Current Legal Issues Affecting Central Banks, Volume IV.

18B. A German Perspective

Robert Effros
Published Date:
April 1997
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The question of which institution of a country should be assigned responsibility for banking supervision is ultimately not a legal question that can be answered in accordance with generally applicable legal principles. It is rather a question of the specific configuration of the public sector, in reply to which, at best, legal policy comments can be made, and these only with due caution, for every country has its own homegrown structures, its own constitutional conditions, and its own administrative culture.

Therefore, this chapter first emphasizes some general aspects that may be of significance for the organization of banking supervision. It defines the objectives of banking supervision and compares these with the goals of monetary policy and the tasks of central banks. Second, it addresses the question of whether central banks may be exposed to conflicts if they are ultimately responsible for banking supervision, and what it means if central banks are to serve as “lenders of last resort.” Finally, this chapter describes the system of banking supervision in Germany and explains the interaction between the Federal Banking Supervisory Office, which has been assigned responsibility for banking supervision, and the Deutsche Bundesbank, which is extensively involved in banking supervision in practice.

Banking Supervision

The supervisory systems of the individual countries depend on the institutional frameworks, which differ considerably across countries and are based on the particular political, legal, and administrative traditions of the countries; their varying banking structures; and their differing approaches to the theory and practice of banking supervision.1 The institutional framework largely depends on the reason for which banking supervision was introduced. The global economic crisis and the number of bank failures at the beginning of the 1930s triggered a concern in many countries about the particular susceptibility of the banking system to disturbances, along with an awareness of the necessity of depositor protection. Comprehensive supervision systems were set up in some countries, including Germany, at that time.

The creation of these systems was in some cases subject to considerable time pressure; in view of the urgency of the measures, there was often not enough time for basic preliminary discussions of the systematic questions associated with the introduction of banking supervision. Initially, the national banking supervision systems—and the underlying supervisory concepts—were determined by the structural aspects of the national financial systems and the particular objectives of banking regulation.

This originally purely national orientation of banking supervision has long since been superseded: the internationalization of the banking business, the globalization of the markets, and the free movement of capital flows after the Second World War have increasingly sharpened the awareness of the need for close cooperation among national banking supervisory authorities and led to a closer material coordination of the various banking supervision systems. The most important role in coordinating the banking supervision systems was assumed by the Basle Committee on Banking Supervision, whose recommendations have set international standards for banking supervision beyond the range of its member countries.2 In the European Community, Council directives have led to an intensive process of harmonizing the material banking supervision legislation of the member states, in order to achieve the European Community’s objective of creating a single market for financial services by abolishing restrictions on freedom of establishment and freedom of services.3

“Introduction of supervision on a consolidated basis,” “harmonization of bank accounting and valuation regulations,” and “standardization of the capital requirements for credit institutions and definition of common criteria for assessing their solvency” are key words characterizing the intensity of the harmonization process in the European Community. In all bodies dealing with the harmonization of banking supervision and the international cooperation of banking supervisory authorities, the question has occasionally been raised of whether banking supervision should be carried out by the central bank or by an independent agency.

The advantages and disadvantages of supervision by the central bank have been discussed in individual countries, too. Rinaldo Pecchioli reports, for instance, on the discussion in Australia, in which it was assumed that the tasks of the central bank in the field of banking supervision may well clash with its monetary policy functions.4 Nevertheless, the responsible body (the Campbell Committee) came to the conclusion that the necessary coordination of these two ranges of responsibilities could best be achieved within a single institution. Conversely, as Mr. Pecchioli reports further, a study group commissioned to amend Swiss banking legislation argued against assigning supervisory functions to the national bank, as the different tasks of banking supervision and monetary policy should be reflected in, among other things, a clear separation of the bodies responsible for them.5 Apparently, none of the international bodies dealing with banking supervision have gained absolute certainty about the advantages of one solution or the other, or given any general recommendations as to which agency should be assigned responsibility for banking supervision.

It is useful to compare the objectives and tasks of banking supervision, on the one hand, and the goals of monetary policy and the resulting functions of the central banks, on the other.

Objectives of Banking Supervision

It is widely agreed that banking supervision must ensure the general order of the banking system; maintain the banking system’s ability to function; and protect the credit institutions’ creditors against losses as far as possible.

At least in countries organized along market economy lines, the tasks of banking supervision can be reconciled with those principles. What is necessary is a synthesis of the basic freedom to make business policy decisions and conduct individual banking transactions or financial services, on the one hand, and the control of these activities through general regulations, requirements of disclosure to supervisory authorities, and mechanisms for intervention by these authorities, on the other hand. This synthesis must lend itself to application whenever an individual institution, a group of institutions, or even the entire banking system—including all financial institutions—is perceived to be threatened or in difficulty.6 Furthermore, the synthesis should confirm that the responsibility for business decisions rests with the credit institutions’ managers. The activity of credit institutions is restricted only by quantitative general provisions and their obligation to open their books to the supervisory authorities, who do not intervene directly in the credit institutions’ individual operations. Only if the fulfillment of a credit institution’s obligations to its creditors, and especially the safety of the assets entrusted to it, is endangered should the supervisory authority be empowered to take general measures to avert the danger.

The protective purpose and the main goal of banking supervision are to ensure the functioning of the banking system in the interest of creditor protection; it cannot be understood to be a direct government guarantee in favor of the individual creditor. For this reason, banking supervision as such is supplemented in many countries by deposit guarantee schemes in favor of the depositors.7

The question of whether the individual depositor benefits directly from banking supervision by being able to seek redress from the government for losses incurred through a failure of banking supervision was examined by the German courts during the 1970s—among other things, as a consequence of the failure of the Herstatt Bank in Cologne. In two 1979 rulings, the Federal Court of Justice, the supreme court for civil law disputes, unexpectedly took the view that in certain circumstances the Federal Banking Supervisory Office has as part of banking supervision the official duty, vis-à-vis an individual third party, to take specific measures to protect depositors if it becomes aware of particular risks.8 To avoid unforeseeable liability risks in the context of individual protection so construed, an amendment was added in 1985 to the Banking Act, stating that “the Federal Banking Supervisory Office performs its functions … in the public interest only.”9 Accordingly, the general principle that the establishment of public banking supervision does not simultaneously imply the establishment of a deposit insurance scheme applies again in Germany, as elsewhere.

In contrast to banking supervision relating to individual institutions, which is sometimes termed “microeconomic supervision,”10 the central banks are responsible for the “macroeconomic” regulation of the total amount of money in circulation and the banking system’s lending potential, with the aim of safeguarding the stability of the currency concerned. According to Section 3 of the Bundesbank Act, for example, the Deutsche Bundesbank is obliged, using the monetary powers conferred on it, to regulate the amount of money in circulation and of credit supplied to the economy, with the aim of safeguarding the currency.11 Moreover, Article 105(1) of the Treaty Establishing the European Community, as amended at Maastricht,12 describes the functions of the European System of Central Banks (ESCB) as follows:

The primary objective of the ESCB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2. The ESCB shall act in accordance with the principle of an open market economy with free competition, favoring an efficient allocation of resources, and in compliance with the principles set out in Article 3a.13

Goal of Monetary Policy

As just outlined, the objectives of banking supervision as part of public regulatory policy are not identical with those of a central bank responsible for monetary policy, although there are major points of similarity. In the banking field, monetary policy and regulatory aspects are often interlinked. Measures taken by banking supervisors may have an impact on the control of the money supply by the central bank. For instance, the raising under banking supervisory aspects of the capital and liquidity ratios of financial institutions to keep the institutions sound and to protect their creditors will at the same time affect the overall lending potential of the banking system, the control of which is the core of the central bank’s function. However, monetary policy measures taken by the central bank may affect the status of individual credit institutions in a way that is significant for banking supervision. An increase in the minimum reserves by the central bank may impair credit institutions’ liquidity and subject individual institutions to considerable tension.

These few examples show that it may be problematical to make the central bank alone responsible for banking supervision. This inference applies all the more as, judging by past experience, banking supervision is particularly required in the case of crisis management. A central bank with sole responsibility for banking supervision may come under pressure from public opinion or politicians and feel obliged to grant sizable liquidity assistance, which would not be appropriate in macroeconomic terms, given its responsibility to safeguard the currency.

Central Bank as Lender of Last Resort

The next question is, How is a central bank’s role as lender of last resort to be defined in this context? This is not a legal question. Thomas Humphrey defines the term “lender of last resort” as referring “to the central bank’s responsibility to accommodate demands for high-powered money in times of crisis, thus preventing panic-induced contractions of the money stock.”14 Ultimately, central banks are the only sources of liquidity available in unlimited quantities; therefore, their assistance is required in crisis situations.

It is not the task of legal experts to lay down how far the functions of a lender of last resort should go. As far as the granting of liquidity assistance is concerned, a distinction must no doubt be made between providing assistance to banks that are basically sound and to those that face severe liquidity and solvency problems of their own making. In the first case, temporary liquidity assistance by the central bank that is justifiable in macroeconomic terms will tend to be appropriate to avoid a crisis of confidence for the entire banking market, provided that the bank in difficulty has sufficient assets to serve as collateral for the central bank. In the second case, however, liquidity assistance is problematical if the bank concerned has lost its capital as a result of business losses and is unable to provide collateral.

If a central bank is ultimately responsible for banking supervision, there may be conflicting interests under the aspects of banking supervision, on the one hand, and monetary policy responsibility, on the other. The key words “too big to fail” and “moral hazard” outline the difficulties. HJ. Muller describes the problem as follows: “The sure knowledge that, in the case of a failure, the public authorities will come to the rescue, could well lead to imprudence on the part of banks and creditors.”15 In an international context, this aspect is reflected in the deliberate vagueness of a 1974 statement by the Group of Ten countries:

The Governors also had an exchange of views on the problem of the lender of last resort in the Euromarkets. They recognized that it would not be practical to lay down in advance detailed rules and procedures for the provision of temporary liquidity. But they were satisfied that means are available for that purpose and will be used if and when necessary…16

U.S. economist Frederic S. Mishkin, speaking on the avoidance of crises in the international financial system, outlined the German point of view: “Some central banks, such as the Deutsche Bundesbank, object to having a direct regulatory role because they believe that it will subject them to political pressures which may interfere with their ability to use monetary policy to combat inflation.”17

If there are some reservations in respect of assigning the sole responsibility for banking supervision to the central bank, there are also many good reasons for involving the central bank in banking supervision and, particularly, for establishing an exchange of information between the authority responsible for banking supervision and the central bank. Whether this authority is to be the ministry of finance or an independent agency is not significant; the choice of the responsible agency will depend on the framework defined by the constitution of a country for its administrative organization.

The interaction mentioned previously between measures by the central bank to control the money supply and measures or regulations by banking supervisors to observe specific capital or liquidity ratios necessitates cooperation between banking supervisors and monetary policymakers. It is ultimately in the interests of the credit institutions concerned that the central bank and the banking supervisory authority obtain the information and data required for their respective monetary or prudential purposes in a joint effort, if possible, to avoid duplication of work. In this sense, at least, the question “Who should be the banking supervisors?” could be answered “the ministry of finance or an independent agency plus the central bank.”

System of Banking Supervision in Germany

In Germany, the concept of banking supervision is implemented through an independent supervisory authority that cooperates with the central bank. This section explains briefly how this cooperation is regulated by law and how it works in practice.

General banking supervision in Germany is a consequence of the banking crisis of 1931. Although the idea of general banking supervision was discussed as early as 1874, in the context of the Act on the Establishment of the Reichsbank,18 it was not pursued further, particularly in view of the reluctance to reimpose restrictions on the general freedom of trade following their abolition only a few years previously. On account of the extraordinary disruptions triggered by the banking crisis throughout the entire economic system, a Reich Commissioner for Banking was appointed in 1931 as an executive arm of banking supervision. A second banking supervisory agency, the Board for Banking, was also established as a coordinating body between the Government and the Reichsbank. After the Second World War, the Länder governments were initially responsible for banking supervision.

Since 1961, banking supervision has been carried out by the Federal Banking Supervisory Office, working in cooperation with the Deutsche Bundesbank. The Banking Act assigns the central role in banking supervision to the Federal Banking Supervisory Office,19 which reports directly to the Federal Minister of Finance.

Recognizing that the functions of the authority responsible for banking supervision and those of the central bank are interconnected, the legislature has provided for the Deutsche Bundesbank to be involved in banking supervision.20 Moreover, the participation of the Bundesbank is necessary because the Federal Banking Supervisory Office has no sub-structure of its own. It is only the Bundesbank system, with its main and branch offices, that permits efficient and cost-effective supervision at the local level of the over 4,000 credit institutions in Germany.

Banking supervisory functions are clearly divided between the Federal Banking Supervisory Office and the Bundesbank. First, sovereign functions, for example, the issuing of administrative acts, are the responsibility of the Federal Banking Supervisory Office. Second, before issuing general regulations, the Federal Banking Supervisory Office must confer with the Bundesbank.21 The degree to which the Bundesbank is entitled to participate is graduated according to the extent to which the regulations affect its functions. Thus, when issuing principles concerning capital and liquidity, the Federal Banking Supervisory Office is required to reach agreement with the Bundesbank22 while, in other cases, the Bundesbank has merely to be consulted. Third, the Bundesbank is fully involved in the regular surveillance of the credit institutions; it also analyzes the annual reports and other documents of these institutions. Observations that the Bundesbank makes in the course of these activities are also used in the monitoring operations. Fourth, the Bundesbank maintains the credit register of loans of DM 3 million or more,23 which is an important source of information both for the banking supervisory authorities and for lenders. This clause stipulates that credit institutions and insurance enterprises must report loans of DM 3 million or more to the Bundesbank, which adds together the loans to individual borrowers and subsequently notifies the lenders of the total indebtedness of their borrowers and the number of lenders involved.24 Finally, to enable the banking supervisory authorities to analyze regularly the credit institutions’ business, the latter have to submit monthly returns to the Bundesbank. The Bundesbank passes on these returns and provides its comments to the Federal Banking Supervisory Office. If the Bundesbank collects monthly balance sheet statistics for its monetary analysis, these are considered to be monthly returns, in order to avoid duplication of work by the credit institutions.

In 1993, the Bundesbank received, among other things, over 2 million reports on loans of DM 3 million or more pursuant to Section 14 of the Banking Act, and 50,000 monthly returns pursuant to Section 25 of the Banking Act.25 The Bundesbank clearly obtains a great many prudential data that are at the same time useful for fulfilling its monetary policy functions.


It is important to mention the role of the future European Central Bank (ECB) in banking supervision. The ECB will not take over responsibility for banking supervision from the national authorities, but it will support the responsible agencies in carrying out banking supervision. Article 105(5) and (6) of the Treaty Establishing the European Community state in this respect:

The ESCB shall contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system.

The Council may, acting unanimously on a proposal from the Commission and after consulting the ECB and after receiving the assent of the European Parliament, confer upon the ECB specific tasks concerning policies relating to the prudential supervision of credit institutions and other financial institutions with the exception of insurance undertakings.26

During the preliminary work on the statute establishing the ECB, there was an exchange of opinions in the Committee of Central Bank Governors on the degree to which the ECB should be involved in coordinating banking supervision. A common starting point for the governments concerned was, in view of the subsidiarity principle, to leave responsibility for banking supervision with the national agencies. The German side, in addition, held that a separation of supervisory responsibilities from monetary policy was appropriate. Not least for that reason, the assignment of further prudential supervision tasks pursuant to Article 105(6) is subject to the proviso of a unanimous Council decision.

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