Globally Important German Financial System is Resilient

IMF News, June 29, 2016

Source details

Publication date: June 29, 2016
Headline assessment: The German financial system, home to systemically important financial institutions, has been bolstered by EU-wide and global reforms but faces risks from low interest rates and the transition to new supervisory and resolution mechanisms.

The German financial sector is complex and characterized by:
- "more than 1,700 institutions" in the banking sector.
- A large number of insurers operating in a competitive environment.
- High degree of interconnectedness domestically and internationally.
Global systemically important institutions based in Germany cited:
- The insurer Allianz SE.
- The bank Deutsche Bank AG.
- The clearing house Eurex Clearing AG, which provides services to almost 190 clearing members from a large number of countries.
Implication: Outside influences can affect developments in Germany, and developments in Germany can have major global repercussions. This increases the importance of risk management, intense supervision of systemic institutions, and close monitoring of cross-border exposures.

Post-2011 transformations:
- Many institutions are reconsidering their business models following the financial crisis.
- The Landesbanken sector has seen important consolidation.
New European institutional framework introduced:
- Single Supervisory Mechanism (SSM) established and introduced in 2015.
- Single Resolution Mechanism (SRM) and the Single Resolution Board established new rules for crisis preparedness and bank resolution.
Germany’s role:
- Germany plays a key role in European reforms and global standard setting.
- A number of important regulatory initiatives implemented since 2011.
Overall judgment: With these reforms, the German financial sector appears resilient to the risks identified, but significant headwinds remain.

Banks:
- German banks’ business models are highly dependent on interest income.
- ECB policy example: the European Central Bank charges "-0.4% annually" on bank deposits.
- Bank vulnerabilities: maturity transformation business models, large branch networks, high overhead costs, and net interest income as the most important component of profits.
- Deposit pass-through: Banks have so far been unwilling, or even legally unable, to pass on negative interest rates to depositors while assets have begun repricing to lower interest rates.
- Result: Squeezed interest margins and profitability concerns absent major restructuring.
- Monitoring note: The IMF will continue to monitor developments closely after the U.K. vote (U.K. referendum on June 24).
Insurers:
- Traditional life insurance models offering guaranteed rates relatively high compared to prevailing interest rates make insurers vulnerable over the medium- to long-term.
- New solvency framework for insurers in Europe introduced in the year of publication (2016), based on a more risk-based forward-looking approach, adds pressures in a low interest environment.
- Offsetting factors: Insurers have maintained significant loss absorption capacity, partly due to German measures since 2011 that tightened regulatory requirements.
- Supervisory response: Supervisors are enhancing oversight to ensure insurers can continue meeting commitments to policy holders in the medium term.

Supervision under the SSM:
- The IMF was positively impressed by achievements in a relatively short period since SSM inception.
- Supervision is now more quantitatively based, with new approaches for direct assessment of credit risk.
- Recommended improvements for Germany: corporate governance, internal audit and compliance functions, and strengthening regulation of related party risk and major acquisitions.
- Process issues: Decision-making under the SSM is "very complicated" and can be cumbersome, resulting in a long reaction time between spotting a problem and taking supervisory action.
- Recommendation: Streamline day-to-day decision-making processes to the extent possible within the existing legal framework.
Recovery and resolution under the SRM:
- Large domestic banks required to have recovery plans; requirement being rolled out to smaller banks.
- Authorities intend to rely on bail-in to resolve systemic banks to safeguard taxpayer resources.
- Policy choice noted: Authorities have decided not to introduce extraordinary government financial stabilization tools available in European legislation — a legitimate policy choice that constrains their toolkit in a systemic crisis.
- Urgent priorities: Operationalize the new framework and test cooperation between the Single Resolution Board, the ECB, and German authorities in a crisis simulation exercise.

Supervisory data needs:
- Importance of more comprehensive and granular data for supervisors.
- EU reporting is harmonized with standardized templates used by German banks, but these are insufficient for comprehensive analysis and supervision.
- Need to map national accounting principles used by many German banks into the international accounting standards used across the EU.
- More granular data required to strengthen macroprudential and financial sector risk analysis and to calibrate macroprudential tools.

Source: IMF News article "Globally Important German Financial System is Resilient", June 29, 2016.