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IMF Country Report No. 22/231

GERMANY

FINANCIAL SYSTEM STABILITY ASSESSMENT

July 2022

In the context of the Germany’s Financial System Stability, the following document has been released and is included in this package:

• The Financial System Stability Assessment (FSSA) for Germany, prepared by a staff team of the IMF for the Executive Board’s consideration on July 18, 2022. This report is based on the work of an IMF Financial Sector Assessment Program (FSAP) mission to Germany during May 2021 and April 2022. The FSSA report was completed on June 27, 2022.

The IMF’s transparency policy allows for the deletion of market-sensitive information and premature disclosure of the authorities’ policy intentions in published staff reports and other documents.

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GERMANY

FINANCIAL SYSTEM STABILITY ASSESSMENT

June 27, 2022

KEY ISSUES

Context: Germany entered COVID-19 with strong public and private sector balance sheets, and large financial buffers. The financial sector has weathered well the shocks related to COVID-19 and the impact of the war has been limited so far. However, financial conditions have tightened recently and risks to the economy and the financial system have increased. The main risks relate to an escalation of the war that could be associated with a Russian gas shut off and higher commodity prices, a global resurgence of COVID-19 with extended supply chain disruptions, and de-anchoring of inflation expectations in the U.S. and advanced Europe. Structural vulnerabilities related to persistent low bank profitability and misalignments in the real estate sector prices indicated in the 2016 FSAP remain a concern.

Findings: Overall, banks are largely resilient to solvency and liquidity shocks, but there are pockets of vulnerabilities that require attention. The macroprudential framework is well developed but can be strengthened further. Good progress has been achieved in the strengthening of the microprudential frameworks for banking and insurance, with some remaining issues, including those related to BaFin’s operational independence. There has also been significant progress on resolution planning and crisis preparedness, but the deposit insurance framework would benefit from a strong public backstop. Clearstream Banking AG Frankfurt (CBF) is a trusted part of the financial market infrastructure landscape. In line with the authorities’ findings, the FSAP found climate transition risks to the banking sector appear to be small.

Policies: Going forward, the FSAP proposes the following directions for policies: (i) continued monitoring of large systemically important commercial banks’ prudential ratios, and strengthening of interest rate risk monitoring of less significant institutions and conducting top down stress testing of interest rate risks; (ii) enhancing legislated powers over yet-to-be activated borrower-based instruments to facilitate their effective use, and rapidly introducing powers to set debt-to-income and debt service limits; (iii) introducing further reforms of the institutional framework to strengthen BaFin’s operational independence, strategic coordination between BaFin and the Bundesbank, and the legal framework and approach to corporate governance in the financial sector; (iv) further strengthening and simplifying the insurer solvency framework, including BaFin’s contingency and resolution powers for insurers; and (v) establishing a single mandatory deposit guarantee scheme as a public body, with access to a robust backstop liquidity line would facilitate greater risk pooling and diversification.

Approved By

May Khamis (MCM) and Laura Papi (EUR)

Prepared By

Monetary and Capital Markets Department

• The FSAP team was led by Prasad Ananthakrishnan (Mission Chief), and included Maria Oliva (Deputy Mission Chief), Mark Adams, Gerard Almekinders, Dan Cheng, Dirk Jan Grolleman, Argyris Kahros, Roland Meeks, Alla Myrvoda, Marco Pani, Thierry Tressel, Sebastian Weber (all MCM), Steve Dawe (LEG), Aiko Mineshima (EUR), and Dale Connock, Michael Hafeman, and Geraldine Low (external experts). Suellen Basilio provided administrative assistance.

• The mission met with Bundesbank Vice-President, Claudia Buch; Bundesbank Director Generals of Financial Stability and of Banking and Financial Supervision; BaFin President, Mark Branson; BaFin Director-General International Policy, Financial Stability and Regulation; Ministry of Finance Director-General for Financial Markets Policy; officials of European Central Bank and European Systemic Risk Board; Chief Executive Officer and other high ranking officials of Clearstream; as well as senior representatives of domestic and foreign banks, insurance companies, and the wider services industry.

• FSAPs assess the stability of the financial system as a whole and not that of individual institutions. They are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion. Certain categories of risk affecting financial institutions, such as operational or legal risk, or risk related to fraud, are not covered in FSAPs.

• Germany is deemed by the Fund to have a systemically important financial sector according to Mandatory Financial Stability Assessments Under the Financial Sector Assessment Program – Update (11/18/2013), and the stability assessment under this FSAP is part of bilateral surveillance under Article IV of the Fund’s Articles of Agreement.

• This report was prepared by Prasad Ananthakrishnan and Maria Oliva, with contributions from the members of the FSAP team.

Contents

• Glossary

• EXECUTIVE SUMMARY

• BACKGROUND

• Context and Macrofinancial Developments

• Financial Sector Landscape

• SYSTEMIC RISK ASSESSMENT

• Macro-Financial Vulnerabilities and Systemic Risk

• Macroprudential Framework and Policy

• Microprudential Oversight

• Crisis Management and Safety Nets

• Financial Integrity

• AUTHORITIES' VIEWS

• FIGURES

• 1. Economic Developments

• 2. The Pandemic in Germany and Government Support

• 3. Credit Standards and Growth

• 4. Non-Financial Corporates’ Insolvency Filings and NPLs

• 5. Residential and Commercial Real Estate Price Dynamics

• 6. Financial Sector Overall Structure, 2016 to 2021

• 7a. Domestic Exposures of Financial Institutions

• 7b. Cross-Border Exposures of Financial Institutions

• 8. Banks’ Business Model

• 9. MFIs’ Exposure to Real Estate and Construction

• 10. Residential and Commercial Property Price-at-Risk

• 11. Macroeconomic Scenarios

• 12. Global Macrofinancial Model Simulations

• 13. Solvency Stress Tests for SIs

• 14. Solvency Stress Tests for LSIs

• 15. LCR and NSFR

• 16. Cash Flow Analysis Results

• 17. Cash Flow Analysis Results, FX

• 18. Bank Contagion Analysis

• 19. Corporate Sector Vulnerabilities—Sensitivity Analysis

• 20. Corporate Sector and Dynamic-Based Regression Analysis

• 21. Simulation of Macroeconomic Impact of Germany’s Mitigation Policy

• 22. German Banks’ Expected Credit Losses Under Climate Mitigation

• 23. German DGS and IPSs

• 24. Pre-Pandemic Buffers

• 25. Recent Developments in Banking Sector Liquidity

• 26. Financial System Structure

• 27. Banking Sector

• 28. Bank Profitability

• 29. Real Estate Markets Developments

• 30. Banks’ Exposure to Real Estate Markets

• 31. Simulated Output Growth Shocks in Key Countries in the GFM Adverse Scenario

• TABLES

• 1. Key Recommendations

• 2. Banking Sector Soundness Indicators (December 2021, in percent)

• 3. Household Sector Macroprudential Tools, Selected OECD Countries

• 4. Selected Economic Indicators (2021-23)

• 5. Financial Soundness Indicators (2008-2021)

• 6. Risk Assessment Matrix (RAM)

• APPENDICES

• I. Banking Sector Stress Testing Matrix

• II. Implementation of 2016 FSAP Recommendations—Staff’s Assessment

Glossary

Executive Summary

1. The financial sector has weathered the impact of the Covid pandemic and the war in Ukraine relatively well so far, but risks remain elevated. High pre-crisis capital and liquidity buffers, strong public and private sector balance sheets, and unprecedented ECB support and fiscal measures supported the economy and the banking sector and helped keep nonperforming loans (NPLs) low. However, while Germany’s financial system has a limited direct exposure to Russia, the war is likely to exert a material drag on GDP growth through higher energy prices, tighter financial conditions, and elevated uncertainty, as well as disruptions in supply chains, including energy supply; and inflation is expected to spike to above 7 percent in 2022.

2. The two structural vulnerabilities identified in the 2016 FSAP, namely low bank profitability and misalignments in the residential real estate prices, remain a concern. Rising interest rates may further squeeze banks’ interest margins over the short-to-near term due to the growing duration mismatch between assets (mortgages) and liabilities (customer deposits). Furthermore, the residential real estate price overvaluation and higher tail risks since the onset of the pandemic suggest potential pockets of vulnerabilities in banks’ exposures to real estate. The FSAP welcomes progress towards closing residential real estate data gaps to support risk monitoring and calibration of macroprudential tools, but more is needed for closing gaps on lending standards.

3. The FSAP solvency stress tests show that the significant institutions (SIs) and less significant institutions (LSIs) are overall resilient to an adverse scenario. The main risks to financial stability relate to a global resurgence of COVID-19 with extended supply chain disruptions, a scarcity of gas and oil, and de-anchoring of inflation expectations in the U.S. and advanced Europe. Under the FSAP’s V-shaped adverse scenario, for SIs, the capitalization levels of three banks fall below the 8.25 percent hurdle rate in 2022-23 but remain above the minimum common equity tier 1 (CET1) ratio. LSIs’ aggregate capital levels remain high under the adverse scenario, with the capital of 20 small banks (comprising 3 percent of total LSIs’ assets) falling below the hurdle rate.¹ The analysis also portrays a banking system that appears generally resilient to liquidity stress. Under severely stressed conditions, some banks might require access to the central bank’s U.S. dollar swap line. To ensure continued robustness of the banking system, the FSAP recommends continued close monitoring of large SIs’ prudential ratios, establishing microprudential buffers (Pillar 2 guidance) for less-capitalized banks as needed, strengthening LSIs’ interest rate risk monitoring and conducting top-down stress tests for interest rate risks, and continuing the close monitoring of larger LSIs with significant foreign exchange exposures.

4. Consistent with the authorities’ findings, the FSAP found small vulnerabilities from climate transition risks to the banking system. The authorities should continue to expand their and banks’ capacity for assessing climate risks and encourage climate-related disclosures in the financial sector. Conducting supervisory climate stress tests for LSIs could be considered.

5. Macroprudential policy is being tightened but rising cyclical vulnerabilities will require additional action. The announced increases in the countercyclical capital buffer (CCyB) of 0.75 percent by Q1 of 2023 and sectoral systemic risk buffers (SSyRB) were well timed and coordinated across the financial stability agencies. But complementary measures are needed and factors delaying the activation of borrower-based tools (e.g., legal and data gaps) need to be addressed. The FSAP recommends enhancing powers over the legislated, but yet-to-be activated, loan-to-value and amortization instruments to facilitate their effective use, and the rapid introduction of additional powers to set debt-to-income and debt service limits. It also urges the authorities to strengthen current guidance to banks on residential real estate lending standards, and develop a communication strategy to support the activation of borrower-based measures.

6. Good progress had been made in strengthening the microprudential frameworks for banking and insurance since the 2016 FSAP. In response to three idiosyncratic cases of bank distress since the 2016 FSAP, the Federal Ministry of Finance (MoF) launched the BaFin reorganization program with several legal and structural reforms. The authorities fully rolled out the European Central Bank (ECB)/Single Supervisory Mechanism (SSM) approach to the Supervisory Review and Evaluation Program to all LSIs in 2020 and enhanced the frameworks for liquidity and operational risks. Going forward, further reforms are required to streamline the current reporting to the MOF to strengthen BaFin’s operational independence; and enhance strategic coordination between BaFin and the Bundesbank, the legal framework and approach to corporate governance, and certain aspects of the overall supervisory framework (e.g., the frequency of onsite inspections for banks and insurers and the role of external auditors). The FSAP also suggests that the authorities further strengthen and simplify the solvency framework and BaFin’s contingency and resolution powers for insurers. Finally, as the largest host of fintech in continental Europe and a proactive participant in the development of European Union (EU) regulation, the FSAP recommends the national authorities step up efforts on fintech data collection, forward looking dynamic market monitoring, and related financial stability analysis.

7. The system of Deposit Guarantee Schemes (DGS)/Institutional Protection Schemes (IPS) needs reform, which should be informed by a review of the distortions resulting from depositors’ high level of protection guaranteed under the current regime. There has been significant progress since the 2016 FSAP on resolution planning and preparedness, with resolution powers broadly in line with best practice and internal resolution processes well developed. Further reforms should include the adoption of a single mandatory deposit guarantee scheme, established as a public body and with a robust government-backed liquidity backstop. This would facilitate greater risk pooling and diversification. The authorities should also address the systemic risk associated with IPS in their recovery and resolution planning work.

8. Clearstream Banking AG Frankfurt (CBF) is underpinned by a solid legal basis and comprehensive and robust frameworks for managing risk. To further enhance CBF practices, the FSAP recommends strengthening the independence of internal control functions at the level of the Executive Board and appointing an independent member as Chair of the Risk Committee.

Table 1.

Germany: Key Recommendations

¹I = Immediate (within one year); NT = Near Term (within 1 to 3 years); MT=Medium Term (within 3 to 5 years).

Table 1.

Germany: Key Recommendations

	Timing1	Agency
Systemic Risk Analysis
Given the elevated uncertainty from a financial stability perspective, continue to closely monitor large SIs prudential ratios and set microprudential (Pillar II guidance) buffers for large SIs, as needed. (¶33)	NT	ECB
Perform top-down stress tests of interest rate risks. (¶33)	I/NT	BaFin/Bundesbank
Strengthen monitoring of larger LSIs with significant FX (USD) exposures to mitigate liquidity risk. (¶31)	NT	BaFin
Climate Transition Risks
Expand the analytical capacity of banks for assessing climate risks, promote the disclosure of climate risks; conduct supervisory climate stress tests for LSIs to facilitate such efforts. (¶38)	NT	BaFin/ Bundesbank
Macroprudential Framework and Policy
Enhance the legislated powers over yet-to-be activated borrower-based instruments to facilitate their effective use, and rapidly introduce powers to set debt-to-income and debt service limits. (¶44)	NT	MoF/BaFin/Bundesbank
Strengthen current guidance on residential real estate lending standards. (¶44)	NT	MoF/BaFin/ Bundesbank
Initiate the development of a communication strategy in support of the activation of borrower-based measures. (¶44)	NT	MoF/BaFin/Bundesbank
Close data gaps on lending standards to monitor existing and evolving risks. (¶23)	I	Bundesbank
Supplement the toolkit to assess real estate risks with price-at-risk model for commercial and residential real estate prices. (¶22)	NT	Bundesbank
Supervision and Regulation: Banking and Insurance
Strengthen BaFin’s operational independence and strategic cooperation between BaFin and Bundesbank on banking supervision. (¶48, 49)	I	BaFin/ MoF/ Bundesbank
Align the corporate governance framework with international best practices; provide additional supervisory guidelines to align MaRisk with EBA Guidelines on key banking risk issues. (¶50, 52)	NT/MT	BaFin/Bundesbank
Review the minimum engagement level and inspection frequency, strengthen the ability to effectively challenge external auditor’s work, and make earlier use of corrective and sanctioning powers. (¶51, ¶53, ¶67)	NT	BaFin/ Bundesbank
Step up efforts on fintech data collection, forward looking dynamic market monitoring and related financial stability analysis. (¶55)	NT	BaFin/Bundesbank
Take steps to strengthen the solvency framework for insurers. (¶56)	I	BaFin/MoF
Clearstream and Financial Market Infrastructure
Improve the independence of the internal control functions at the Executive Board level. (¶58)	NT	CBF/BaFin
Broaden Clearstream’s explicit identification criteria for clients of direct participants by including system-level thresholds. (¶59)	NT/MT	CBF/BaFin
Crisis Management and Financial Safety Nets
Ensure robust planning for financial distress of IPSs, including planning for recovery and resolution at a consolidated level, promoting review of EU legislation if necessary. (¶63)	NT	BaFin/MoF
Establish a single mandatory DGS as a public body, with access to a robust backstop liquidity line. (¶62)	NT	MoF

¹I = Immediate (within one year); NT = Near Term (within 1 to 3 years); MT=Medium Term (within 3 to 5 years).

View Table

Table 1.

Germany: Key Recommendations

	Timing1	Agency
Systemic Risk Analysis
Given the elevated uncertainty from a financial stability perspective, continue to closely monitor large SIs prudential ratios and set microprudential (Pillar II guidance) buffers for large SIs, as needed. (¶33)	NT	ECB
Perform top-down stress tests of interest rate risks. (¶33)	I/NT	BaFin/Bundesbank
Strengthen monitoring of larger LSIs with significant FX (USD) exposures to mitigate liquidity risk. (¶31)	NT	BaFin
Climate Transition Risks
Expand the analytical capacity of banks for assessing climate risks, promote the disclosure of climate risks; conduct supervisory climate stress tests for LSIs to facilitate such efforts. (¶38)	NT	BaFin/ Bundesbank
Macroprudential Framework and Policy
Enhance the legislated powers over yet-to-be activated borrower-based instruments to facilitate their effective use, and rapidly introduce powers to set debt-to-income and debt service limits. (¶44)	NT	MoF/BaFin/Bundesbank
Strengthen current guidance on residential real estate lending standards. (¶44)	NT	MoF/BaFin/ Bundesbank
Initiate the development of a communication strategy in support of the activation of borrower-based measures. (¶44)	NT	MoF/BaFin/Bundesbank
Close data gaps on lending standards to monitor existing and evolving risks. (¶23)	I	Bundesbank
Supplement the toolkit to assess real estate risks with price-at-risk model for commercial and residential real estate prices. (¶22)	NT	Bundesbank
Supervision and Regulation: Banking and Insurance
Strengthen BaFin’s operational independence and strategic cooperation between BaFin and Bundesbank on banking supervision. (¶48, 49)	I	BaFin/ MoF/ Bundesbank
Align the corporate governance framework with international best practices; provide additional supervisory guidelines to align MaRisk with EBA Guidelines on key banking risk issues. (¶50, 52)	NT/MT	BaFin/Bundesbank
Review the minimum engagement level and inspection frequency, strengthen the ability to effectively challenge external auditor’s work, and make earlier use of corrective and sanctioning powers. (¶51, ¶53, ¶67)	NT	BaFin/ Bundesbank
Step up efforts on fintech data collection, forward looking dynamic market monitoring and related financial stability analysis. (¶55)	NT	BaFin/Bundesbank
Take steps to strengthen the solvency framework for insurers. (¶56)	I	BaFin/MoF
Clearstream and Financial Market Infrastructure
Improve the independence of the internal control functions at the Executive Board level. (¶58)	NT	CBF/BaFin
Broaden Clearstream’s explicit identification criteria for clients of direct participants by including system-level thresholds. (¶59)	NT/MT	CBF/BaFin
Crisis Management and Financial Safety Nets
Ensure robust planning for financial distress of IPSs, including planning for recovery and resolution at a consolidated level, promoting review of EU legislation if necessary. (¶63)	NT	BaFin/MoF
Establish a single mandatory DGS as a public body, with access to a robust backstop liquidity line. (¶62)	NT	MoF

¹I = Immediate (within one year); NT = Near Term (within 1 to 3 years); MT=Medium Term (within 3 to 5 years).