Transcript of Conference Call on the Completion of Article IV Consultation with Germany

IMF News, June 29, 2016

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Bibliographic details

• Published: June 29, 2016

Participants and logistics

• Date: June 29, 2016
• Organizers: IMF Communications Department, MEDIA RELATIONS
• Contact: Phone: +1 202 623-7100; Email: MEDIA@IMF.org
• Speakers: Enrica Detragiache (Assistant Director, European Department; IMF Mission Chief for Germany, Article IV) and Michaela Erbenova (Division Chief, Financial Supervision & Regulation Division, Monetary & Capital Markets Department; IMF Mission Chief for Germany, FSSA)
• Reports finalized: June 10, 2016 (Article IV documentation and FSSA)

Economic outlook and growth projections

• Recent growth characterized as "moderate" and expected to be led by domestic demand rather than foreign demand.
• Supporting factors identified:
  • good wage growth
  • low energy prices
  • expansionary fiscal and monetary policies
• Forecast caveat:
  • The released forecast was prepared before the U.K. vote; it is already under review.
  • The U.K. decision to leave the European Union is identified as a downside risk for Germany.
  • The IMF is preparing a new set of forecasts for all member countries as part of the forthcoming update to the World Economic Outlook; an update is expected "around the middle of July."
• On revisions relative to the World Economic Outlook: revisions in this round were described as "really minimal."
• On immediate market reaction to the U.K. vote: "massive, but also not excessively disorderly."

Medium-term challenges and structural reforms

• Key medium-term risks to growth:
  • Population aging: "going to happen faster than in any other country."
  • Slowing productivity growth in advanced countries, including Germany.
  • Combined effect described as a "double down-draft on long-term growth" from fewer workers and lower productivity.
• Policy recommendations to boost medium-term potential:
  • incentivize women to work longer hours
  • prolong working lives for all workers
  • better labor market integration for immigrants
• Urgent message: encourage German authorities to "deal more forcefully with the challenging structural reforms" described in the report and accompanying blog.

Financial Sector Stability Assessment (FSSA) — overall findings

• Frequency: Germany undergoes the FSSA every five years; this was the first such IMF staff assessment in euro area countries since the launch of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM).
• Overall conclusion: Germany's financial system "as a whole appears resilient to risks that we have identified," but faces longstanding profitability challenges.
• Profitability pressures exacerbated by the prevailing low interest rate environment, affecting both banks and insurers.
• Identified needs:
  • increased review of business models in light of prolonged low interest rates
  • completion of regulatory and supervisory reforms
  • expanded capacity to monitor financial stability risks and cross-sectoral spillovers using more granular and comprehensive data
  • development and deployment of necessary macro-prudential instruments
  • continued reforms of banking supervision with a focus on:
  • improving banks’ risk management practices
  • improving corporate governance
  • more thorough regulation and supervision of related-party exposures and of operational risk

Specific FSSA observations on exposures and market effects

• Cross-border banking exposures:
  • Exposures to the United Kingdom are the second-largest after exposures to the United States but are "small in absolute terms."
  • Largest share of exposures to the U.K. is to the non-bank private sector.
  • These exposures "will take some time to materialize" in terms of impact on German banks.
• Observed market reaction post-U.K. vote:
  • Flight-to-quality effects; German government bonds retained safe-haven status with reduced yields.
  • Reduced yields lead to cheaper refinancing for banks but also further pressure on interest rates and returns from domestic sovereign portfolio and other exposures.
• Insurance sector:
  • No expectation of significant direct impact on solvency ratios from immediate market movements.
  • German insurers have "long, stable and well-diversified liabilities," mitigating potential liquidity risks.
  • German insurers hold relatively small amounts of pound-denominated corporate bonds; thus, corporate bond spread increases are not expected to have a material direct impact.

Banking and insurance profitability dynamics

• Structure of the German banking sector:
  • Dominated by banks; highly heterogeneous (large global institutions plus many savings and cooperative banks).
  • Savings and cooperative banks: traditional business model dependent on net interest income and relationship-based, cost-intensive models with extensive branch networks and employees.
  • Consolidation trend: number of institutions has fallen "by about 100" since the previous FSSA; consolidation has continued since the mid-1990s.
• Impact of negative/low interest rates:
  • Low interest rates can be beneficial (support loan demand, improve creditworthiness) but negative interest rates may accelerate margin compression.
  • German banks have a large deposit base and have been largely unwilling or legally unable to pass on negative rates to depositors, squeezing interest margins as mortgages reprice downward.
• Insurers:
  • Many German insurers rely on traditional life insurance products with relatively high guaranteed rates of return; the low-rate environment stresses their ability to meet those guarantees.
  • Product redesign and gradual liability replacement would be required to adapt, but this is a gradual process.

Assessment of European institutional changes: SSM and SRM

• Institutional context:
  • SSM has been in operation "for a little over a year."
  • SRM was launched "at the beginning of 2016."
• Team judgment: assessments of SSM and SRM functioning are necessarily early-stage judgments given limited practical experience.
• Positive view: both SSM and SRM "made great progress" and "have the potential to greatly improve supervision and crisis management framework in Germany."
• Concerns and recommendations:
  • Existing decision-making structures may lead to "lengthy and very complex decision-making."
  • Advice to authorities: consider ways, within the existing legal framework, to simplify routine decision-making to make supervision and resolution "timely and more efficient and more responsive to the needs."

Policy stance and immediate responses to Brexit-related uncertainty

• On fiscal response: premature to recommend policy responses (such as increased spending) before assessing the impact of the shock.
• IMF next steps: prepare updated forecasts in the forthcoming World Economic Outlook update to provide a first assessment of the U.K. vote's effects.
• Market interventions: major central banks provided liquidity and steps that "appear to have been helpful so far" in curtailing excess volatility.

Notable references within the documentation

• FSSA cross-border exposure charts: referenced as on "Page 14" of the FSSA documentation.
• Discussion on susceptibility to negative interest rates: referenced as on "Page 15" of the Financial Stability Assessment Report.

Transcript of Conference Call on the Completion of Article IV Consultation with Germany — June 29, 2016; IMF Communications Department (participants: Enrica Detragiache; Michaela Erbenova; Wiktor Krzyzanowski).

References

• Germany and the IMF
• United Kingdom and the IMF
• IMF Policy Advice -- A Factsheet
• Financial Sector Assessment Program (FSAP)
• Transcripts
• PRESS CENTER
• https://www.imf.org/en/home