Financial Sector Assessment Program-Financial System Stability Assessment

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.


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

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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

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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)

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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)

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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)

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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).

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.


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)

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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)

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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 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.


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

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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

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Source: Association of German Public Banks

Private sector investors


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

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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

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

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