## IMF Survey: Germany: Policy Lessons from Financial Market Turbulence

_IMF News, April 23, 2008_

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## Bibliographic details
- Authors: Jurgen Odenius IMF European Department April
- Published: April 23, 2008

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### A swift but costly rescue
- The near-collapse of IKB in July (year not restated on page) was precipitated by problems in conduits or special investment vehicles (SIVs) that invested in longer-dated securities and financed them with short-dated commercial paper.
- As defaults on subprime mortgages rose, these vehicles faced rollover difficulties, triggering contractual obligations for sponsoring banks to provide financing.
- A swift rescue limited further fallout but proved costly: by March 2008, estimated rescue costs mounted to almost €8 billion, exceeding the bank's equity about fivefold.
- The rescue of IKB was largely shouldered by the KFW, a public sector bank that owned 38 percent of IKB at the onset of the crisis.
- Sachsen LB faced similar difficulties in August 2007 and was rescued by Germany's largest public sector bank.
- West LB required a rescue package in early 2008; many other banks, including Bayern LB and Deutsche Bank, reported larger than expected writedowns.

### Structural challenges
- Deep-rooted fragmentation has kept interest margins low by international standards.
- Germany's banking sector has made only modest progress in generating income from nontraditional services.
- Sector-wide profitability remains low, which can incline banks to take on excessive risks.
- High leverage ratios and the large scale of conduits operated by rescued institutions exemplify the excessive-risk profile.
- The turbulence raises questions about the viability of many banks’ business models, especially the Landesbanken.

### Banking sector restructuring
- Banking sector consolidation is proceeding amid heightened competitive pressures: the number of banks has declined by approximately one quarter since the beginning of this decade.
- Public sector banks have been critical to consolidation, but public mergers have often been ad hoc.
- Current consolidation mainly within the public pillar of the three-pillar banking system (private, cooperative, public) risks creating regional banks that may not withstand global competition.
- Policy recommendations:
  - Ensure market forces and private sector capital can play their legitimate role in consolidation.
  - Broaden private sector investment opportunities in the public pillar (example cited: HSH Nordbank in 2006).
  - Lift regional limitations on the business operations of publicly owned savings banks to enhance efficiency.
  - Avoid political compromises that constrain future options.

### Strengthening supervision
- Failures in U.S. mortgage origination and in internationally accepted ratings methodology contributed to the crisis; risks from conduits were underestimated even though operations were broadly known to supervisors.
- Current supervision relies on both the Bundesbank and BaFin (Federal Financial Supervisory Authority).
- A recently revised protocol has reduced duplication of supervisory visits, but further consolidation of bank supervision and prudential enforcement in either institution would increase accountability.
- Regulatory positioning:
  - Regulation should stay with BaFin to maintain its role as a consolidated supervisory agency.
  - Under any supervisory arrangement, the Bundesbank must have all necessary information to fulfill financial stability and lender-of-last-resort responsibilities.

### Support crisis prevention
- Effective implementation of Basel II minimum capital adequacy standards will require:
  - Reduced reliance on external auditors.
  - Stepped-up efforts to attract and retain skilled supervisors.
- Greater transparency and stronger incentives for prudent action will support crisis prevention and management.
- Bank resolution framework improvements recommended:
  - Allow quick resolution while improving management incentives through possible dilution of private shareholders' equity.
  - Supervisors should require more frequent financial statements.
  - Encourage more widespread use of International Financial Reporting Standards to better capture off-balance-sheet activity.

*IMF Survey: Germany: Policy Lessons from Financial Market Turbulence — IMF European Department, April 23, 2008.*

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## References

- [https://www.imf.org/en/News/country-focus](https://www.imf.org/en/News/country-focus)
- [PRESS CENTER](http://presscenter.imf.org/)
- [IMF Country Focus](https://www.imf.org/en/news/country-focus)
- [Read the assessment](https://www.imf.org/external/pubs/cat/longres.cfm?sk=21759.0)
- [IMF Board discussion](https://www.imf.org/external/np/sec/pn/2008/pn0826.htm)
- [Germany and the IMF](https://www.imf.org/external/country/DEU/index.htm)
- [Statement by IMF on Germany](https://www.imf.org/external/np/ms/2007/121007.htm)
- [German inflation not a worry](https://www.imf.org/external/pubs/ft/survey/so/2008/CAR022708A.htm)
- [Major German budget reforms](https://www.imf.org/external/pubs/ft/survey/so/2007/CAR1121A.htm)
- [European outlook](http://www.imf.org/external/pubs/ft/survey/so/2008/CAR042108A.htm)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/socar042308a_