«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»
The above-mentioned failure of the SSM to trigger a decisive improvement in banks’ average valuation (in price-to-book terms) should act as a wake-up call, and serve as a reminder to the financial policy community that banking union has not yet fulfilled its initial promise.
6 Germany Sascha Steffen The German banking landscape Germany hosts the largest number of significant institutions (SI) among banking union countries (even though the French SIs are larger in aggregate when measured by assets). Germany also has almost half of the euro area’s less significant institutions (LSI). The 22 German SIs include the euro area’s third-largest banking group, Deutsche Bank. The LSIs finance about 70 percent of the country’s small and medium enterprises (SMEs) (Lautenschläger, 2016). Cooperative and savings banks are usually bound to a specific region and cannot engage in business activities anywhere else in Germany, under what is referred to in German banking circles as the ‘regional principle’ (Regionalprinzip). The regional principle is a rule within the savings bank sector and ensures that savings banks do not compete with each other. While these banks develop ties to the companies and households in their regions, they also face concentrated risks with regard to specific local industries, which might make them vulnerable.
Germany has two large institutional protection schemes (IPS), covering 80 percent of the banks and representing about 40 percent
of total assets of the German banking sector (Lautenschläger, 2016):
the savings banks sector (Sparkassen), and the cooperative sector (Verbundstrukturen, including Volksbanken and Raiffeisenbanken).
The regional public banks (Landesbanken), most of which are SIs, and regional ‘building savings banks’ (Landesbausparkassen), all of which 90 | BRUEGEL BLUEPRINT are LSIs, also belong to the public-sector IPS, together with the savings banks. The central bodies of the cooperative banking sector (DZ Bank and WGZ Bank, which are in the process of merging) are members of the cooperatives’ IPS. These protection schemes raise potential issues from a financial stability perspective, as detailed later in this chapter.
It is common in Germany to describe the system as based on three pillars: (1) the public banks, including all Sparkassen and Landesbanken; (2) the cooperative banks; and (3) the commercial banks. While the latter do not have a formal IPS, they also rely on contingent risk-sharing mechanisms such as the German Banking Association’s Deposit Insurance Fund, which can be used to guarantee not only deposits but also bank bonds.
The German bank supervisory authority is BaFin (Bundesanstalt für Finanzdienstleistungsaufsicht). BaFin also regulates Germany’s insurers and securities markets, and conducts banking supervision in cooperation with the national central bank (Deutsche Bundesbank), which also has certain supervisory tasks as explained below.
Germany’s representatives on the ECB’s Supervisory Board are from both BaFin and the Bundesbank, whereas only BaFin has voting rights.
Some of the German SIs (eg Hamburger Sparkasse, also known as HASPA) have no cross-border business at all, and are SIs only on the basis of their balance sheet size. One criticism made by some German stakeholders is that size alone should not trigger SI status, and that a bank’s business model should also be taken into account so that banks like HASPA should be directly supervised by BaFin in cooperation with the Deutsche Bundesbank.
The initial impact of European banking supervision Banking supervision in Germany has changed under the SSM, for both SI and LSI banks. Before the late-2014 transition, banking supervision was institution-specific, a tailor-made approach for each bank or group of banks. This approach was based on the structure of the German banking system, with hundreds of small banks with a
91 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSregion-specific focus. BaFin and the Bundesbank as supervisors have accumulated substantial knowledge about the banks and the institutional environment, and used this information in a highly individualised and qualitative approach to the supervision of German banks.
This relationship has changed – partly because the people who are responsible for supervision have changed. ECB supervisory staff typically lack the institution- and region-specific knowledge, and might also have a different approach to banking supervision. This obviously affects the SIs, eg through the Joint Supervisory Teams (JSTs), but also the LSIs which experience direct requests (eg for data) from the ECB via BaFin.
Banking supervision under the SSM has become more template-driven. Reporting requirements have expanded and supervision has therefore become more quantitative in nature. An advantage of this approach is comparability of institutions and the possibility to benchmark them in order to identify their main strengths and weaknesses and to assess their interconnectedness. However, supervision that is purely based on numbers can also be problematic. First, numbers only make sense if they are put into context, and it will take some time for ECB banking supervision to understand the context. Second, an institution-specific view is necessary to spot risks that cannot be identified based on numbers only. A recent example is Maple Bank, which was closed by BaFin in February 2016. This Frankfurt-based bank had to set up provisions for tax payments because of illegal share purchases around dividend payment dates, which rendered the bank insolvent. These types of risks cannot be identified based on quantitative data alone.
Banking supervision has also become more complex. The number of supervisors, particularly for SIs, has increased and has become more international. The JST for Deutsche Bank, for example, comprises almost 70 individuals of at least 12 nationalities. Almost 40 of the JST members are German and work for BaFin and the Bundesbank;
the rest are from countries in which Deutsche Bank has significant 92 | BRUEGEL BLUEPRINT branches or are ECB employees. Whereas the number of staff from the different national supervisory authorities in this team is by and large the same as before the start of European supervision, the ECB staff members have been added on top. The team is headed at the ECB by a French national. BaFin and Deutsche Bundesbank each have appointed a sub-coordinator of the JST.
Banking supervision used to be less formal and more direct, with sustained conversations between the banks and their German supervisors. Under the SSM the relationship between bank and supervisor has become both more formal and less direct.
Many decisions, such as introducing a new board or supervisory board member, which used to be made by BaFin, must now be prepared by the ECB Supervisory Board and adopted by the Governing Council. More than 4,000 of these decisions had to be made in 2015 alone (Europe-wide), and the Governing Council cannot fully delegate these decisions on the basis of current law. So far, the possibility of delegation has not been used. This, of course, is leading to substantial delays in taking some decisions and is also associated with more work for the national supervisor, such as filling out templates for the ECB.
In some cases, the delays amount to several months or even a full year.
These delays have the potential to cripple the implementation of bank’s management decisions (eg the installation of a new board member, the transfer of assets from one of the banking group’s legal entities to another, or strategic decisions on business projects). That said, in most cases the decisions are taken in a timely manner by the ECB.
Another important aspect of complexity is the increasing number of relevant capital ratios. There are too many different capital ratios and regulatory metrics that investors have to look at. As a result, some banks now increasingly focus on regulatory capital instead of economic capital, because regulatory capital and ratios are the only ratios of interest for investors. The use of regulatory capital ratios might be problematic given the inclusion of risk-weighted assets as part of the ratio. Risk weights that are out of sync with the actual risk of these
93 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSassets might create incentives for banks to arbitrage these risk weights, leaving them severely undercapitalised (Acharya and Steffen, 2014a and 2014b; Korte and Steffen, 2016).
Regulation overall has become more complex. One important issue is the interdependence of different regulatory requirements coming from different agencies. Currently, different regulators have only partial overviews of the applicable regulations, and work largely in isolation from each other. An example is the definition of the maximum distributable amount (MDA)80 by regulators, which involves the European Banking Authority (EBA), the European Commission and ECB banking supervision. The automatism of restrictions on distribution policies, envisaged by Article 141 of CRD IV, is intended to be a minimum common measure applicable to all banks authorised in any EU member state. But the implementation of the concrete calculation of the MDA differs between the euro area and other EU jurisdictions (eg Denmark and the United Kingdom). As a consequence, there is not always a level playing field in the European Union, or between the EU and the US, with negative consequences in particular for large banking groups with global competitors. Moreover, we know relatively little about how the regulatory requirements set by microprudential (eg Pillar-2 capital requirements) and macroprudential authorities (eg systemic risk buffers) work in combination, and whether and how they balance the policy objectives of financial stability and economic growth.
BaFin vs Bundesbank BaFin was created in 2002 through the merger of separate supervisory authorities for banks, insurers and securities firms. The Bundesbank 80 Pursuant to Article 141 of the CRD IV, on breaching the combined buffer requirement (defined by Article 128(6) of CRD IV), banks face distribution restrictions.
The restrictions have the objective of capital restoration when capital buffers are breached, in contrast to the minimum requirements under Pillar-1 and Pillar-2 capital, which are to be met at all times. The MDA is the payout amount that must not to be exceeded in order to restore capital buffers.
94 | BRUEGEL BLUEPRINT and BaFin share tasks related to banking supervision. While BaFin is primarily responsible for issuing administrative acts such as licenses, authorisations and fines, the Bundesbank does most of the ongoing supervision of institutions. With the start of European banking supervision, the separation of tasks between BaFin und Bundesbank remains unchanged, including in relation to their cooperation with the ECB’s direct supervision of SIs81.
All 1,600-odd German LSIs are still directly supervised by BaFin and the Bundesbank, with the same division of labour as pre-SSM.
Supervision of SIs German SIs report delays in approvals of, for example, changes to their internal models. They complain that supervisors responded much more quickly pre-SSM. The consequence is that banks have to operate under greater uncertainty.
More broadly, market participants (including investors and banks) complain about the lack of transparency of European banking supervision. Investors feel they do not have the information they need to value bank equity or bank debt. Despite an enormous amount of data collection by the ECB, the information that is released to investors is very limited. For example, information remains scarce at best on how much bail-inable debt is available within each large institution. Genuine market discipline is not possible if the market cannot assess the risks of (and price) banks’ liabilities and equity.
Among banks, a widespread complaint is that the supervisory review and evaluation process (SREP) is not transparent at all. Banks complain of not receiving information about interim SREP scores or about what factors contributed to their eventual scores. Also, the ECB has some discretion to adjust scores at each step of the SREP process.
Banks receive a final score between one and four, and a regulatory 81 German regulation specifies this in Section 7, 1a of the Banking Act (KWG, Kreditwesengesetz).
95 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHScapital ratio that they have to meet. Naturally, banks want to know how the scores have been calculated and make some effort to reverse engineer the individual SREP scores. While reverse engineering might lead to perverse incentives for regulatory arbitrage, more SREP transparency could help banks mitigate identified weaknesses.
Some banks are concerned that the ECB uses the lack of transparency of the SREP process and exerts some discretion over how target bank capital ratios are set. For example, the ECB might already incorporate buffers that are supposed to come into effect only in 2018-19, making it more difficult for banks to meet their capital requirements.
The ECB is also competent to decide on the application of the capital and the liquidity waiver for significant institutions. One aim of the ECB’s project on options and national discretions was to ensure a level playing field across the euro area that would allow the granting of these waivers to the greatest extent possible. The ECB might also raise the large exposure limit for cross-border intra-group transactions, in line with the German Large Exposure Regulation. In a crisis situation and as a residual power, however, the decision to limit the flow of capital and liquidity within a banking group across borders remains with the BaFin.
Differences in accounting standards are another important topic for the German SIs. Of the 22 SIs in Germany, seven prepare their financial statements using German national accounting standards (known as HGB for Handelsgesetzbuch, or German commercial law) and not IFRS. These institutions are: Deutsche Apotheker-und Ärztebank, Erwerbsgesellschaft der S-Finanzgruppe (Landesbank Berlin), Hamburger Sparkasse, L-Bank, Münchener Hypothekenbank, State Street Europe Holdings and NRW.Bank. Given the amount of data that SIs must deliver to the ECB, some of these banks might consider switching to IFRS. But German bankers are concerned that the ECB wants all SIs to eventually switch to IFRS; they view this as outside the scope of the mandate of European banking supervision.
Bankers are also concerned that they do not have enough time to implement the new rules and regulations and to raise capital. This 96 | BRUEGEL BLUEPRINT process requires a substantial amount of new resources, in particular specialists (IT, lawyers, consultants) who need to be hired. If all banks start this process at the same time, there might be a shortage of skilled experts in the market.
Raising capital is particularly challenging in a low (or negative) interest rate environment. German banks have long suffered from low profitability, but low interest rates and resulting declines in net interest margins aggravate this problem. SIs worry that they cannot attract sufficient interest from investors who require a high return on equity.
Supervision of LSIs The ECB plans SREP guidance for LSIs as of 2018, but BaFin decided to take the first SREP capital decision in 2016, in line with the EBA SREP Guidelines. Capital add-ons will be common practice in the future because of the requirements set out in the EBA Guidelines, which define a ‘Pillar-1-plus’ approach for the quantification of Pillar-2 risks.
Beyond the SREP minutiae, the major challenge facing the SSM is to balance the objective of a single rulebook for the euro area with the principle of proportionality. LSIs in Germany are concerned that the ECB eventually wants to apply the same rules for SIs and LSIs, which might threaten their business models.
As mentioned, most German LSIs are part of one of the two German institutional protection schemes. The CRR provides significant advantages to banks that are in such schemes with respect to liquidity requirements, capital requirements and concentration limits.
It should be noted, however, that all German banks have to meet the liquidity coverage ratio requirement at the individual bank level.