A. Cushioning the Impact of Spiking Energy Prices and Supply Disruptions, and Enhancing Energy Security

17. The German government has responded to the fallout from the war with timely and generally well-designed measures (Annex IV and V).

• Households. Higher consumer prices are reducing households’ real disposable income, especially among low- and middle-income groups that tend to spend a greater share of their incomes on energy. The government has introduced several measures to help, including various forms of income support for vulnerable households, a one-time payment to the employed, a cut in the “renewable energy surcharge” (a surcharge on electricity bills that helped finance the subsidies for renewable energy generation)¹³, and a temporary cut in the fixed excise taxes for gasoline and diesel (taking effect between June and August). Providing one-off income support payments to vulnerable individuals while allowing high energy import prices to pass through onto domestic prices are the ideal way to help the economy as they provide temporary relief to those with the least means to cope with the shock while preserving incentives to conserve energy. By contrast, cuts to the renewable energy surcharge or the energy tax are not targeted and thus an inefficient way of supporting the vulnerable, and they blunt the incentives to save energy. The fuel tax cut should be phased out after three months as planned and the government should strive to rely on income support measures for lower income groups should additional relief become necessary. The work being done to develop a comprehensive information system on households will in the future allow the government to deliver relief to a broader group than only those that are currently receiving social assistance benefits, which can be also helpful during the green transition.

• Firms. The war has led to an abrupt surge in the prices of energy commodities, which, in the case of natural gas, has been more pronounced for European economies. Futures markets suggest that the price increase is likely to be partially reversed. Even if temporary, the surge in energy costs and intensified supply disruptions may damage firms’ balance sheets, discourage new investments and/or lead to unwanted bankruptcies of otherwise viable firms, scarring economic potential. In this context, the government has sketched a new plan for liquidity support to firms that includes loans through KfW (the state-owned development bank) on favorable terms, an extension of the pandemic-era loan guarantee programs, and loans to energy producers to post margins on their hedging contracts.¹⁴ Staff agree with the need to prepare contingent plans and, by being available for firms to draw on if severe downside risks are realized, these facilities can help to put a floor under the economy in such circumstances. However, the government has also announced that it would offer temporary and targeted subsidies for firms’ increased energy costs over the summer.¹⁵ Given the need to accumulate gas reserves as soon as possible, which would be easier if consumption were to be reduced, such energy subsidies should be dropped.

18. The immediate priority for Germany is to secure energy supplies and build resilience. Germany plans to stop its imports of Russian coal by the fall of 2022 and oil by end-2022. At the same time, it also aims to reduce its imports of Russian gas by half this year and terminate them by 2024. To diversify sources of gas imports and lessen dependence on gas, the government is securing additional LNG supplies, establishing facilities to re-gasify LNG, requiring operators to fill their storage tanks before the winter, reactivating previously shuttered coal-fired power stations, and encouraging voluntary reductions in energy demand. Activating the first stage of the national emergency plan for gas allowed intensive monitoring of the market. Laws were amended to allow the government to take control of critical energy infrastructure and order retail price adjustments. However, infrastructure bottlenecks under gas shut-off scenarios remain unclear—more transparency would be helpful to plan the necessary investment and help firms develop their crisis plans. Cooperation with other EU countries, including in the context of the REPowerEU, is key to secure additional gas supplies, and to ensure that infrastructure and legal frameworks are adequate to share gas between members in the event of a shortage. Germany has signed solidary agreements with Denmark and Austria, and a Memorandum of Understanding with other neighboring countries, including to ensure adequate supplies in land-locked countries dependent on flows through Germany. A program could be offered to exchange gas heaters for heat pumps. To encourage voluntary gas-saving behavior and build gas reserves, meaningful financial incentives—such as rebates or block tariffs, which would depend on technical feasibility constraints—could be considered. Following the curtailment of gas supplies from Russia in mid-June, the authorities declared the second phase of the three-stage emergency gas plan and took measures to accelerate the filling of storage facilities, reduce the use of gas for power generation (which will raise reliance on coal-fired plants), and announced their intention to develop an auction mechanism that could encourage further gas savings by firms.

19. A Russian gas shutoff can entail substantial costs, requiring additional policy support. Most existing studies put the output loss at up to 6 percent of yearly GDP, spread over one to two years, with the wide range of estimates partly reflecting uncertainty around the potential amount of gas shortages and how the economy can adjust. Staff assess that the impact of production constraints, downstream amplification, and elevated uncertainty alone could reduce GDP by about 1.5 percent in 2022, 2.7 percent in 2023 and 0.4 percent in 2024, with output then converging to its baseline level in subsequent years (for details, see the accompanying Selected Issues Paper). Depending on how much European wholesale gas prices rise, German headline inflation could be 2 percentage points higher on average in 2022 and 2023. To protect vulnerable households and workers, automatic stabilizers would be the first line of defense. To help ensure the solvency of energy companies, which is important to prevent financial constraints from exacerbating the shortages, the government might allow energy companies to pass on cost increases to end-users on otherwise fixed-price contracts. If that happens, it should be complemented with further targeted support for vulnerable households. Also, firms’ demand for the government’s liquidity support facilities would grow, and further discretionary financial support to firms might be necessary. The authorities’ ongoing assessments of the economic and financial implications of this scenario will help to plan such support. If rationing becomes necessary, macroeconomic implications should be considered alongside technical, legal, and social dimensions. The authorities’ ongoing efforts to plan the distribution of gas in a potential emergency are welcome.

Authorities’ Views

20. The government agreed that international energy prices should be allowed to pass through onto domestic prices while the vulnerable should be protected with targeted support, but also highlighted that the need for a quick deployment of relief measures currently warranted certain less targeted measures. Cuts to fuel taxes, which are under the control of the Ministry of Finance, can be enacted quickly and the associated relief can begin to unfold immediately. The government also pointed out that a lump-sum income-taxable transfer to all the employed, another quick measure, is progressive because the fixed lump-sum is more material for lower-income households and progressive income taxation means that the after-tax benefit is greater for lower income groups. The abolition of the renewable surcharge is also progressive because the relief for lower income households is greater as a percentage of income. The government is concerned that households are vulnerable to higher energy prices, thus it is developing an information system to allow even more targeted relief measures in the future. The government considers temporary support to firms justifiable to cushion the immediate impact of the war, the associated economic impact of sanctions, and higher energy prices. In the authorities’ view, subsidies for firms’ gas and electricity costs would not materially disincentivize energy saving because they have strict eligibility criteria (including a doubling of energy prices relative to one year ago), last only until September, cover only a portion of the increased energy cost, and they also decline over time.

21. The government is putting significant efforts into enhancing energy security, analyzing the economic impact of a potential Russian gas shutoff, and developing contingency plans. The authorities agreed that the economic impact of a shut-off of Russian gas would be sizable but emphasized that difficulties in substituting gas and energy-intensive intermediate inputs could lead to even larger impacts than estimated by staff. To build resilience against a gas shutoff scenario, the government is in discussions with neighboring countries about concluding further solidarity agreements. It agreed that financial incentives could be offered to encourage gas saving behavior, which would allow gas inventories to build faster ahead of next winter. However, the government expressed concerns about implementation constraints, such as the lack of smart meters for households to monitor consumption in real time and technical constraints on the ability to vary supply to different users. The authorities agreed that additional fiscal support would be needed in the event a Russian gas shutoff. The government noted that it aimed to spare households from rationing, and that market mechanisms would be used as much as possible to distribute gas in a way that minimizes the economic effects of rationing. The energy regulator is actively working on such plans, including by surveying and interviewing firms on how they use gas.

B. Mitigating Climate Change

22. A green investment push is a key priority to achieve Germany’s climate and energy-security goals and boost its potential growth, which requires an improved public investment management system. The Coalition Treaty sets out numerous goals in line with Germany’s emissions targets, some of which have been made more stringent recently in a bid to boost energy security (Annex VI). Much of additional green investment must be undertaken by the private sector, for which strong carbon pricing is key. However, public green investment—e.g., upgrades to the electricity transmission system and an expansion of electric-vehicle charging stations—is vital to tackle network externalities and crowd-in private investments. Several experts estimate that additional investment spending of €72 bn (1.3 percent of GDP) per year over a decade is needed to achieve Germany’s emissions targets.¹⁶ The Energy and Climate Fund is the federal government’s key vehicle for financing green projects, which is currently expected to provide €157 bn (3.8 percent of GDP) during the period 2022–25. The government also plans to transform the state-owned development bank KfW to a major co-risk capital provider for the private sector and leverage the balance sheet of public corporations, such as the state-owned railway company. Scaling up public investment has been proven challenging in recent years as Germany lacks a multi-year public plan to set out a clear national vision for the priority public investments and an institutional framework that would ensure its implementation. To boost public investment in energy security and decarbonization, digitization, and transportation infrastructure, the government should urgently simplify administration and enhance planning capacity, financing, and coordination across different levels of governments. This investment would also help reduce Germany’s large external imbalances.

23. Additional measures could enhance the cost-effectiveness of the climate change mitigation strategy.¹⁷ The introduction of a national Emission Trading System (ETS) in 2021 for the transportation and building sectors was an important step, ahead of the introduction of EU ETS2 under the “Fit for 55” initiative, which is expected to cover these sectors. However, national carbon price (€30/tonne) is considerably lower than EU ETS carbon prices (fluctuating around €80–90/tonne in May) and also lower than the levels needed to decarbonize these sectors. Measures to raise the carbon prices for buildings and transportation to equalize them with the levels of the EU ETS carbon prices would not only help decarbonize these sectors faster, but also help ensure that abatement occurs where marginal costs are lowest. If international fossil fuel prices decline (as implied by futures markets), it would become possible to raise the level of national carbon pricing without increasing retail energy prices relative to previous levels. In addition, introducing feebates and enhancing support for improving the energy efficiency of buildings could be an additional helpful tool in hard-to-decarbonize sectors. Germany has been making commendable efforts to boost international cooperation on climate, such as Chancellor Scholz’s proposal of an “international climate club,” which seeks agreement with large emitters on minimum standards for emissions-measurement and carbon pricing. Further enhancing the venture capital market and reduce administrative red tape can also promote green innovation and, more broadly, private investment.

Authorities’ Views

24. The authorities agreed that removing obstacles to investment is key to a green investment push and emphasized the government’s commitment to addressing the issue. The government is keenly aware of the obstacles to ramping up investment even faster—e.g., cumbersome administrative procedures, legal hurdles related to environmental regulations, lack of planning capacity, labor and material shortages, and difficulties in coordination across different levels of government—and highlighted that a working group has been set up in the Chancellery to address or at least reduce them. In addition, the government has been expanding the publicly-owned consultancy firm Partnerschaft Deutschland, which provides consultancy services for all levels of government (federal, state, and local) to supplement their planning and procurement capacity. Regarding climate-change mitigation policy, the “Easter package” contains an omnibus of legislative changes to accelerate the expansion of renewable energy. The “summer package” will contain another bundle of decarbonization measures in transport, building, and agriculture. The finance ministry highlighted that carbon pricing is the most efficient and effective instrument to reduce emissions and saw merit in having a single carbon price in the EU. It also emphasized the importance of the predictability of carbon pricing, and thus is reluctant to alter the already-planned path of national carbon pricing (for transportation and buildings) through 2026. The government continues to focus on enhancing the funding possibilities of start-ups for the capital-intensive scaling-up phase. In this context, as part of the 10 billion Euro Future Fund, the government has commissioned KfW Capital, a 100 percent subsidiary of KfW Group, to implement a growth fund as a market-conforming, non-aid venture capital fund of funds, aiming to broaden the investor base in the venture capital market.

C. Ensuring a Dynamic Labor Market

Boosting Participation in the Labor Market

25. Germany’s labor force will continue to shrink amidst population aging unless labor force participation rises meaningfully or immigration rebounds. In the last quarter of 2021, the labor force participation rate was 0.5 to 1 percentage point smaller than two years ago (depending on the data source used), in contrast to the gains observed in some peers during the pandemic period (Text Figure 7). Much of the drop in Germany’s labor force can be explained by demography: a decline in the share of the German population in the prime-age group and an increase in the share of the population older than 60 years, where participation rates tend to be lower. In the pre-pandemic years, within-group participation rates had been rising and partially offsetting the effects of aging. By contrast, participation rates weakened in 2021, contributing to the drop in the overall labor force participation rate. Unless participation rates (especially for those 40 and older) resume their pre-pandemic upward trend, or a recovery in immigration augments the share of the working-age population, Germany will have to confront a rapidly diminishing labor force, a growing dependency-ratio, and lessened per capita potential growth in the years ahead.

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Germany: Real GDP

(Index, 2019=100)

Citation: IMF Staff Country Reports 2022, 229; 10.5089/9798400216497.002.A001

Sources: Destatis and IMF staff calculations.

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Germany: Labor Force Dynamics

Citation: IMF Staff Country Reports 2022, 229; 10.5089/9798400216497.002.A001

1/ The economy wide participation rate is given by the population-weighted average of cohort-specific participation rates. The decomposition splits the change in the eeconomy-wide participation rate to parts coming from shifts in population shares (driven by demographics) and shifts in the participation rates of different cohorts.

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26. The government should continue its efforts to boost participation, especially via removing the obstacles and disincentives to work.

• Expanding high-quality childcare and strengthening incentives to work for secondary earners— e.g., by reducing the high effective marginal tax rate for secondary earners within couples (IMF, 2019)—can promote labor-force participation by females and increase their working hours.

• Training to reskill/upskill workers, especially in the context of accelerated digitalization, can encourage higher participation rates among older workers.

• The Federal Employment Agency estimates that 400 thousand immigrants are needed each year to replace those retiring from the workforce. In this context, the new government’s plan to address the shortage of skilled workers by further easing immigration rules is welcome. To continue supporting job-seeking refugees, including Ukrainians, integration programs paused during the pandemic, such as language training and vocational training, should swiftly resume.

• Reducing the labor tax for lower-skilled workers would boost their disposable income and stimulate their labor supply at the same time. Such a measure would be ideally accompanied by a permanent increase in revenue.

Boosting Skills and Human Capital

28. Long-standing skill mismatches and the efforts to green the economy and jobs call for policy actions to boost training and reskilling. Information Communication Technology (ICT) specialists were already scarce before the pandemic. The pandemic accelerated digitalization and enhanced skills mismatches. To mitigate shortages in digital skills and facilitate adaption to new technologies, it will be crucial to provide workers with lifelong learning opportunities in collaboration with employers, leveraging digital learning formats that could ease time and location constraints. Curricula reforms to include computer programming and upgrades in ICT equipment in schools would foster the acquisition of digital skills. Transition from internal combustion engine production to EVs will require prime-age workers to transition into greener occupations. Targeted training programs can facilitate the needed reallocations, and stepped-up efforts would help to make up the learning deficits caused by the pandemic.

29. The authorities acknowledged the need for up- and re-skilling of workers to facilitate structural transformation. They assess that the green transition would increase labor demand, most notably in the construction sector and in the areas of battery production and digitalization of the automotive sector. A decrease of labor demand will take place in the automotive sector that produces parts for the internal combustion engine and in some basic business-related services (e.g., travel agencies). While highlighting the role of the National Skills Strategy with the goal to reform, systematize, and strengthen Continuing Education and Training (CET) policies, the government noted weak pockets such as lower participation in CET programs among workers in SMEs and shortages in teachers in digital training. To address the weakness, the government has launched the “Hubs for Tomorrow” program to support companies and employees in shaping digital change and is currently working on a national user-centered one-stop shop CET platform.

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Skill Constraints

Citation: IMF Staff Country Reports 2022, 229; 10.5089/9798400216497.002.A001

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D. Putting It All Together—Fiscal Policy

30. Faced with a new shock of uncertain duration and intensity, the government has been appropriately vigilant and flexible in setting fiscal policy in 2022. It has introduced generally well-designed and time-bound support to the economy and launched measures that can help avert an adverse macro-financial feedback loop in a potential gas cut-off scenario. The broadly neutral overall fiscal stance is appropriate for 2022, striking a balance between supporting the economy through generally well-targeted relief measures and not adding too much to inflationary pressures. Near-term fiscal plans may have to be revised again to accommodate any other spending needs stemming from the fallout from the war, including assistance for refugees. The government has already stepped-up humanitarian support for refugees, with a budget allocation of €4 billion (0.1 percent of GDP), and more may be needed.

Box 1.

Digitalization of the German Economy—Status Quo

The pandemic has accelerated the expansion of high-speed internet and boosted demand for data-driven services. The necessity for work-from-home during the pandemic has advanced the availability of broadband, yet the availability outside large cities and towns remains relatively limited (Box Figure 1). At the same time, German firms have lagged in adopting key ICT tools required to create value with data (see the 2021 Article IV Staff Report). Further expanding the coverage of fiber optic connections and the 5G mobile network is important to enhance productivity and innovation.¹ The expansion will be driven mostly by the private sector,² but in rural and sparsely populated regions where market-driven expansion is weak, the federal government is promoting the expansion of digital infrastructures with additional financing via the “digital infrastructure” special fund (BMWK 2022). To accelerate the expansion of the broadband network, the government has helpfully streamlined digital application and approval procedures, standardized alternative laying techniques, and established a nationwide gigabit land register.

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Promoting the development of a modern, digital, and innovative economy requires a multi-faceted strategy. To strengthen technological sovereignty, the Coalition Treaty indicates that the EU’s digital single market should be deepened, data infrastructure further developed in accordance with European standards, and digital skills and innovation promoted. At the same time, to secure a safe data-driven economy, the Treaty also calls for secure data access and trading, as well as effective and fair competition on digital marketplaces, as is intended with the Digital Markets Act. It is also advisable to expand ICT training for teachers and to introduce computers and programming earlier in curricula (OECD 2020).

^1/ The government is also considering the development of a 6G mobile network. ^2/ At least €43 billion are available for the commercial expansion of fiber optic networks in Germany over the next five years (BMWK 2022).

31. Fiscal policy should remain flexible in 2023. The draft federal budget for 2023 assumes a return to complying with the debt brake rule that limits new borrowing to 0.35 percent of GDP. Yet, the government can carry a deficit exceeding that amount in the coming years, since spending to be financed by general reserves and special funds (totaling €240 bn or 6.7 percent of GDP)¹⁹, including the Energy and Climate Fund and Special Defense Fund, is not bound by the debt rule. The government’s plan is to reduce the general government deficit by 1¾ percentage of GDP to 2 percent of GDP in 2023 by letting the relief measures introduced for the pandemic and high energy prices expire at the end of the year. This adjustment is manageable under the baseline economic forecast where international energy prices would soften, and the take-up of the programs introduced during the pandemic would drop autonomously as private demand strengthens. However, if downside risks materialize, such as higher commodity prices and weaker growth, further relief measures would be called for. In particular, the government would likely extend relief to vulnerable households for coping with higher energy costs, maintain the expanded Kurzarbeit program to avert layoffs, and prolong the pandemic-era grant program for firms. Given high inflation, continuing with targeted relief measures rather than broad-based fiscal support would be of the essence. In a severe downside scenario, postponing the reactivation of the debt-brake rule by a year might be called for, to ensure that fiscal policy can be sufficiently supportive.

Text Table 2.

Germany: Fiscal Balances

(Percent of GDP)

Sources: Destatis, Federal Ministry of Finance, and IMF staff.

Text Table 2.

Germany: Fiscal Balances

(Percent of GDP)

	201 9	202 0	202 1	202 2	202 3	202 4	202 5	202 6	202 7
Headline balance	1.5	-4.3	-3.7	-3.0	-1.5	-1.0	-0.8	-0.6	-0.5
Cyclically-adjusted balance	1.2	-2.2	-2.7	-2.3	-1.0	-0.8	-0.8	-0.6	-0.5
Drawdown of the Energy and Climate Fund, Special Defense Fund, and Reserves	0.0	0.0	0.0	0.6	1.1	1.0	0.7	0.5	0.0
Balance that is compatible with the debt brake	1.2	-2.2	-2.7	-1.7	0.0	0.2	-0.1	-0.1	-0.5
	-				-	-	-	-	-
Memorandum: Debt brake	0.35	…	…	…	0.35	0.35	0.35	0.35	0.35
Government debt	58.9	68.7	70.2	70.4	67.5	64.6	62.4	60.6	59.3

Sources: Destatis, Federal Ministry of Finance, and IMF staff.

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Text Table 2.

Germany: Fiscal Balances

(Percent of GDP)

	201 9	202 0	202 1	202 2	202 3	202 4	202 5	202 6	202 7
Headline balance	1.5	-4.3	-3.7	-3.0	-1.5	-1.0	-0.8	-0.6	-0.5
Cyclically-adjusted balance	1.2	-2.2	-2.7	-2.3	-1.0	-0.8	-0.8	-0.6	-0.5
Drawdown of the Energy and Climate Fund, Special Defense Fund, and Reserves	0.0	0.0	0.0	0.6	1.1	1.0	0.7	0.5	0.0
Balance that is compatible with the debt brake	1.2	-2.2	-2.7	-1.7	0.0	0.2	-0.1	-0.1	-0.5
	-				-	-	-	-	-
Memorandum: Debt brake	0.35	…	…	…	0.35	0.35	0.35	0.35	0.35
Government debt	58.9	68.7	70.2	70.4	67.5	64.6	62.4	60.6	59.3

Sources: Destatis, Federal Ministry of Finance, and IMF staff.

32. Extensive use of extra-budgetary funds can undermine the credibility of the fiscal framework over time, and should therefore be minimized. Given a political commitment to return to Germany’s debt-brake rule, the government is increasingly leveraging extra-budgetary vehicles for boosting investments in decarbonization and defense spending. All associated spending is reported above the line in the general government accounts under the EU Stability and Growth Pact standards. Nonetheless, extensive use of extra-budgetary funds to bypass the debt-brake rule may undermine the credibility of the fiscal framework, and erode support for the reforms and transformation the funds are meant to facilitate. Further use of extrabudgetary funds should therefore be minimized. To further enhance fiscal transparency and risk management, the Ministry of Finance could provide a consolidated report of fiscal risks, covering the contingent liabilities associated with the quasi-fiscal activities undertaken by state-owned banks (e.g., KfW) and public corporations, based on analysis by line ministries on the public corporations under their respective span of control. The expected cost and maximum probable loss of contingent liabilities should be quantified in this report.

33. Germany continues to have ample fiscal space that it can use to invest to enhance its growth potential and resilience. Higher spending compared to the pre-pandemic era—on childcare, decarbonization, defense, energy security, innovation, and digitalization—and some tax reduction (e.g., partial abolition of the solidarity surcharge) have narrowed the room for maneuver within the constitutional debt brake rule (which limits the federal deficit to 0.35 percent of GDP in the medium term).²⁰ Despite heightened spending, however, Germany’s public debt is projected to resume its downward trajectory from 2023 onwards, declining to its pre-pandemic level of about 60 percent of GDP by 2027 (Annex VIII). In addition to tapping into the remaining room within the rule, the government could review Germany’s overall fiscal framework—including the level and composition of expenditures and revenues, and the design of the debt-brake rule—to ensure that fiscal policy can continue to respond to structural needs.

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Germany: Nonresidential Investment

(Percent of GDP, average 2017–21)

Citation: IMF Staff Country Reports 2022, 229; 10.5089/9798400216497.002.A001

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Authorities’ Views

34. The government generally shared staff’s assessment of the fiscal stance and agreed that fiscal policy should be tuned to help cushion the economic effects of the war and the pandemic, while still supporting the green and digital transformation. They concurred that the fiscal stance in 2022 would be broadly neutral, and such a fiscal stance under the baseline, with vulnerable households and firms receiving generally well-targeted support, should add little to inflation pressures. The government noted that once resources in the defense fund are used up and climate and defense spending are fully brought under the coverage of the debt limit, fiscal space (under the national debt-brake rule) would be largely exhausted. While the government does not plan to modify the debt brake rule by amending the constitution, the government suggested that technical modifications—such as the method of adjusting fiscal variables for the business cycle and symmetric use of the control account—could create additional fiscal space. They noted that line ministries are primarily in charge of managing fiscal risk related to public corporations, yet the finance ministry reports public corporations’ financial conditions in a collective manner on an annual basis.

E. Ensuring Financial Sector Stability

35. Staff assess the German banking sector to be generally resilient to shocks, but pockets of vulnerability require close monitoring and some additional action. In the FSAP, staff assessed that overall bank capital is generally sufficient to withstand a severe adverse scenario including a three-standard deviation shock to growth over two years. Stress tests also confirmed that the banking system is resilient to liquidity shocks. Yet, the stress tests identified shortfalls of capital and US dollar liquidity at some individual banks under severe adverse scenarios. Furthermore, structurally low bank profitability remains a persistent source of vulnerability. To address vulnerabilities identified in the stress tests, the FSAP has suggested that the authorities continue to closely monitor prudential ratios for large, systemically important commercial banks, establish additional bank-specific buffers for less capitalized banks as needed, and strengthen data collection at less systemically-important institutions about remaining maturity of retail deposits, wholesale funding, and interest-bearing assets to allow them to perform their own top-down stress tests of interest rate risk. The authorities should also review the design of the fragmented deposit insurance system and consolidate existing mandatory schemes into a single scheme with a government liquidity backstop, which would facilitate greater risk pooling and diversification.

36. Further analysis of the financial stability implications of the war, sanctions, and rising energy prices would be useful. The authorities’ preliminary analyses suggest that exposures of the financial sector to energy-intensive firms will be manageable. The authorities are analyzing the financial stability implications of gas shutoff scenarios, which would be useful to develop a full stress test.

37. The authorities have appropriately tightened macroprudential policy in the face of house price risks, but further actions are needed. Rapid rises in housing prices (12.4 percent between 2021Q4 and 2020Q4) have led to residential real estate valuations above fundamental levels for Germany overall, and even greater misalignment in larger cities. Nationwide, price-to-rent and price-to-income indicators suggested deviations from the long-run average of about 37 and 21 percent, respectively at end-2021,²¹ while estimates of an econometric model suggest overvaluations of 10–15 percent at 2021Q3. Meanwhile, a city-level panel model suggests greater overvaluation in the largest cities.²² Mortgage origination has also been strong and lending standards appear somewhat loose in certain segments. For example, according to different private sector data sources, between 7 and 20 percent of mortgage loans exceed the underlying property value (e.g., Text Figure 11).²³ With these vulnerabilities in mind, the authorities appropriately raised the counter-cyclical capital buffer to 0.75 percent, from zero previously, and introduced a sectoral systemic risk buffer of two percent on loans secured by domestic residential real estate to apply from February 1, 2023. The authorities have also cautioned banks against taking excessive risks in mortgage lending. However, legal concerns and a lack of comprehensive data on lending standards remain obstacles to the activation of borrower-based measures, like the imposition of limits on loan-to-value ratios on new lending. As noted in the FSAP, precautionary use of borrower-based measures is warranted, and the authorities should remove obstacles to their activation by modifying the law on borrower-based measures, while in the interim strengthening guidance on lending standards (for example, encouraging banks to adhere to loan-to-value ratio limits through issuing a Guidance Note to banks). The authorities are also urged to accelerate the closure of data gaps and add income-based measures into the macroprudential toolkit.

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Germany: Mortgages in Excess of the Property Value

(Percent of mortgages)

Citation: IMF Staff Country Reports 2022, 229; 10.5089/9798400216497.002.A001

Sources: Europace and Vdp.

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Authorities’ Views

38. While generally sharing staff’s assessment of financial sector health and recommendations, the authorities assessed that risks in the housing market do not warrant the activation of borrower-based measures at this juncture. The authorities appreciated the FSAP’s stress tests of bank solvency and liquidity and found the results to be in line with their expectations. They are aware of U.S. dollar liquidity risks at some LSIs but judge that these are already sufficiently managed in the supervisory process. They emphasized the risk-sharing that takes place between savings and cooperative banks and their regional wholesale bank partners. The authorities highlighted the appropriateness of the macroprudential policy package announced by BaFin in January 2022. They noted that important data gaps on lending standards will be closed in 2023 and legislative proposals are being drafted to add income-based instruments to the toolkit. Furthermore, the Bundesbank has set up a project dedicated to monitoring the effects of the macroprudential policy package—inter alia its effects on lending standards. Existing private sector data on LTV and DSTI ratios currently provide mixed signals. On financial safety nets, the authorities considered that maintaining the existing multiple deposit guarantee schemes appropriately reflects the three-pillar structure of the German banking system.

F. Governance and Transparency

39. FATF indicated in 2010 and 2014 that Germany’s anti-money laundering and countering the financing of terrorism (AML/CFT) measures are generally sound, but implementation needs strengthening in some areas. Preventive measures relevant for helping prevent foreign officials from laundering the proceeds of corruption largely comply with the AML/CFT standards and are well implemented by most, especially larger, financial institutions but some smaller non-financial businesses find such implementation challenging. Information on beneficial ownership of companies and trusts is available (through a Transparency Register) for use by the private sector and by the authorities in investigations, and to provide to foreign partners but some gaps exist. Germany provides good assistance to other countries in foreign corruption cases and prosecutes and obtains convictions for ML related to corruption, as well as freezes and confiscates proceeds of foreign corruption. The authorities should continue to strengthen the AML/CFT system, by: (i) continuing to focus, in AML/CFT supervision, on enhancing compliance with customer due diligence requirements and reporting of suspicious transactions as well as using more remedial actions and sanctions to deal with non-compliance; (ii) strengthening AML/CFT supervision of sectors favored by foreign corrupt actors such as lawyers and trust and company service providers; (iii) continuing to improve the availability of beneficial ownership information in the Transparency Register; and (iv) putting more emphasis during criminal investigation on pursuing money laundering independently of the underlying crime.

40. The government has taken measures to reduce fraud cases related to the COVID relief measures, which would also be useful for future firm subsidy programs, including envisaged energy subsidies. The implementation of COVID-related firm support programs and associated criminal proceedings are carried out by Länder governments. Through March 2022, Länder reported about 24,000 cases in which investigation proceedings were open, with the majority pertaining to the first Immediate Assistance Programme in 2020. To reduce misuse in the assistance programs, the government has refined the approval process and enhanced screening criteria within the process (e.g., applications for companies were required to be made by tax consultants, auditors, or lawyers in order to guarantee an additional assessment of admissibility). Furthermore, it also introduced an automated comparison of application data with the data of tax authorities.

Authorities’ Views

41. The authorities agreed with staff’s assessment on the AML/CFT system and noted a range of ongoing initiatives to further strengthen the system. In 2021, the government implemented the FATF “Travel Rule,” requiring virtual asset providers to collect and share customer data for transactions over a certain threshold. In March, BaFin restructured its AML department, aiming to focus on specific issues (e.g., banks, non-bank financial institution, digital supervision, strategy, and national coordination). BaFin has also been stepping up targeted training of AML/CFT supervisory staff and enhancing information exchanges across government entities. Federal and Lander coordinating offices are currently conducting in-depth analysis of AML/CFT risks in the domestic real estate sector, aiming to update the National Risk Assessment (NRA) by end-2022. The government also intends to reflect on findings of the June 2022 FATF assessment.