. Furthermore, in case of reaching or exceeding certain thresholds (large loans according to section 14 KWG and large exposures according to Article 394 CRR), exposures to related parties have to be reported to the supervisor, too.

In addition, granting exposures to related parties is part of the institution’s credit granting and surveillance process. Therefore, not only section 15 of the KWG, which, among other things, defines transactions with related parties and regulates the unanimous decision by all general managers of the institution in advance of the credit granting, but also all the other provisions as section 18 KWG or the guidance provided by the MaRisk have to be respected. Consequently, related party exposures have to be monitored and controlled and there is no need for a separate regulation in this context.

Even if there is no separate legal limit for exposures with related parties, the large exposure limit according to Article 395 of the CRR is applicable. Besides, according to section 15 (2) KWG, BaFin can impose limits on exposures to related parties on a case by case basis.

Finally, regarding the definition of related party transactions or the relevant provision, the supervisor can always decide on a case by case basis if there are some doubts.

Regarding Principle 21 we have difficulties in understanding the basis for your assessment that banks would have little guidance on country risk. Country risk as part of credit risk is subject to the guidance provided by MaRisk standards to credit business like “normal” credit risk. Country risk includes an economical and a political aspect which of course has to be analysed. According to BTO 1.2 para 3 MaRisk all important aspects of a credit engagement have to be fleshed out (not only at the time of the granting of the loan but also during the ongoing monitoring), whereby country risks are to be considered in an appropriate way. The bulk of German banks operate regionally and are usually not engaged in foreign exposures (with the exception of some EU sovereign bonds) so that country risk is rather in exceptional cases an essential risk in the LSI-context. According to the national Guidelines on the supervisory assessment of bank-internal capital adequacy concepts (published in December 2011) unrealised losses in relation to hidden burdens which have occurred with European sovereign bonds in the near past must be considered.

In addition, reporting requirements regarding country risk follow from the guidance provided by BTR 1, para 7 MaRisk: according to lit. a information must be given on the development of the credit portfolio, inter alia broken down by countries. If significant positions with country risk exist, a special presentation of these risks is necessary (see para 7c).

Finally, regarding the verification of internal limits we would like to mention that auditors of Bundesbank also examine the limit system in the context of their audits and whether country risks are appropriately taken into account and limited, of course (the guidance provided by MaRisk emphasizes that country risks as part of the credit risk have to be regarded). However as mentioned above, this is a rather exceptional case with LSIs as most LSIs don’t have significant country risks.

Regarding Principle 25: We disagree with the classification because it is not clear where Germany does not comply with the Basel framework.

We agree that there might be room for improvements, which is always the case. But the benchmark has to be the BCP requirement and not what seems to be desirable.

However, we do not agree that the findings justify a verdict of material non-compliance. The Basel text is fully covered by the CRR and the guidance provided by the MaRisk. OpRisk management, disaster recovery and BCP are regular topics of bank examinations, in dedicated operational risk audits as well as in examinations with a broader or different scope where it is implicitly covered. As a material risk, operational risk is covered by the guidance provided by MaRisk examinations by default. It is also touched upon in market and credit risk examinations where boundary issues are concerned. Moreover, in our opinion some of the requests of the IMF assessors went beyond what the Basel text asks for. We would therefore like to ask for clarification on the conclusion of the assessors. For any details with respect to the individual ECs, please refer to our statements below.

Concerning the findings of EC1, Bundesbank has both supervisors dedicated exclusively to operational risk as well as quantitative and qualitative experts with a lot of experience on operational risk examinations. Bundesbank furthermore offers in-house trainings for supervisors on operational risk that covers both regulation and presentations from bank practitioners.

Concerning the findings of EC3, we disagree that the use test does not receive sufficient attention during AMA examinations. AMA banks are thoroughly examined before given accreditation and the monitoring of KRIs and other risk management instruments is part of our ongoing supervision. The four elements of an AMA and their use are also an explicit part of AMA first-time inspections and a common part of follow-up inspections. In the past, AMA examinations have rendered 12 findings with respect to the integration of the AMA into day-to-day management and an additional 36 findings with respect to the four data elements.

While a benchmarking of losses is currently not performed by Bundesbank, such an exercise is in progress by ECB (DG IV). Please be mindful that the (desirable) supervisory collection of loss data for BIA-banks would exceed BCBS requirements. We agree that a cross-sector analysis of operational risks is not performed; however, this is not envisaged by the Basel text either. We also see no basis for such an analysis as the Basel text does not require small banks to systematically collect loss data and we consider the BIA capital requirement to be not risk sensitive enough to allow for comparisons.

The assessors criticize that the frequency, scope and depth of operational risk examinations could be enhanced. In the past we have had dedicated operational risk exams for large banks, which have each lasted several weeks with teams of more than 6 people. While the frequency of follow-up AMA assessments varies from bank to bank, our largest bank is examined on at least a yearly basis. All other banks that do not have an approved AMA are regularly examined for compliance with BTR 4 MaRisk, which regularly results in findings with regard to the banks’ operational risk management. In total, MaRisk examinations have yielded more than 90 operational risk findings since 2013. We are hoping for a statement from the assessors what is considered an adequate frequency, scope and depth for operational risk examinations.

Concerning EC4, the assessors state that there are “no provisions within the regulations to establish minimum expectations with respect to testing, review and approval by board of DR and BCP plans.” However, the German banking act clearly states in section 25a that “risk management shall comprise, in particular, (…) the definition of an adequate contingency plan, especially for IT systems.” Further in section 25c, the banking act states that “As part of its overall responsibility to ensure a proper business organization of the institution pursuant to section 25a (1) sentence 2, the management board of an institution shall ensure that the institution has in place the following strategies, processes, procedures, functions and frameworks:

adequate contingency plans pursuant to section 25a (1) sentence 3 number 5 for contingencies affecting time-critical activities and processes; as a minimum, the management board shall ensure that regular contingency tests are carried out in order to verify the suitability and effectiveness of the contingency plan and the results are communicated to the respective responsible staff.” Between 2012 and 2014, Bundesbank has conducted more than 50 audits with a focus on DR and BCP (MaRisk AT 7.3) that have resulted in 71 findings.

The assessors also criticize that in relation to DR and BCP, the MaRisk contains high level guidance and does not prescribe minimum standards for the frequency, scope or nature of DR and BCP testing and that banks are obliged to follow industry standards instead. In addition, the assessors criticize that there is scope for the JST to pay greater attention to the assessment of DR and BCP planning and the results of DR tests. In addition to the banking act and the MaRisk which are more principle based, it should be mentioned that all Bundesbank supervisors are given guidelines on how to examine DR and BCP and that we have done roadshows and in-house training to create awareness for this topic. Furthermore, industry standards are not only defined by regulators but also by independent bodies such as the federal office for information security (BSI) which sets ISO norms among others.

Regarding EC6, the assessors criticize that loss data from AMA SI banks should be collected and compared. Once again, we reference to the on-going SSM exercise. It should also be noted that large loss events are discussed with JSTs on a regular basis and that management awareness is created through the regular reporting of operational risk losses and scenarios. While a cross-sector comparison for Germany might seem desirable, we still see no legal basis to ask this from the supervisors.

It is also not correct that MaRisk does not contain a level of specificity for the collection and classification of operational risk data. MaRisk specifically states in its BTR 4 that “It shall be ensured that any material operational risk is identified and assessed at least once a year.” The upcoming revisions of the MaRisk guidance will also include the requirement to use loss databases.

In total, further clarification where exactly Basel rules are violated would be useful so we can further improve our supervisory approach.

Regarding the assessment of BCP 26, we would like to refer to the comments regarding the assessment of BCP 14 and 15.

In addition, we would like to point out, that in contrary to the statements in the assessment, the internal audit function and the compliance function have alternative reporting lines to the supervisory board.

According to sec. 25d (8) and (9) KWG, the chair of the risk committee and internal audit committee respectively or, if the respective committee has not been established, the chair of the supervisory board may make direct inquiries to the heads of the both control functions. Additionally, according to the guidance provided by BT 2.4 para. 4 of MaRisk’s amended version, the Internal Audit function has to write an overall report on its performed audits on a quarterly basis and provide them to both, the management board and the supervisory board.

Since the internal audit function is an instrument of the management board, the function is obliged to report directly to this body in the first instance (BT 2.4 MaRisk). However, if management board members might be involved, the internal audit function has to report directly to the supervisory board. According to BT 2.4 para. 5 MaRisk, in case the audit reveals serious findings concerning members of the management board, the internal audit function shall inform the chair of the supervisory board if the management board fails to meet its reporting obligation or if it fails to adopt appropriate remedial measures.

As already pointed out in the comments to BCP 14, the compliance function is also an instrument of the management board regarding the specific responsibility of this body. For this reason, the compliance function has to report to the management board directly. But in addition, according to the guidance provided by AT 4.4.2 para. 6 MaRisk, the reports of the compliance function shall additionally be passed to the supervisory board (and the internal audit function).

Finally, we do not share the view that the supervisory board is informed of a replacement of the internal auditor, compliance officer and risk officer ex-post only. According to the guidance provided by MaRisk, the supervisory board shall be notified, if the head of the risk control function (AT 4.4.1 para. 5) and the compliance officer (AT 4.4.2 para. 7 MaRisk) and the head of internal audit function (AT 4.4.3 para. 6 MaRisk) respectively is replaced. It is clearly not required to provide any of this information ex-post but instead in a sufficient time before the removal so that the supervisory board is able to discuss these issues with the management board. The draft of the revised version of the MaRisk (consultation process was opened in February 18th 2016) will be clearer in this regard. In future, if the head of the risk control function (AT 4.4.1 para. 6 revised version) and the compliance officer (AT 4.4.2 para. 7 revised version) and the head of internal audit function (AT 4.4.3 para. 6 revised version) respectively is replaced, the supervisory board shall be notified in advance in a timely manner, stating the reasons for the replacement.

Therefore, we are convinced that Germany is compliant with the BCP 26 guidelines.

b) ECB’s Response

The ECB welcomes the assessment prepared by the IMF based on the “Basel Core Principles (BCP) for Effective Banking Supervision” in the context of the Germany FSAP. In general, the ECB concurs with the views expressed in the report, as they generally reflect in a very balanced and thoughtful manner the reality of the SSM and take due account of the complexity of the matter. The ECB highlights the excellent cooperation with the IMF mission team and the German authorities all throughout the process.

The ECB strongly supports the IMF in its objective to promote globally best supervisory practices via FSAPs, as this is fully in line with the SSM’s objective of ensuring that banks across the euro area are supervised according to the same high standards. More specifically, SSM banking supervision does not have a national focus, but takes a European perspective, allowing the ECB to compare and benchmark banks across institutions and identify problems at an early stage. In addition, it combines the experience and expertise of 19 national supervisors, enabling the ECB to draw on the best national practices. Finally, SSM banking supervision is shielded against undue influence from different stakeholders.

The ECB also welcomes that the report acknowledges that in 2015 the European banking supervision took a great step towards harmonised and unbiased supervision by conducting a euro area-wide Supervisory Review and Evaluation Process (SREP) according to a common methodology. For the first time, all significant institutions in the euro area were assessed against a common yardstick. Quantitative and qualitative elements were combined through a constrained expert judgment approach, which ensured consistency, avoided supervisory forbearance and accounted for institutions’ specificities.

Notwithstanding the general positive view on the report, the ECB considers that the assessment of BCP 25 on operational risk does not fully take into consideration the initiatives undertaken by the SSM, by means of the actions of the Joint Supervisory Teams, to measure and assess these risks in significant institutions. The ECB is of the view that, while recognizing that of course there is still room for improvement, the progress made so far and the initiatives that are still ongoing to improve the supervision of operational risk were not fully recognised in the assessment. Most notably, the SSM supervisory assessment guidance, which, while tailored to more advanced risk management practices as applicable under AMA, in practise also provides BIA banks with guidance on this matter. In addition, operational risk issues are addressed in the specific risk control assessments that are part of the regular supervisory activity of the JSTs. In this regard, for example, questions relating to adequate risk management processes, potential data weaknesses or risks resulting from technical or human errors are covered in JSTs’ assessments not only for operational risk itself but also when analysing credit, liquidity or market risk, as well as in governance risk control assessments.

Regarding the remarks included in the report that there should be more supervisory focus on ensuring reported data quality, including the verification that risk management policies exist and are effectively implemented, the ECB indicates that the JSTs – following the SSM Supervisory manual – undertake quantitative and qualitative assessments to determine respectively the actual level of exposure to this risk and the internal risk controls established by the banks. These assessments are included in the RAS assessment and in the monitoring reports that are produced at least once per year, which are complemented with additional supervisory assessments for AMA banks. In addition, JSTs perform specific assessments, the so-called ‘deep dives’, and cover these issues through on-site inspections.

Finally, it is also worth to be noted that the SSM undertook a number of reviews – notably on CyberCrime, BCBS 239 and cybercrime incident reports – and is currently in close contact with key service providers to assess preparedness to risks related to systemic threats.

The ECB will duly consider the observations and recommendations included in the report to further improve the quality of the SSM banking supervision.

Report on the Observance of Standards and Codes: CPMI-IOSCO Principles for Financial Market Infrastructure

A. Executive Summary

Eurex Clearing observes the CPSS/IOSCO Principles for Financial Market Infrastructures (PFMIs). In particular, it has a sound, coherent, and transparent legal basis. Its governance arrangements and composition of Boards and management are well defined, and the Boards are adequately staffed to promote the safety and efficiency of the central counterparty (CCP) while supporting the stability of the financial system through a conservative approach to risk appetite. It has developed a comprehensive and adequate risk management framework to address financial, business, and operational risks. The participant default rules and procedures are comprehensive and adequate. Participant assets as well as Eurex Clearing’s collaterals are safely kept in regulated central securities depositories and deposited at central banks accounts.

While Eurex Clearing has managed well to cope with volatile markets and strengthened international standards, it is encouraged to enhance some functionalities to further contribute to its soundness and to financial stability. In particular, cross-managerial responsibility at the level of heads of departments should be abolished in order to eliminate the appearance of potential conflict of interest. Moreover, it is crucial to ensure effective business continuity arrangement by strengthening the secondary site with appropriate arrangements in order to allow swaps of operations between the primary and secondary sites on a business-as-usual basis.

The regulatory, supervisory, and oversight framework is comprehensive and effective. The authorities’ objectives, policies, and roles are well defined and made public. Nevertheless, the legal basis in the German law for the Bundesbank’s oversight function over CCPs should be strengthened. Given the increasing systemic relevance of Eurex Clearing as a global CCP at a time where clearing obligations enter into force, enforcement of supervisory and oversight framework can be further improved by being more proactive and increasing the intensity of on-site inspection.

B. Methodology used for Assessment

The assessment of Eurex Clearing against the CPSS/IOSCO Principles for Financial Market Infrastructures (PFMIs) was undertaken in the context of the IMF’s Financial Sector Assessment Program (FSAP) Update for Germany, November 2015.1 Prior to the mission, Eurex Clearing conducted a comprehensive self-assessment following the methodology of the PFMIs published in 2012. The assessors also benefited from discussions with BaFin, the Deutsche Bundesbank, as well as market participants. The assessors also benefited from discussions with ESMA and the European Central Bank (ECB). The mission would like to thank the German authorities, Eurex Clearing management and staff, and other stakeholders for their cooperation and hospitality.

C. Institutional and Market Structure

Eurex Clearing is a global CCP that clears a broad range of both listed and over-the-counter (OTC) products. It offers fully automated and straight-through post trade services to the derivatives markets Eurex Deutschland and Eurex Zürich, the Frankfurt Stock Exchange, the multilateral trading systems of Eurex Bonds GmbH and Eurex Repo GmbH, the Irish Stock Exchange as well as clearing services for OTC interest rate derivatives (EurexOTC Clear), as well as clearing services for transactions in cash equities, bonds, repos, derivatives, secure funding, securities financing and transactions. This comprises a trade management functions, comprehensive risk management services, and collateral management tools.

Eurex Clearing maintains accounts at multiple central securities depositories (CSD) and International CSDs (ICSDs). It reports to the trade repository REGIS-TR in order to fulfill the reporting requirements out of European Market Infrastructure Regulation (EMIR). Eurex Clearing does not have any link to other CCP.

Eurex Clearing serves more than 186 clearing members, located in 17 European countries, at end-2015. As of end-2015, Eurex Clearing processed approximately 1.8 billion transactions with a total value of cleared transactions of EUR 200,949 billion and an average daily value of transactions amounting to EUR 794 billion, and held a Clearing fund of EUR 3.8 billion.

D. Main Findings

Eurex Clearing has a well-founded legal basis, and its governance arrangements and risk management framework promote safety and efficiency, and support financial stability. Its rules, procedures and contracts are clear and consistent with German laws and regulations. It is managed by highly skilled professionals and its Executive Board ensures that major decisions reflect appropriately the interests of its participants and relevant stakeholders. The Executive Board and Supervisory Board are advised by several Committees. Eurex Clearing has a comprehensive risk management framework. It pays considerable attention to identify, monitor, and mitigates its risks. This framework, periodically reviewed by the Executive Board, involves its clearing members in designing its policies and provides various incentives for members to monitor the risk they pose to Eurex Clearing.

Eurex Clearing has established a comprehensive risk management framework for credit and liquidity risks. This framework is based on collateral requirements and credit limits to maintain the credit risk within acceptable parameters and maintains sufficient financial resources to cover losses resulting from the default of the two largest clearing members. To cover its current and future exposures, Eurex Clearing has developed multiple layers of defense, including pre-funded clearing fund, calibrated to cover losses resulting from the default of the two largest clearing members, and a dedicated amount of Eurex Clearing equity.

Eurex Clearing has adequate risk management arrangements and developed comprehensive recovery plan. It developed policies, procedures, and systems to identify, monitor, and manage its business risks, including losses from poor execution of business strategy, negative cash flows, or unexpected and excessively large operating expenses. Eurex Clearing holds sufficient liquid resources to cover potential business losses and sufficient own funds for a winding down or the recovery of its own business during a period of 6 months. Eurex Clearing has developed a comprehensive recovery plan in line with ongoing international best practice aimed at ensuring continuation of critical operations. The plan, which was approved by the authorities, identifies CCP’s critical activities and the measures to be undertaken in order to ensure business continuity of these activities.

Eurex Clearing has effective and sound procedures to reduce custody risk. It has rules and procedures that enable the segregation and portability of positions of a Clearing Members’ customers and the collateral provided to Eurex Clearing with respect to those positions, and publishes the appropriate disclosure document. Furthermore, it assesses the robustness and sound accounting practices, safekeeping procedures, and internal controls that fully protect these assets.

While Eurex Clearing has a robust operational risk management framework, it should strengthen the functionality of the secondary site. Eurex Clearing’s business continuity plan is a group-wide policy covering Deutsche Börse Group. However, the critical services for Eurex Clearing are defined separately, which was approved by the Eurex Clearing Executive Board. Eurex Clearing conducts annually workspace and staff unavailability tests, during business hours. It also involves clearing members, external providers and relevant institutions with which interdependencies have been identified in the BCM Plans in the testing process. In order to ensure the continuity of critical functions, it should establish a fully-fledged secondary site cloning the primary site with appropriate staffing arrangements which would allow swaps of operations between the primary and secondary sites.

Eurex Clearing’s participation is risk based. Market participants are required to have sufficient financial resources and operational capacity to meet their obligations and minimize the risks toward Eurex Clearing. The admission requirements are clearly defined in the Clearing Conditions and available on Eurex Clearing website. Furthermore, Eurex Clearing has in place rules, procedures, and agreements to identify and monitor and manage risks arising from clearing members’ customers.

Eurex Clearing has in place adequate processes for taking into account the needs of its participants and the markets it serves. In particular, it has set up several specialized committees with its market participants as an integral part of its consultation process. It also defined goals and objectives that are measurable and achievable, such as in the areas of minimum service levels, risk management expectations, and business priorities. Moreover, it has clear and comprehensive rules and procedures that are fully disclosed to participants to allow the assessment of their rights, obligations, and related risks.

Eurex Clearing is regulated and supervised by several authorities, including BaFin, the Deutsche Bundesbank, and the Federal Agency for Financial Market Stabilization. BaFin is the regulatory authority responsible for the supervision. Furthermore, BaFin is designated as a National Competent Authority for the supervision of Eurex Clearing, as defined by European Market Infrastructure Regulation (EMIR). According to the German Banking Act, the Bundesbank shall, as part of the ongoing supervision process, conduct off-site and onsite-inspections. As a financial market infrastructure, it is also subject to the Bundesbank’s oversight. In addition, it falls within the scope of the Recovery and Resolution Act. The regulatory and supervisory objectives and policies are clearly defined and publicly disclosed. Eurex Clearing has been recognized by the Swiss authorities as a systemically important FMI to the Swiss market, and an MOU has been signed by BaFin/Bundesbank and the SNB/Switzerland Financial Markets Regulator. In February 2016, Eurex Clearing was approved by the U.S. Commodity Futures Trading Commission (CFTC) as a registered derivatives clearing organization to offer proprietary OTC clearing services to clearing members domiciled in the U.S. The German authorities and the CFTC signed an MOU for cooperation and exchange of information in the supervision and oversight of Eurex Clearing.

Appendix Table 3.

Eurex Clearing Summary Compliance with the CPMI-IOSCO Principles for FMIs—ROSC

article image
article image
article image
article image
article image
article image
Appendix Table 4.

Germany: Prioritized List of Recommendations for Eurex Clearing

article image
article image
Appendix Table 5.

Authorities’ Summary Compliance with the CPMI-IOSCO Responsibilities—ROSC

article image
article image
Appendix Table 6.

Germany: Prioritized List of Recommendations for Authorities

article image
E. Authorities’ response to the CPMI-IOSCO Assessment

The German authorities BaFin, Deutsche Bundesbank, and FMSA, thank the IMF assessment team for their valuable work and detailed study on the application of the CPMI/IOSCO Principles for Financial Market Infrastructures regarding Eurex Clearing.

The German authorities indicate that on 1 February 2016, between the completion of this report by the IMF assessment team and its publication, Eurex Clearing was registered with the U.S. Commodity Futures Trading Commission (CFTC) as a Derivatives Clearing Organization (DCO). Shortly before, on 25 January 2016, BaFin and Deutsche Bundesbank signed a Memorandum of Understanding with the CFTC to enhance the existing supervision arrangements of cross-border clearing organisations.

As a consequence, CFTC, BaFin and Deutsche Bundesbank will cooperate even closer in order to ensure the sound supervision of Eurex Clearing. We envisage a tightened cooperation with the CFTC including but not limited to the exchange of information both on ad hoc basis and upon request, periodic and ad hoc meetings and joint on-site visits.

The German authorities take note of the areas of concern where the IMF identifies room for improvement. With regard to operational risk (Principle 17), the German authorities would like to emphasize that Eurex Clearing has a secondary site with hot backup-arrangements in place. Even though not all members of the business team at the secondary site are present on a permanent basis, the members of the team can be called in on short notice or fulfil their duties via remote access, as appropriate. The German authorities are convinced that these arrangements fully observe the regulatory requirements on operational risk management.

With respect to Responsibility E, the enhanced cooperation with the CFTC will add to the understanding of the foreign regulatory environment both for the German and the US authorities. In addition, Deutsche Bundesbank and BaFin are in close contact with the Monetary Authority of Singapore (MAS), including by meeting in person on a regular basis, with regard to CCP supervision.

In general, the German authorities cooperate closely with other CCP supervisors to strengthen and widen their expertise in CCP-supervision (e.g. Eurex Clearing and LCH. Clearnet Ltd., a CCP supervised by the Bank of England, recently conducted a multi CCP fire drill with the supervisory authorities from the United Kingdom and Germany acting as sponsors).
1

The number of banks has declined by about 100 compared with the time of the last FSAP, with consolidation mainly taking place at local savings and cooperative banks level.

2

The impact on banks depends on their capacity to reprice loans, deposits and non-deposit liabilities, the relative importance of net interest income to profitability, and ability to generate noninterest income. Current negative interest rates may be unique in accelerating margin compression over time as German banks have a large deposit base and have so far proven unwilling or legally unable to pass on the negative rates to depositors, while mortgage loans started repricing to lower rates. See IMF (2016), “Global Financial Stability Report,” April 2016, Chapter 1, Box 1.3 for a discussion on broader effects of low and negative interest rates on banks.

3

See Technical Note on “Systemic Bank Liquidity and Funding.”

4

For several banks with shipping loan portfolios, these loans are large in proportion of capital and are concentrated in the container segment with the biggest over-capacity. While parts of the legacy portfolios—arguably the riskiest exposures—have been wound down, the ECB’s 2014 asset quality review (AQR) revealed that most of these banks operated under optimistic cash-flow projections, requiring EUR 2 billion of additional provisioning for shipping loans (30 percent of the total AQR capital effect for German banks in the sample). The AQR was undertaken before the recent slowdown in global trade, fall in commodity prices and the ensuing increase in overcapacity.

5

Repeated fines for involvement in the systematic manipulation of benchmarks, misleading regulators, and violating U.S. restrictions on conducting business with sanctioned countries, hit Deutsche Bank’s bottom line and may be indicative of corporate governance issues.

6

See the Technical Note on “Stress Testing the Banking and Insurance Sectors” for details.

7

The stress tests were performed against the end-2019 “fully-loaded” regulatory definitions, including applicable buffers.

8

The drop in bank profitability would not reduce the regulatory capital ratio as long as net after-tax profits remain positive. As with the Bundesbank’s results, despite the impact on system profitability, the capital shortfalls in a few individual banks were not sufficient to cause a decline in the aggregate capital ratios.

9

One-off effects are an important driver of the capital shortfall, in particular, non-recurring write-offs. In contrast to the 2016 EU-wide bottom-up stress test of the European Banking Authority (EBA), such events in the base year (2015) have not been removed from the balance sheet when profit and loss positions were projected three years (2016-2018) into the future.” See “2016 EU-wide stress test-Methodological note” for the EBA methodology. http://www.eba.europa.eu/-/eba-launches-2016-eu-wide-stress-test-exercise.

10

See Bundesbank (2015), Survey on the Profitability and Resilience of German Credit Institutions in a Low-Interest-Rate Setting. http://www.bundesbank.de/Redaktion/EN/Pressemitteilungen/BBK/2015/2015_09_18_bafin_bbk.html

11

Analysis used the applicable regulatory standard under which held-to-maturity portfolio is not marked to market, while for the available-for-sale portfolio, the prudential filter is being phased-out. Therefore, if banks had to mobilize liquidity under stress, and sell securities in the banking book, losses would increase.

12

Together with rating migration effects, this exacerbates the challenge to meet Solvency II requirements as higher capital must now be held against riskier assets. Evidence of search for yield includes increasing investment in non-German sovereign bonds and higher risk investments (such as BBB) with longer duration.

13

German life insurers recognize EUR 136 billion of future discretionary bonuses as part of their liabilities. In the stress test, the future discretionary bonuses are assumed to be reduced by EUR 58 billion.

14

Most insurers that did not perform well in the test have already been on BaFin’s watch list and placed under intensive supervision, such as enhanced reporting and more frequent on-site inspections, etc.

15

See Annexes VI and VII for methodology.

16

The interconnectedness measure is derived from the variance decomposition of the underlying vector autoregression (VAR) of equity returns. Similarly, Bundesbank analyses based on CDS prices for a European sample also indicate a risk transmission from insurers to banks. See Bundesbank Monthly Report July 2014.

17

Analysis was performed across 16 BIS reporting countries with the highest banking sector exposures to Germany.

18

The Act also tasks the FSC with strengthening the cooperation between its members in the event of a crisis situation but it does not envisage a formal role for the FSC in the operational crisis management decision-making.

19

For details, see Report on the Observance of Standards and Codes—Summary Assessments, Basel Core Principles for Effective Banking Supervision.

20

For details, see Report on the Observance of Standards and Codes—Summary Assessments, Principles for Financial Market Infrastructures.

21

With 186 clearing members, 1.8 billion contracts and transactions have been cleared in 2015 amounting to a total value of over EUR 200 trillion, compared to EUR 159 trillion in 2010 based on the EMIR compliant reporting of Eurex Clearing AG.

22

The stress testing exercise of EU CCPs and their clearing members, initiated and coordinated by ESMA, and authorities’ participation in the Study Group on Central Clearing Interdependencies are important first steps.

23

For details, see technical Note on “Insurance Sector Supervision.”

24

Since 2011, over EUR 20 billion of profits have been allocated to the ZZR on a cumulative basis at year-end 2014.

25

Insurers are subject to both Solvency II requirements for regulatory purposes and the continuing national GAAP framework, based on historic cost accounting, for financial statements.

26

For detail, see Technical Note on “Fund Management: Regulation, Supervision and Systemic Risk Monitoring.”

27

For detail, see Technical Note “Anti-Money Laundering and Combating the Financing of Terrorism.”

28

For detail, see Technical Note on “Crisis Management, Bank Resolution and Crisis Management Frameworks.”

29

These rules also cover subsidiaries, financial holding companies, mixed financial holding companies and mixed activity holding companies.

30

A draft RTS by the EBA outlines the criteria that resolution authorities should apply when setting MREL.

31

This moratorium should be limited to the maximum time necessary in order to minimize any destabilizing effects in the market.

1

The big bank group includes Commerzbank, Deutsche Bank, Deutsche Postbank, and UniCredit.

2

Some rating agencies such as Fitch, consider the planned merger a supporting factor in affirming the rating of cooperative banks in Germany.

1

See, for example, Hüfner, Felix, The German Banking System: Lessons from the Financial Crisis, OECD Economics Department Working Paper No 788, July, 2010. Also, Hilgert, Heinz, Jan Pieter Krahnen, Günther Merl and Helmut Siekmann, On a Fundamental Reorganisation of the Landesbanks and Savings Bank Sector in Germany, Johann Wolfgang Goethe Universität, Institute for Monetary and Financial Stability Working paper No. 44, 2011.

1

A loss given default rate of 100 percent is also assumed in Espinoza-Vega and Sole (2010), the Italy 2013 FSAP and the 2012 Japan FSAP. Espinoza-Vega and Sole (2010) and Wells (2004) argue that network studies should consider higher loss-given-default estimates than typically assumed, as banks tend to face substantial uncertainty over recovery rates in the short run. The simulation results should be interpreted as the maximum possible impact of systemic instability. Note that collaterals and hedging instruments are not taken into account due to data limitations.

2

The same assumptions on the funding shock were made in Espinoza-Vega and Sole (2010). While the final numerical results are sensitive to these assumptions; however, the relative importance of systemic countries remain the same.

3

The sample consists of Australia, Austria, Belgium, Canada, Finland, France, Germany, Italy, Japan, Korea, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States.

4

The sample size for the German bank-insurer analysis was restricted by data availabilities, in particular, for the Deutsche Pfandbrief bank. The data source is Bloomberg.

1

This Assessment Report has been prepared by Fabiana Melo (IMF), Jose Tuya (Consultant) and Christopher Wilson (IMF).

2

This section draws from other documents produced for the FSAP. A complete analysis of the macroeconomic framework is contained in Article IV reports.

1

The assessment was performed by Elias Kazarian of the IMF’s Monetary and Capital Markets Department, and Marguerite Zauberman, IMF expert.

Same Series

Other IMF Content

Other Publishers

  • Collapse
  • Expand
Cover IMF Staff Country Reports
Germany: Financial Sector Assessment Program-Financial System Stability Assessment
Author:
International Monetary Fund. Monetary and Capital Markets Department
Volume/Issue:
Volume 2016: Issue 189
Publisher:
International Monetary Fund
ISBN:
9781475577730
ISSN:
1934-7685
Pages:
118
DOI:
https://doi.org/10.5089/9781475577730.002
Figure 1.

Germany: Real Estate and Shipping Developments
Figure 2.

Germany: Financial System Structure
Figure 3.

Germany: Banking Sector

Germany: Cross-Border Banking Exposures

Germany: Sectoral Interlinkages, June 2015
Figure 4.

Germany: Bank Liability Structure by Segment

(In EUR billion, September 2015)
Figure 5.

Germany: Systemic Risk Indicators
Figure 6.

Germany: Macroeconomic Scenarios—Key Variables
Figure 7.

Germany: Solvency Stress Test
Figure 8.

Germany: Low Interest Rates and Bank Profitability
Figure 9.

Germany: Sovereign Exposures, Risk Index, and Valuation Losses under Stress
Figure 10.

Germany: LCR Estimates

(In percent)
Figure 11.

Germany: LCR and NSFR Reported by German Banks in the BCBS QIS
Figure 12.

Germany: Insurance Earnings, Solvency, and Risk Analysis
Figure 13.

Germany: Insurance Stress Testing Results
Figure 14.

Germany: Financial Sector Interconnectedness
Figure 15.

Global Systemic Risk
Annex Figure 1.

Germany: Risk-Weighted Assets of Landesbanken, 2007–15

(In EUR billion)
Annex Figure 2.

Net Contributions to the Systemic Risk