Germany: Financial Sector Assessment Program -- Financial System

IMF Country Report No. 16/189

GERMANY

FINANCIAL SECTOR ASSESSMENT PROGRAM

FINANCIAL SYSTEM STABILITY ASSESSMENT

This report on Financial System Stability Assessment on Germany was prepared by a staff

team of the International Monetary Fund. It is based on the information available at the

time it was completed in June 2016.

Copies of this report are available to the public from

International Monetary Fund  Publication Services

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Price: $18.00 per printed copy

International Monetary Fund

Washington, D.C.

June 2016

GERMANY

FINANCIAL SYSTEM STABILITY ASSESSMENT

Approved By

James Morsink

Mahmood Pradhan

Prepared By

Monetary and Capital

Markets Department

This report is based on the work of the Financial Sector

Assessment Program (FSAP) mission that visited Germany in

November 2015 and February–March 2016. The findings were

discussed with the authorities during the Article IV consultation

mission in May 2016. More information on the FSAP may be

found at http://imf.org/external/np/fsap/fssa.aspx

 The team comprised Michaela Erbenová (mission chief), Jodi Scarlata (deputy mission chief),

Ulric Erickson von Allmen, Elias Kazarian, Emanuel Kopp, Cecilia Marian, Fabiana Melo, Jean-

Marc Natal, Nobuyasu Sugimoto, Hans Weenink, Christopher Wilson, and TengTeng Xu (all

IMF staff), as well as Jonathan Fiechter, David Scott, Robert Sheehy, Richard Stobo, Ian

Tower, José Tuya, and Marguerite Zauberman (external experts). David Jutrsa provided

research assistance from Washington. The mission met the Ministry of Finance (MOF), the

Deutsche Bundesbank, Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), the

European Central Bank (ECB), the European Securities and Markets Authority (ESMA), the

Federal Agency for Financial Market Stabilization (FMSA), the European Systemic Risk Board

(ESRB), the Single Resolution Board (SRB), representatives of deposit guarantee schemes,

institutional protection schemes (IPS), industry associations, financial sector firms,

academics, and representatives of the auditing, accounting and legal professions.

 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.

This FSAP evaluates the risks and

vulnerabilities of the German financial system and reviews both the German regulatory

and supervisory framework and implementation of the common European framework

insofar as it is relevant for Germany.

 Germany is deemed by the Fund to have a systemically important financial sector 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 Michaela Erbenová and Jodi Scarlata, with contributions from

the FSAP team members. It draws on several Technical Notes and Detailed Assessment

Reports on compliance with the Basel Core Principles for Effective Banking Supervision

(BCP) and with Principles for Financial Market Infrastructure (PFMI).

June 10, 2016

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CONTENTS

EXECUTIVE SUMMARY ___________________________________________________________________________ 6

MACROFINANCIAL SETTING ____________________________________________________________________ 9

RISKS, RESILIENCE, AND SPILLOVERS _________________________________________________________ 15

A. Key Risks Facing the German Financial System ________________________________________________ 15

B. Financial System Resilience ____________________________________________________________________ 19

C. Systemic Risk and Spillovers ___________________________________________________________________ 29

MACRO- AND MICROPRUDENTIAL OVERSIGHT ______________________________________________ 32

A. Macroprudential Policy Framework____________________________________________________________ 32

B. Microprudential Oversight _____________________________________________________________________ 33

FINANCIAL SAFETY NETS _______________________________________________________________________ 40

BOXES

1. Trends in Residential Real Estate ______________________________________________________________ 11



2. Cyber Risk and Financial Stability in Germany _________________________________________________ 34

FIGURES

1. Real Estate and Shipping Developments ______________________________________________________ 10



2. Financial System Structure _____________________________________________________________________ 12

3. Banking Sector _________________________________________________________________________________ 13

4. Bank Liability Structure by Segment ___________________________________________________________ 17

5. Systemic Risk Indicators _______________________________________________________________________ 18

6. Macroeconomic Scenarios—Key Variables ____________________________________________________ 19

7. Solvency Stress Test ___________________________________________________________________________ 21

8. Low Interest Rates and Bank Profitability ______________________________________________________ 22

9. Sovereign Exposures, Risk Index, and Valuation Losses under Stress __________________________ 23

10. LCR Estimates_________________________________________________________________________________ 24

11. LCR and NSFR Reported by German Banks in the BCBS QIS _________________________________ 25

12. Insurance Earnings, Solvency, and Risk Analysis ______________________________________________ 26

13. Insurance Stress Testing Results ______________________________________________________________ 27

14. Financial Sector Interconnectedness _________________________________________________________ 30

15. Global Systemic Risk __________________________________________________________________________ 31

TABLES

1. FSAP Key Recommendations ____________________________________________________________________8



2. Selected Economic Indicators, 2013–17 _______________________________________________________ 44

3. Financial Soundness Indicators for the Household Sector, 2006–15 ___________________________ 45

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4. Financial Soundness Indicators for the Corporate Sector, 2006–14 ____________________________ 46

5. Financial Soundness Indicators, 2008–14 ______________________________________________________ 47

6. Germany: Risk Assessment Matrix (RAM) ______________________________________________________ 48

ANNEXES

I. Germany: Implementation Status of 2011 FSAP Recommendations ___________________________ 50



II. Structure of the German Banking System ______________________________________________________ 54

III. Landesbanken—Recent Developments _______________________________________________________ 55

IV. Stress Test Matrix (STeM) for the Banking Sector ____________________________________________ 58

V. Stress Test Matrix (STeM) for the Insurance Sector ___________________________________________ 67

VI. Stress Test Matrix (STeM) for Systemic Risk Analysis _________________________________________ 69

VII. Methodology for Systemic Risk and Spillover Analysis _______________________________________ 70

APPENDIX

I. Report on the Observance of Standards and Codes (ROSCs)—Summary Assessments ________ 74

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Glossary

AFS Available for Sale

AIFMD Alternative Investment Fund Managers Directive

AML/CFT Anti-Money Laundering and Combating the Financing of Terrorism

AQR Asset Quality Review

AUM Assets Under Management

BaFin German Federal Financial Supervisory Authority

BCP Basel Core Principles for Effective Banking Supervision

BIS Bank for International Settlements

BO Beneficial Ownership

BRRD Bank Recovery and Resolution Directive

BU Bottom-up (stress test)

CCB Countercyclical Capital Buffer

CCP Central Counterparty

CDS Credit Default Swaps

CET1 Common Equity Tier 1 Capital

CMG Crisis Management Group

CPMI Committee on Payments and Market Infrastructures

CPSS Committee on Payment and Settlement Systems

CRDIV Capital Requirements Directive

CRE Commercial Real Estate

CRR Capital Requirements Regulation

CSD Central Securities Depository

CVA Credit Valuation Adjustment

DGSD

EBA

ECB

Deposit Guarantee Scheme Directive

Euro area

European Banking Authority

European Central Bank

DNFBP Designated Non-financial Businesses and Professions

EEA

EIOPA

European Economic Area

European Insurance and Occupational Pension Authority

ELA Emergency Liquidity Assistance

EM Emerging Markets

EMIR European Market Infrastructure Regulation

ESMA European Securities and Markets Authority

ESRB European Systemic Risk Board

FMI Financial Market Infrastructure

FMSA Federal Agency for Financial Market Stabilization

FSB Financial Stability Board

FSC Financial Stability Committee

FX Foreign Exchange

G-SIBs Global Systemically Important Banks (designated by the FSB)

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G-SIIs

Global Systemically Important Insurers (designated by the FSB)

IAIS

International Association of Insurance Supervisors

ICAAP

Internal Capital Adequacy Assessment Process

ILAAP

Internal Liquidity Adequacy Assessment Process

IOSCO

International Organization of Securities Commissions

IPS

Institutional Protection Scheme

IRRBB

Interest rate risk in the banking book

HQLA

High Quality Liquid Assets

Households

KA FSB’s Key Attributes for Effective Resolution Regimes

LCR Liquidity Coverage Ratio

LSIs Less Significant Institutions (in the context of SSM)

LTV Loan-to-value ratio

MiFID Markets in Financial Instruments Directive

MOF

MOU

German Ministry of Finance

Memorandum of Understanding

MREL Minimum Requirement for Own Funds and Eligible Liabilities

NCA National Competent Authority

NFC Non-financial corporations

NII Net Interest Income

NPL Non-performing Loans

NSFR Net Stable Funding Ratio

ORSA Own Risk and Solvency Assessment

OTC Over-the-counter

PFMI CPSS-IOSCO Principles for Financial Market Infrastructures

PSIs Potentially Significant Institutions

QIS Quantitative Impact Study

RRP Recovery and Resolution Plan

RWA Risk-Weighted Assets

SCR Solvency Capital Requirement (for insurers)

SIs Significant Institutions (in the context of SSM)

SME Small and Medium-size Enterprise

SRB Single Resolution Board

SREP Supervisory Review and Evaluation Process

SRF Single Resolution Fund

SRM

SSM

SSMR

Single Resolution Mechanism

Single Supervisory Mechanism

Single Supervisory Mechanism Regulations

TD Top-down (stress test)

TLAC Total loss-absorbing capacity

UCITs EU Directive on Undertakings for Collective Investment in Transferrable

Securities

YTM Yield-to-maturity

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EXECUTIVE SUMMARY

Germany’s financial sector plays a key role in the global economy. The country is home to two

global systemically important financial institutions, Deutsche Bank AG and Allianz SE, as well as to

one of the largest global central counterparties (CCP), Eurex Clearing AG. The system is also very

heterogeneous, with a range of business models and a large number of smaller banks and insurers.

Its asset management industry is the third largest in the European Union (EU), while its sovereign

bond market is a safe haven and benchmark for fixed income instruments globally. Consequently,

Germany’s contribution to ensuring the success of the new European financial stability architecture

is crucial for fostering its domestic financial stability and the success of the European reform agenda.

The resilience of the German financial sector is bolstered by major financial sector reforms,

driven by EU-wide and global developments, which are now nearing completion. The

regulatory landscape has changed profoundly with strengthened solvency and liquidity regulations

for banks (the EU Capital Requirements Regulation (CRR) and Directive IV (CRD IV)), and the

introduction of macroprudential tools. The establishment of the Single Supervisory Mechanism

(SSM) has positively impacted the supervision of the banking system as a whole, while the bank

resolution regime has been significantly strengthened following the implementation of the EU Bank

Recovery and Resolution Directive (BRRD). Introduction of Solvency II enhanced the regulatory and

supervisory regime for insurance, leading to a more risk-based approach. The framework for

Financial Markets Infrastructure (FMIs) has been strengthened by the European Market Infrastructure

Regulation (EMIR). Germany is making progress towards compliance with the new EU Directives on

Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment

Fund Managers (AIFMD). Overall, there is welcome emphasis on quantitative analysis to augment

the traditional qualitative and relationship-based supervision.

The key risks facing the financial system reflect euro area (EA) and global developments as

well as characteristics unique to the domestic financial architecture:

 The ongoing transition to the new supervisory and resolution architecture may give rise to

decision-making and implementation frictions. The newly established European recovery and

resolution framework entails a major cultural change. Its complex decision-making process still

needs to be tested. The coordination of the European and domestic authorities to handle a

systemic crisis is being set up. While the SSM supervisory practices are evolving quickly, the

SRB—in charge of resolution measures for significant German banks—is still in a startup mode.

This constitutes a transition risk until the EA level authority is fully operational.

 Low profitability, rooted in banks’ and insurers’ business models, is exacerbated by the

low interest rates. The low interest rates are helping to boost credit demand and stimulate

growth. However, prevailing business models make banks and life insurers particularly

vulnerable to the associated adverse side-effects of unconventional monetary policy. Banks

faced with falling net interest margins may be tempted to adopt risky search-for-yield strategies,

and bank equity prices have been dropping markedly. Low profitability of life insurers hampers

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their ability to pay guaranteed yields to policyholders. Real estate assets, while currently broadly

in line with fundamentals, could become overvalued.

 A global growth shock, sharp downturn in emerging markets (EMs), or renewed tensions in

the EA could lead to a rapid hike in global risk premia and asset price volatility. This may give

rise to domestic financial risks and second round adverse spillovers because of the globally

interconnected financial sector and the importance of German G-SIFIs for shock transmission.

The uncertainties associated with the possibility of British exit from the EU weigh on the outlook.

Although long-standing challenges remain, the financial system as a whole appears resilient

to these risks:

 Households’ and corporate balance-sheets are strong. Deleveraging has progressed steadily,

and mortgage-related debt-service is largely insensitive to rapid changes in interest rates.

 Risk-based bank solvency measures indicate substantial capital buffers, and non-performing

loans (NPLs) are generally low and declining, although bank profitability is low and leverage is

high in some institutions. While banks have continued to consolidate and reduce costs, mainly

through branch reductions and increased IT services, further progress is needed.

 Notwithstanding severe challenges from low interest rates and Solvency II implementation, life

insurers generally retain significant loss absorption capacity. Large insurers enjoy diversification

benefits from multiple business lines and an international presence, while many small insurers

are less affected by the low interest rates owing to their business mix. Some medium-sized

insurers do not have such clear strengths.

 Eurex Clearing CCP has a comprehensive risk management framework. Preliminary results of the

EU-wide stress test indicate that the CCP could withstand an extreme but plausible shock

scenario, covering losses with pre-funded resources.

At this juncture, the German authorities, in close collaboration with their European partners,

should keep their focus on finalizing the agenda and, crucially, ensuring that the new

architecture is effective in practice. In this context, the following priorities are highlighted:

 Rapidly completing the processes to facilitate the resolvability of German financial firms while

safeguarding taxpayer resources, and building capacity to implement the new resolution regime.

 Expanding further the capacity to monitor financial stability risks and cross-sector spillovers, by

collecting comprehensive and granular data and completing the macroprudential toolkit.

 Continuing to integrate quantitative analysis into ongoing supervisory monitoring and

promoting sound risk management practices in banks, including on strengthening the oversight

role of supervisory boards, internal control and audit, related party exposures, and operational

risk.

Key FSAP recommendations are summarized in Table 1.

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Table 1. Germany: FSAP Key Recommendations

Recommendations Time Frame

Financial stability policy framewor

Establish a core set of readily-available, consistent data for banks and non-banks to strengthen

financial stability and macroprudential policy analysis

Short term

Develop the legal basis for real estate-related macroprudential tools

Short term

Banking oversight

Implement measures to strengthen the oversight role of the banks’ supervisory board

Short term

Provide guidance on risk management and other supervisory requirements, e.g. regarding loan

portfolio management, concentration and related party risk, and operational risk

Short term

Increase granularity and coverage of bank supervisory data Short term

Strengthen rules and supervisory processes for acquisitions and exposures to related parties Medium term

Streamline and simplify the SSM decision making processes (to be taken at the EU level) Medium term

Insurance oversight

Prepare a communication strategy ahead of the publication of Solvency II indicators

Short term

Extend the application of G-SII toolkit on a risk-based basis to other large groups, including

recovery and resolution planning, enhanced supervision and regular stress tests

Medium term

Communicate supervisory expectations based on the ORSA review more systematically; and use

Solvency II framework to impose capital add-ons

Medium term

Require action plans for companies facing difficulties in meeting Solvency II requirements,

including stress testing to ensure that they would be met even after a plausible shock

Medium term

sset management oversight

Intensify frequency of on-site inspections and enhance risk classification methodology

Short term

Introduce stronger rules on reporting of pricing errors and investor compensation rules

Short term

Crisis management and resolution

Develop a formal systemic crisis coordination mechanism including German authorities, SRB and

ECB

Short term

Ensure plans for adequate funding to support the orderly resolution of banks and discretionary

ELA post-resolution

Short term

Remedy operational challenges to resolution actions; ensure authorities retain control during the

resolution process; and test contingency plans in a system-wide crisis exercise

Short term

Review efficiency of SRM decision making (to be taken at the EU level)

Medium term

Financial Market Infrastructure

—

Eurex Clearing

Strengthen the liquidity stress tests and upgrade the secondary site with staffing arrangement

Short term

ML/CFT

Increase the effectiveness of the AML/CFT supervisory framework over cross-border banks

Short term

Near term is one year. Medium term is 2–3 years.

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MACROFINANCIAL SETTING

1. The German economy is growing at a steady pace. Strengthening domestic demand,

bolstered by robust labor market developments, higher public expenditures and lower oil prices

(Table 2) offset a weaker foreign environment in 2015.

2. Private sector balance sheets continue to strengthen as monetary conditions ease and

house prices increase (Figure 1, Tables 3 and 4). Households’ (HH) and non-financial

corporations’ (NFC) debt and interest expenses have declined in relation to income. HH debt service

is largely insensitive to rapid rises in interest rates with most mortgage rates being fixed for a 10–15

year period. Following more than a decade-long correction, house prices have risen rapidly since

2010, though still broadly in line with fundamentals. Recent real estate developments warrant

monitoring as pockets of vulnerability may be emerging (Box 1).

3. The authorities have made progress in addressing the 2011 FSAP recommendations

(Annex I). The financial oversight framework has been strengthened. The restructuring of the

Landesbanken is under way but with only a limited progress to reduce non-commercial influences.

Improvements are evident in the intensity of banking and insurance supervision and the adoption of

analytical tools to support system-wide monitoring. The crisis management framework has been

reformed owing to the EU-wide developments. Government support to banks is being wound down.

4. The financial system is dominated by banks and is generally domestically oriented and

robust to shocks—a relatively unchanged financial structure since the last FSAP (Figures 2 and

3, Table 5). The banking system, with assets equivalent to 245 percent of GDP, is structured around

three pillars and has gone through a sustained period of consolidation (Annexes II and III).

Bank

funding, in aggregate, is more reliant on deposits compared to other advanced economies. Banks’

foreign exposures are a fifth of total assets, with only small exposure to vulnerable emerging

markets and Central and Eastern Europe. Approximately half of the claims are against the foreign

non-bank private sector, followed by banks and the public sector. Germany’s insurance sector is

smaller than its peers as a share of GDP, with guaranteed return life products playing a dominant

role. The asset management sector is the third-largest in Europe as measured by assets under

management, and comprises a broad range of management companies and funds. Financial

infrastructures are fewer than in other financial centers, but are interconnected with G-SIBs.

The number of banks has declined by about 100 compared with the time of the last FSAP, with consolidation mainly

taking place at local savings and cooperative banks level.

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Figure 1. Germany: Real Estate and Shipping Developments

House prices have reached long-term equilibrium value … … as mortgage credit accelerates significantly…

… and the CRE market is heating up. Pockets of vulnerability may need to be monitored

*Top 5 includes: Berlin, Dusseldorf, Frankfurt, Hamburg and Munich

Container freight prices dropped sharply in 2015 …

… and floating storage (tankers) becomes less profitable

-2

-40

-10

110

Jan-2004

Jan-2005

Jan-2006

Jan-2007

Jan-2008

Jan-2009

Jan-2010

Jan-2011

Jan-2012

Jan-2013

Jan-2014

Jan-2015

Jan-2016

New loans, 5-10 years New loans, over 10 years

Existing loans, over 5 years (RHS)

Housing Loans

(in percent)

Sources: Bulwiengesa, Bundesbank, Destatis, and IMF staff calculations.

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

CRE Investment Turnover

(in EUR bn)

Total

Top 5*

Source: CBRE Research Q4 2014, Q4 2015

100

110

120

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

2015

Real house price index (LHS, 1985=100)

Price to income per person ratio (LHS, 1985=100)

Price to rent ratio

Housing Market Valuation Indices

Sources: Bulwiengesa, Bundesbank, Destatis, and IMF staff calculations.

800

1200

1600

2000

2400

2800

Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15

WCI Composite Container Freight

(Benchmark Rate per 40ft Box)

100

120

Jan-14 Jun-14 Nov-14 Apr-15 Sep-15

Oil Prices

(Brent USD/Barrel)

Brent Crude Oil

ICE Brent Crude 12 Months Futures

ICE Brent Crude 24 Months Futures

0% - 60% 60% - 80% 80% - 100% 100% - 120% over 120%

2009 2010 2011 2012 2013

Source: Bundesbank special survey among 116 banks in 24 towns and cities.

*The ratio of a loan to the mortgage lending value of the purchased asset, where a haircut on the market

value is generally applied to reflect the sustainable value of the property. LTV measurement in Germany

therefore differs from other internationally used concepts making comparison with LTVs from other

countries difficult.

New Residential Mortgages by Sustainable LTV Ratio*

(number of banks)

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Box 1. Trends in Residential Real Estate

For the fourth consecutive year, house price increases in 2015 exceeded the growth in nominal income,

but with important regional differences. While apartment price increases in the largest and most dynamic

German cities (Berlin, Munich, and Hannover) reached double-digits in 2015H2, sustained East-West migration

continues to weigh on residential prices in former East Germany.

The positive trend in real house prices that started in 2010 broadly reflects fundamentals. Following the

post-reunification fiscally-triggered excesses of the early nineties, real estate prices declined, reaching a trough

in 2009–10. Since then, higher income growth, immigration, supply bottlenecks, declining inventories, higher

construction costs, and record-low interest rates contributed to the positive price trend. In real terms, house

prices have reached a level consistent with measures of long-term equilibrium in 2015, as confirmed by price-

to-rent and price-to-income ratios as well as the Bundesbank’s internal valuation models. As households take

advantage of record-low interest rates to lock-in new mortgage debt, mortgage credit growth has also been

trending up, but at a moderate pace with largely unchanged credit standards.

However, recent developments warrant closer monitoring. Despite a pickup in construction activity, supply

continues to fall short of demand in selected areas fueling higher prices. The Ministry for the Environment

estimates that around 400,000 new residential units per year are needed to keep up with current demand, or

about 100,000 more units than are currently put on the market each year. Absent a rise in mortgage interest

rates or a sudden burst in house supply—both rather unlikely in the next couple of years—house prices should

continue to rise quickly in the most dynamic regions. The arrival of refugees will put additional pressure on

vacancy rates and boost house prices in the next few years.

Pockets of vulnerability may be emerging. While the financial stability assessment has been hampered by

the lack of granular loan-by-loan data, survey evidence suggests that for a notable part of mortgage loans in

the largest urban areas, loan-to-value ratios may exceed prudent levels.

Future mortgage developments

therefore warrant close supervisory monitoring. Authorities should address administrative housing supply

bottlenecks and ready the macroprudential toolkit.

__________________________________

The acceleration in 2015 may have been partially driven by the renewals of a large number of loans granted in 2005

in anticipation of the abolishment of the home owners’ subsidy.

Surveys in selected urban areas suggest that about a third of mortgages have a loan-to-value ratio (LTV) of more

than 100 percent based on the German sustainable LTV (Beleihungsauslauf) – a conservative measure that applies a

prudential haircut to the value of properties. Also, debt service exceeds 40 percent of income for about

10–15 percent of indebted households (about 8 percent due to mortgage).

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Figure 2. Germany: Financial System Structure

Financial sector remains bank-dominated….

…with conservative business model.

*Measured by Total Assets. Does not sum to 100% due to rounding.

Insurance premia grew in line with GDP …. …with pension funds expanding only moderately.

Market capitalization is low amongst peers… ..while asset management is the third largest in the EU.

68%

Financial System Overall Structure

Banks

Pension Funds

Life Insurers

Reinsurers

Other Insurers

Retail Funds

Special Funds

Source: Bundesbank

2011 2015 2011 2015

Banking System Assets and Liabilities

(in EUR tn)

Cash

Lending to MFIs

Lending to non-MFIs

Participating interests

Other assets

Deposits of MFIs

Deposits of non-MFIs

Debt securities

Capital

Other liabilities

Source: Bundesbank

Total Assets Total Liabilities

Germany Belgium France Italy Spain UK US

Insurance Premium Income

(in percent of GDP)

2011 2014

Source: Statistical Yearbook of German Insurance 2015, IMF WEO Oct 2015

Germany Belgium France Italy Spain UK US

Pension Funds Total Assets

(in percent of GDP)

2011 2013

UK13: 100.7

UK11: 94.0

Source:Statistical Yearbook of German Insurance 2015

US13: 83.0

US11: 71.7

0 10 20 30 40 50 60

Spain

Luxembourg

Italy

France

Belgium

Germany

UCITS

Non-UCITS

Source: EFAMA Quarterly Statistical Release Q4 2014, IMF WEO Oct 2015

4,889

837

UCITS and non-UCITS, Assets Under Management

(in percent of GDP)

0 50 100 150 200 250

Germany*

Austria

Ireland

Luxembourg

Spain

Switzerland

Domestic Stock Market Capitalization

(in percent of GDP)

2011

2014

*Germany excludes “Freiverkehr” (unofficial regulated market)

Source: World Federation of Exchanges

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Figure 3. Germany: Banking Sector

Banking system is domestically oriented …. …with a sizable share of exposure to the sovereign.

Bank leverage is masked by strong capital ratio…. ..with an RWA density lowest among peers.

*Leverage is defined as Total Regulatory Capital over Total Assets.

Asset quality remains solid… …but bank return on equity has fallen.

*EA Peers includes: Austria, Germany, Italy, France, Netherlands, Portugal, and Spain.

Domestic

Exposures

80%

Advanced

Economies

w/o China

17%

Central and

Eastern

Europe, CIS

Developing

Asia w/China

Other

Geographical Loan Distribution

2014 Q3

Source: IMF Financial Soundness Indicators

Germany

Belgium

France

Ireland

Italy

Japan

Netherlands

Portugal

Spain

Source: : IMF, FRBNY estimates, National sources

AE Bank Claims on Domestic Government, 2014

(in percent of assets)

100

2009 2010 2011 2012 2013 2014

RWA to Total Assets

(in percent)

Germany US G-7, average EA Peers, average

Source: IMF Staff Calculations

2009 2010 2011 2012 2013 2014

Non-performing Loans

(in percent of total loans)

Germany US G-7, average EA Peers, average

Source: IMF Financial Soundness Indicators, IMF Staff calculations

-10

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Return on Equity

(in percent)

Germany US G-7, average EA Peers, average

Source: IMF Financial Soundness Indicators, IMF Staff calculations

2009 2010 2011 2012 2013 2014

Capital Adequacy and Leverage

(in percent)

Germany CAR US CAR

G-7 Avg. CAR EA Peers Avg. CAR

Germany Leverage, RHS US Leverage, RHS

G-7 Leverage Avg., RHS EA Peers Leverage Avg., RHS

Source: IMF Staff Calculations

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Germany: Cross-Border Banking Exposures

Sources: BIS Consolidated Banking Statistics, IMF Staff Calculations.

5. Intermediation is concentrated between HHs and financial institutions, while NFCs rely

less on banks and more on intra-segment financing. HHs are closely interlinked with banks (via

loans; deposits, bank bonds and equity holdings) and insurance companies (via claims on insurance

reserves). NFC financing by households mainly constitutes payments to corporate pension funds.

Insurance companies and investment funds are expanding their claims to investment funds via debt

securities, which have almost doubled since 2008.

Germany: Sectoral Interlinkages, June 2015

Source: FSAP team model and estimation based on Bundesbank data, using the Reingold-Tilford network algorithm Note: The

category “banks” includes all monetary financial institutions as defined by the ECB. All financial instruments for which

comprehensive debtor/creditor relationships exist are taken into account (deposits, debt securities, loans, listed shares,

investment fund shares and claims on insurance corporations and pension funds). The arrows show the direction of

interlinkages (from who to whom) and their thickness indicates strength of interlinkages. The size of the node the

interconnectedness within a sector.

Households NFC

PublicSector

Banks

OtherIntermediaries

Insurance

PensionFunds

InvestmentFunds

100

200

300

400

500

France

Italy

Spain

Netherlands

Switzerland

Austria

Ireland

Sweden

Public Sector Non-bank private sector Banks

German Banks' Combined Foreign Claims:

Top 10 Countries by Exposure

(in USD bn)

Numbers are from Q2 2015 on an ultimate risk basis.

120

160

200

Italy

Netherlands*

France

Japan

Switzerland

Sweden

Spain

Austria

Public Sector Non-bank private sector Banks

Consolidated Foreign Claims on Germany:

Top 10 Countries by Origin

(in USD bn)

Num ber s a re fr om Q2 2015 on an ultim ate ri sk b asis.

Note '*' : For the Netherlands, the breakdown by public sector, non-bank private sector and

banks were were estimated by the corresponding share for total foreign claims on Germany,

as the disaggregated data were not published by the BIS.

GERMANY

INTERNATIONAL MONETARY FUND 15

RISKS, RESILIENCE, AND SPILLOVERS

A. Key Risks Facing the German Financial System

6. The FSAP analyzed three macrofinancial scenarios using a number of quantitative

techniques (Table 6):

 A global stress with recessions in advanced economies, triggered by a tightening of global

financial conditions and credit cycle downturns in emerging economies (EMs): German

exporters would be hit, and both investment and consumption would drop as confidence

deteriorates. A sharp correction of asset prices, paired with strong foreign exchange rate

movements, would affect unhedged market positions and hit banks’ trading income.

 The return of the EA crisis: Sovereign yields in highly indebted EA countries would increase

sharply. Flight-to-quality effects would diminish and the ‘core’ countries would see their

refinancing conditions deteriorate, albeit to a lesser extent. Investor sentiment would

deteriorate, and the EA would enter a deflationary phase. The uncertainties associated with the

possibility of a British exit from the EU could usher in a heightened macroeconomic uncertainty

and financial market volatility.

 Excessive risk-taking associated with the protracted low interest rate environment: Banks

and insurers may be tempted to adopt risky search-for-yield strategies against the backdrop of

squeezed profitability and persistent structural weakness. Banks are key beneficiaries of the

unconventional monetary policy in the EA through improved growth prospects and borrower

credit worthiness, among other. However, prevailing business models of German banks and

insurers may make them particularly vulnerable to the associated adverse side effects.

Separately, lower market liquidity fuels asset price volatility. Banks could see a drop in deposit

funding, and institutional investors could channel funds towards higher-yield investments.

7. The overall stability assessment paints a mixed picture. While reported risk-based bank

solvency indicators point to substantial capital buffers across all pillars, the risk-weighted assets

(RWA) density (at 30 percent on average for large banks) is among the lowest in Europe. Capital

ratios may, therefore, understate risks as leverage remains high for some banks. Bank profitability is

low and cost-to-income ratios are high, reflecting banks’ cost-intensive business model. NPLs are

low and falling on aggregate, although asset quality and provisioning in Landesbanken are below

average. Commercial (and large) banks, Landesbanken, and the regional institutions of credit

The impact on banks depends on their capacity to reprice loans, deposits and non-deposit liabilities, the relative

importance of net interest income to profitability, and ability to generate noninterest income. Current negative

interest rates may be unique in accelerating margin compression over time as German banks have a large deposit

base and have so far proven unwilling or legally unable to pass on the negative rates to depositors, while mortgage

loans started repricing to lower rates. See IMF (2016), “Global Financial Stability Report,” April 2016, Chapter 1,

Box 1.3 for a discussion on broader effects of low and negative interest rates on banks.

GERMANY

16 INTERNATIONAL MONETARY FUND

cooperatives appear more liquid compared to local savings and cooperative banks, in part owing to

an intra-pillar distribution of liquidity.

Germany: Financial Statement Indicators for Different Types of Banks

(End-2014 data or last available year)

8. A legacy of the crisis has been a shift in the availability and form of funding and

subdued credit growth (Figures 4 and 5). Loose monetary conditions are prominent on the

domestic risk map. The crisis exposed weaknesses in bank funding practices, and precipitated

ongoing restructuring. Short-term markets contracted significantly, while longer-term markets

became more domestically focused. Funding flows across the banking pillars continue to be

concentrated among a few key financial institutions, which themselves receive significant amounts

of intra-pillar financing. The ECB liquidity injections are ensuring a high level of liquidity in the

system, but markets will face further challenges as they adapt to new bank liquidity and leverage

regulations. While the new regulatory regime may result in improved sectoral resilience, it may also

result in higher volatility. Measures to facilitate the transfer of excess liquidity within and across the

banking pillars, and elimination of barriers to competition and consolidation among banks,

particularly within the savings banks and credit cooperatives sectors, could help promote efficient

intermediation of excess savings.

See Technical Note on “Systemic Bank Liquidity and Funding.”

Inter-

connectedness

Tier 1

Capital

Ratio

Total

Capital Ratio

(CAR)

Liquid Assets

Total Assets

Liquid assets

ST funding ROAE ROAA

Net

Interest

Margin

Cost to

Income

Ratio

NPL

Ratio

Provisioning

Coverage

Ratio /2

Interbank

Ratio /3

Commercial banks 14.5 22.5 27.9 51.3 3.6 0.5 1.0 79.1 3.2 40.5 159.1

Big banks 14.4 17.6 25.0 47.1 3.3 0.2 1.2 81.6 3.9 42.5 185.2

Savings bank sector 15.4 18.2 11.4 13.3 2.1 0.2 2.3 70.8 3.3 47.4 103.3

Landesbanken 12.7 15.6 21.6 40.1 2.5 0.1 0.8 64.2 6.7 31.9 61.2

Savings banks 15.4 18.3 11.2 12.8 2.1 0.2 2.3 70.9 3.2 46.2 104.0

Cooperative banks 14.1 18.7 9.8 11.1 3.7 0.3 2.5 68.9 3.5 39.9 94.0

Regional institutions of credit cooperatives

13.7 16.8 28.5 48.6 10.0 0.4 0.7 48.6 2.3 31.4 75.2

Other cooperative banks 14.1 18.7 9.8 11.0 3.6 0.3 2.5 69.0 3.5 39.9 94.0

Real Estate & Mortgage Banks 15.3 17.1 14.7 19.8 0.9 0.1 1.2 79.9 2.7 36.5 143.5

Average (arithmetic mean) 15.1 19.3 13.0 19.9 3.2 0.3 2.2 71.8 3.5 44.1 102.6

Source: Bankscope, Bundesbanks and IMF staff calculations.

Notes: Unless otherwise noted, numbers are in percent.

/1 Return on average equity (assets).

/2 Loan loss reserves to impaired loans.

/3 Net interbank lending; money lent to money borrowed. Numbers above (below) 100 percent indicate net liquidity provision (consumption).

Solvency and liquidity Profitability /1 Asset quality

GERMANY

INTERNATIONAL MONETARY FUND 17

Figure 4. Germany: Bank Liability Structure by Segment

(In EUR billion, September 2015)

9. The banking system faces structural headwinds and will need to adapt. Financial

technology innovation is introducing new competitive pressures while the post-crisis regulatory

reforms have raised the bar with respect to capital and liquidity requirements. The Landesbanken

have generally become more efficient, but the risk of inefficient use of public resources in some

institutions remains. For some Landesbanken, viable restructuring may require further downsizing,

opening of capital to private investors and further reform of governance structure. Chronic

overcapacity in the context of slowing international trade has put the shipping industry under

intense pressure. Further provisioning related to shipping may become necessary in banks with large

shipping exposures.

10. Consolidation is ongoing, albeit gradually. Banks have been reducing costs mainly

through reduction of branch networks and introduction of IT-based services. Among the largest

banks, Deutsche Bank announced a major shift in strategy, while Commerzbank is dealing with

legacy commercial real estate and shipping assets.

A merger of DZ Bank AG and WGZ Bank AG, two

central institutions for cooperative banks, will be effective in 2016 creating the country’s third-

largest bank by total assets and should lead to improved efficiency.

For several banks with shipping loan portfolios, these loans are large in proportion of capital and are concentrated

in the container segment with the biggest over-capacity. While parts of the legacy portfolios—arguably the riskiest

exposures—have been wound down, the ECB’s 2014 asset quality review (AQR) revealed that most of these banks

operated under optimistic cash-flow projections, requiring EUR 2 billion of additional provisioning for shipping loans

(30 percent of the total AQR capital effect for German banks in the sample). The AQR was undertaken before the

recent slowdown in global trade, fall in commodity prices and the ensuing increase in overcapacity.

Repeated fines for involvement in the systematic manipulation of benchmarks, misleading regulators, and violating

U.S. restrictions on conducting business with sanctioned countries, hit Deutsche Bank’s bottom line and may be

indicative of corporate governance issues.

877.6

153.5

103.9

540.5

837.1

596.1

486.7

140.4

102.4

400

800

1,200

1,600

2,000

Large commercial banks Savings banks Cooperative banks

Deposits of banks Deposits of non-banks Other Liabilities 1

1/Other liabilities include bearer debt securities, capital and reserves, and other liabilities.

Source: Deutsche Bundesbank

GERMANY

18 INTERNATIONAL MONETARY FUND

Figure 5. Germany: Systemic Risk Indicators

Global risk map changed… … while loose monetary conditions dominate in Germany.

*Components of drivers differ for GFSR and Germany risk maps.

Perceived riskiness of banks grew in early 2016… … while yield curve remains flat…

largest banks’ stocks underperform… … and market volatility has risen.

2. Emerg ing mark et ri sks

3. Credit risks

4. Market and liquidity

risks

5. Risk appetite

6. Monetary and financial

conditions

1. Macroeconomic risks

GFSR Risk Map

April 2016

April 2011

No te: Away fr om ce nt er sig ni fies highe r risk s, easier m one tary and

financial conditions

or hi

her risk a

etit

2. Inward spillover risks

3. Credit risks

4. Market and liquidity

risks

5. Monetary and financial

conditions

6. Risk appetite

1. Macroeconomic risks

Germany Risk Map

2016Q1

2011Q1

No te: Away fr om ce nt er si gni fies hi gher r isk s, ea si er monetary and

financial conditions, or higher risk appetite

200

400

600

800

1000

1200

May-11 May-12 May-13 May-14 May-15 May-16

German Banks 5y CDS Spreads

(in pps)

Deutsche

Commerzbank

UniCredit

LBBW

DZBank

Source:Bloomberg

100

120

140

160

180

200

May-11 May-12 May-13 May-14 May-15 May-16

Banking Performance

(2011 = 100)

S&P500 Banks

FTSE 300 Banks

Deutsche Bank

Commerzbank

Source: Bloomberg

May-11 May-12 May-13 May-14 May-15 May-16

VDAX Index

(in pps)

VDAX

Expected fluctuations in DAX deriv.market for the following 45 days.

Source: Bloomberg

GERMANY

INTERNATIONAL MONETARY FUND 19

B. Financial System Resilience

Banking Solvency Tests

11. Solvency tests covering all banks operating in Germany were performed to evaluate

the stability of the German banking system (Figures 6 and 7, Annex IV). The analysis covered

1776 institutions operating in Germany and assessed banks’ resilience to credit and market risk,

including foreign exchange rate and sovereign risk, equity price, and house price risk, in the baseline

based on the October 2015 World Economic Outlook and two stressed scenarios.

12. The German banking system would remain broadly stable under the baseline scenario.

Banks are relatively well capitalized, with CET1 ratios around 15 percent, on average, and found to

be resilient, with an improvement in their solvency levels under the baseline. For both large banks

(also known as significant institutions or SIs) and small and medium-sized banks (less significant

institutions or LSIs), interest revenue would continue to deteriorate, albeit more or less offset by

See the Technical Note on “Stress Testing the Banking and Insurance Sectors” for details.

The stress tests were performed against the end-2019 “fully-loaded” regulatory definitions, including applicable

buffers.

Figure 6. Germany: Macroeconomic Scenarios—Key Variables

Source: IMF Staff Calculations.

-10

-8

-6

-4

-2

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Growth in Real GDP

(Percent, yoy)

Growth in real GDP

Baseline Sce nario

Global Stress Scenario (Adverse 1)

Euro Area Crisis Scenario (Adverse 2)

Global Financial Crisis (hypothetical)

100

105

110

115

-10123

Severity Comparison

(Real GDP Growth in Percent, yoy)

Global Financial Crisis (2008 = 100)

Baseline (2015 = 100)

Adverse 1 (2015 = 100)

Adverse 2 (2015 = 100)

Year

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Unemployment Rate

(Percent)

Unemployment rate

Baseline Scenario

Global Stress Scenario (Adverse 1)

Euro Area Crisis Scenario (Adverse 2)

-6

-4

-2

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Consumer Price Inflation

(Percent)

Inflation

Baseline Scenario

Global Stress Scenario (Adverse 1)

Euro Area Crisis Scenario (Adverse 2)

100

150

200

250

300

Global Stress Scenario

(Adverse 1)

Euro Area Crisis Scenario

(Adverse 2)

Shocks to Sovereign Bond Yields

(Change in basis points)

EA periphery

EA core

US, UK, Japan

Duration risk premia shocks

80%

85%

90%

95%

100%

105%

110%

115%

120%

2015 2016 2017 2018

Change in House Prices

(Base=2015)

Baseline Adverse scenarios

GERMANY

20 INTERNATIONAL MONETARY FUND

lower interest expenses. Nevertheless, in the current low interest rate environment, business models

concentrating on maturity transformation continue to weigh on bank profitability.

13. Under the adverse scenarios, banks would see an increase in loan losses, while adverse

market price movements take a toll on trading income and the value of sovereign bonds. The

credit risk model implies that loan losses would rise by up to 80 percent, as a result of a rise in

default probabilities. Banks’ annual credit impairment needs would almost double, albeit from a very

low level, in part because of the impact of house prices stress on mortgage collateral values. SIs

would suffer a 40 percent drop in trading income, while LSIs with very little trading exposure and

open foreign exchange (FX) positions would be affected much less. The direction of net FX positions

varies across banks and, on average, the impact is not large. Some SIs are affected by credit risk and

sovereign bond valuation losses. LSIs mainly suffer from continuously falling net interest income,

and structurally high costs.

 Under the Global Stress Scenario, the CET1 ratio of SIs would drop by 2.6 percentage points,

but remain above 10 percent. On aggregate, capital shortfalls amount to EUR 6.0 billion, or

0.2 percent of annual GDP. LSIs appear more resilient, and that group as a whole would

experience a drop in CET1 ratio of only around 0.3 percentage points against the fully-loaded

CET1 hurdle. The CET1 capital shortfall amounts to around EUR 450 million. Only 32 banks out of

1,755 in this bucket would see their CET1 capital ratios drop below fully-loaded regulatory

hurdle rates in 2018.

 The EA Crisis Scenario would cause the average CET1 ratio to drop by 2.2 percentage points, to

12.7 percent in 2018 for SIs, corresponding to a capital shortfall of EUR 4.2 billion, or 0.1 percent

of annual GDP. LSIs would see CET1 ratio eventually rising 0.6 percentage points above the

current level, after a 0.2 percentage point drop, against the fully-loaded CET1 hurdle, including

buffers. The aggregate CET1 capital shortfall stands at around EUR 450 million, with 30 small and

medium-sized banks breaching the regulatory hurdles.

14. Sensitivity analysis shows that the persistently low interest rates weigh significantly on

the profitability of LSIs (Figure 8).

Under banks’ own interest rate projections, profitability is

expected to decline by around 25 percent by 2019. Should the low interest rates persist, operating

profit could slump by 50 percent, on average. If the interest rate were to fall by a further 100 basis

points, the operating profit of LSIs could decline by 60 percent or 75 percent, under a dynamic or

static balance sheet assumption, respectively.

The drop in bank profitability would not reduce the regulatory capital ratio as long as net after-tax profits remain

positive. As with the Bundesbank’s results, despite the impact on system profitability, the capital shortfalls in a few

individual banks were not sufficient to cause a decline in the aggregate capital ratios.

One-off effects are an important driver of the capital shortfall, in particular, non-recurring write-offs. In contrast to

the 2016 EU-wide bottom-up stress test of the European Banking Authority (EBA), such events in the base year (2015)

have not been removed from the balance sheet when profit and loss positions were projected three years (2016-

2018) into the future." See “2016 EU-wide stress test-Methodological note” for the EBA methodology.

http://www.eba.europa.eu/-/eba-launches-2016-eu-wide-stress-test-exercise.

See Bundesbank (2015), Survey on the Profitability and Resilience of German Credit Institutions in a Low-Interest-

Rate Setting. http://www.bundesbank.de/Redaktion/EN/Pressemitteilungen/BBK/2015/2015_09_18_bafin_bbk.html

GERMANY

INTERNATIONAL MONETARY FUND 21

Figure 7. Germany: Solvency Stress Test

Source: IMF Staff Calculations.

Note: The top panel shows the evolution of CET1 ratio under the three scenarios. Capital shortfalls to regulatory hurdles are

shown as bars in the panel below, together with the share of total assets that the banks dropping below hurdle rates correspond

with (markers, rhs). The drivers are expressed in terms of percentage points of the CET1 ratio. For example, the credit risk losses

experienced by large banks in the Global Stress Scenario equal 2.3 percentage points of the CET1 ratio.

-20

-15

-10

-5

Global Stress Scenario Euro Area Crisis

Main Drivers of CET1 Ratio,

Large Banks

(in percent)

Dividends

Tax

RWA (unexpected loss)

FX gains/losses

Sovereign bonds valuation

gain/loss

Loan loss impairments (expected

loss)

Personnel and other expenses

Other income

Net trading income (w/o sovereign

valuation gains/loss)

Net fee and commission income

Net interest income

16.7

14.9

12.3

12.7

2015

2016

2017

2018

Baseline

Global Stress Scenario

Euro Area Crisis Scenario

Common Equity Tier 1 Capital

Large Banks

(in percent of RWA)

16.8

15.0

15.4

15.6

2015 2016 2017 2018

Baseline

Global Stress Scenario

Euro Area Crisis Scenario

Common Equity Tier 1 Capital

Small- and Medium-sized Banks

(in percent of RWA)

-15

-10

-5

Global Stress Scenario Euro Area Crisis

Main Drivers of CET1 Ratio,

Small- and Medium-sized Banks

(in percent)

Dividends

Tax

RWA (unexpected loss)

FX gains/losses

Sovereign bonds valuation

gain/loss

Loan loss impairments (expected

loss)

Personnel and other expenses

Other income

Net trading income (w/o sovereign

valuation gains/loss)

Net fee and commission income

Net interest income

Baseline Global Stress

Scenario

Euro Area Crisis

Scenario

CET1 Capital Shortfall (EUR bn)

CETI Capital Shortfall below CET1 Minimum

Large Banks

(incl. CCB and OSII buffers)

0.0

0.2

0.4

0.6

Baseline Global Stress

Scenario

Euro Area Crisis

Scenario

CET1 Capital Shortfall (EUR bn)

CET1 Capital Shortfall below CET1 Minimum

Small- and Medium-sized Banks

(incl. CCB)

GERMANY

22 INTERNATIONAL MONETARY FUND

Figure 8. Germany: Low Interest Rates and Bank Profitability

Source: Bundesbank

Note: The charts show, for five different tests, the evolution of operating profit to total assets for some 1500 LSIs. The top-left

chart gives weighted averages for each scenario tested, while the other charts show the median and the 5

/95

percentile of

individual banks’ operating profit. Details about methodology, scenarios, and samples can be found in the Stress Test Matrix in

the Annex IV.

15. Sovereign risk analysis shows diversity across banks (Figure 9). While noticeable in some

banks, valuation losses from sovereign exposures tend to be rather low overall. Banks usually keep

more risky securities in the held-to-maturity portfolio, which is not being marked to market.

Also,

duration differs considerably across portfolios and banks. Banks with higher sovereign risk index

values hold longer-term or riskier paper, or try to generate profit from market movements in yields.

Analysis used the applicable regulatory standard under which held-to-maturity portfolio is not marked to market,

while for the available-for-sale portfolio, the prudential filter is being phased-out. Therefore, if banks had to mobilize

liquidity under stress, and sell securities in the banking book, losses would increase.

-25%

-50%

-10%

-75%

-60%

0.1

0.2

0.3

0.4

0.5

0.6

2014 2015 2016 2017 2018 2019

Overview

(Operating profit, in percent of total assets)

Banks' own projections

Low interest rate environment

+200bp shift (static)

-100bp shift (static)

-100bp shift (dynamic)

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2014 2015 2016 2017 2018 2019

Banks' own projections (dynamic)

(in percent)

Median 5th percentile 95th percentile

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2014 2015 2016 2017 2018 2019

Low interest rate environment (static)

(in percent)

Median 5th percentile 95th percentile

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2014 2015 2016 2017 2018 2019

+200bp Shift (static)

(in percent)

Median 5th percentile 95th percentile

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2014 2015 2016 2017 2018 2019

-100bp Shift (static)

(in percent)

Median 5th percentile 95th percentile

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

2014 2015 2016 2017 2018 2019

-100bp Shift (dynamic)

(in percent)

Median 5th percentile 95th percentile

GERMANY

INTERNATIONAL MONETARY FUND 23

Figure 9. Germany: Sovereign Exposures, Risk Index, and Valuation Losses under Stress

Source: IMF Staff Calculations using EBA 2015Q2 data.

Note: The sovereign risk index gives for each bank the valuation loss (VL) with the gross volume of sovereign bond exposures

held (Exp), relative to the total sample

If the index value is 1, the valuation loss corresponds to the total sovereign exposure held by the bank, signaling average risk

from sovereign exposures. If the value is above 1, the bank’s valuation loss is disproportionally higher than its holdings would

imply, indicating that the sovereign bond portfolio has relatively more risk (and vice versa). Index values are determined by (i) the

issuer’s risk as expressed by the sovereign yield and its volatility of time, (ii) average maturity of the bonds in the portfolio

together with (iii) the bank’s accounting of that exposure (HTM, AFS, FVO, HFT).

160

240

320

400

HTM AFS FVO HFT

Net Direct Exposures and Duration

(in EUR bn and Years)

Net direct ex

osure (lhs) Avera

e maturit

(rhs)

Scenario 1 Scenario 2

Valuation Loss

(in EUR bn)

0123

Aareal Bank AG

Bayerische Landesbank

Commerzbank AG

DekaBank Deutsche Girozentrale

Deutsche Apotheker-und Ärztebank eG

Deutsche Bank AG

Deutsche Zentral-Genossenschaftsbank AG

HASPA Finanzholding

HSH Nordbank AG

Hypo Real Estate Holding AG

Landesbank Baden-Württemberg

Erwerbsgesellschaft der S-Finanzgruppe

Landesbank Hessen-Thüringen Girozentrale

Landeskreditbank Baden-Württemberg–Förderbank

Landwirtschaftliche Rentenbank

Münchener Hypothekenbank eG

NORD/LB Norddeutsche Landesbank Girozentrale

NRW.BANK, Düsseldorf

VW Financial Services AG

WGZ BANK AG

Sovereign Risk Index

(in EUR bn)

Valuation Loss (EUR bn)

Sovereign risk index

VL Exp

Idx

VL Exp







GERMANY

24 INTERNATIONAL MONETARY FUND

Bank liquidity tests

16. Tests based on the LCR show that the banks would be able to withstand market and

funding liquidity shocks (Figure 10). Almost all banks show ratios above 70 percent, and most

banks already today have LCR ratios above 100 percent, with foreign banks showing the lowest

dispersion.

17. Banks have been increasing both the LCR and the Net Stable Funding Ratio (NSFR),

and larger banks appear to be managing their ratios more efficiently (Figure 11). Analysis of

detailed Basel Committee’s (BCBS) Quantitative Impact Study (QIS) results, reported by participating

banks, shows a general improvement in ratios since 2011, and the variation across banks’ LCRs has

also reduced over time.

Figure 10. Germany: LCR Estimates

(In percent)

Source: Bundesbank.

Note: Results were estimated from reporting data through a matching with CRD IV asset and liability categorization (i.e., net

outflows and liquid assets). The Whisker plots give the lower and upper quartile, the median (black line inside the box), and the

lower and upper 5 percent percentile. The orange line is the current (2016) regulatory minimum of 70 percent, while the dashed

line shows the fully phased-in hurdle rate of 100 percent. Outliers are not shown. Results for the four big banks are not shown,

as individual LCRs could be identified. However, they are all above 70 percent regulatory minimum. The big bank group includes

Commerzbank, Deutsche Bank, Deutsche Postbank, and UniCredit.

GERMANY

INTERNATIONAL MONETARY FUND 25

Insurance solvency tests

18. Low interest rates pose particular challenges to life insurers over the medium- to long-

term, reflecting the predominance of traditional products with high guaranteed rates of

return (Figure 12). Capital adequacy ratios have been showing a downward trend in recent years.

Since 2016, Solvency II has created new pressures on life insurers to recognize the impact of low

interest rates in a forward-looking assessment of solvency. Some evidence of search for yield has

been emerging.

Health, property and casualty, and reinsurance companies appear to be more

robust, reflecting lower dependence on investment returns.

Together with rating migration effects, this exacerbates the challenge to meet Solvency II requirements as higher

capital must now be held against riskier assets. Evidence of search for yield includes increasing investment in non-

German sovereign bonds and higher risk investments (such as BBB) with longer duration.

Figure 11. Germany: LCR and NSFR Reported by German Banks in the BCBS QIS

Source: Bundesbank

Note: Results as reported by banks participating in BCBS QIS. The box gives the lower and upper quartile, the median is shown

as black line separating the box, the weighted average as orange circle, and whiskers are at the 5th and 95th percentile. For the

LCR, the orange line marks the 2016 regulatory minimum of 70 percent, while the dotted line gives the fully phased-in 2019

minimum of 100 percent. For the NSFR, the dotted orange line marks the future expected regulatory minimum of 100 percent,

to be introduced in 2018. Whiskers extending above the vertical axis’ range are removed.

GERMANY

26 INTERNATIONAL MONETARY FUND

Figure 12. Germany: Insurance Earnings, Solvency, and Risk Analysis

P&C and reinsurers maintain high Solvency Ratios, while

life insurers have the lowest ratios.

Publicly available Solvency II figures suggest that the end-

2014 ratio is a good proxy of the latest figure.

Fixed income portfolios are gradually shifting to lower

credit grades.

Modified duration o

fixed income

ortfolio of life

insurers have increased in the last 4 years.

Life insurers are making efforts to cope with lower

investment returns by reducing guaranteed rates and

policyholders’ bonuses.

Guaranteed rate and the duration of German life insurers

are some of the highest among EU countries.

Source: BaFin, Bundesbank, EIOPA, Insurer disclosures (Allianz, Munich Re, AXA and Generali), Assekurata, IMF Staff Calculations.

100 300 500 700 900 1,100

Life

P&C

Reinsurance

Solvency I Ratio

(in percent)

0 50 100 150 200 250 300

End 2014

End 2015

End Jan 2016

Solvency II SCR Ratio (Group Level)

(in percent)

Allianz Munich Re AXA Generali

20%

40%

60%

80%

100%

2011 2012 2013 2014

Life Insurers: FI Portfolio Rating Distribution

High Yield BBB A AA AAA

03691215

AAA

BBB

High

Yield

Total

Duration of Assets

(Year)

2011 2012 2013 2014

3.0

3.4

3.8

4.2

4.6

5.0

2008 2009 2010 2011 2012 2013 2014

Life Insurers' Key Interest Rates

(in percent)

Current Avg ROI (excl. gains from hidden reserves)

Net ROI

Guranteed Rate + Policyholders' Dividends

Avg Guranteed Rate in Life Insurers' Portfolios

0.0

1.0

2.0

3.0

4.0

5.0

0 4 8 12 16 20

Internal Effective Rate of Liabilities

Sensitivity of Liabilities

Liabilities Sensitivity and IRR

(in percent)

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INTERNATIONAL MONETARY FUND 27

19. Stress tests analyzed the impact of low interest rates under Solvency II (Annex V). The

scenarios covered major market shocks, while sensitivity analysis assessed the potential impact of

other insurance-specific risks, such as longevity and lapse risks. A majority of life insurers (93 percent

of the sector by assets) were covered. The methodology reflected the significance of policyholder

participation in traditional life insurance and the scope for insurers to reduce future policyholders’

profit participation in a stressed situation.

20. The results are stated with respect to the Solvency II Capital Requirement (SCR) ratio,

with and without transitional measures (Figure 13). Based on EU law, the so-called transitional

measures allow insurers, on BaFin’s approval, to mitigate material Solvency II impacts arising from

lower interest rates over the 16-year long phase-in period. Both ratios—with and without

transitional measures—will be published in 2017, the stress tests apply the two hurdle rates.

Figure 13. Germany: Insurance Stress Testing Results

SCR ratio with transition is above the minimum after

stress. Without transition, the majority of life insurers may

not be able to meet the requirement.

Spread and interest rate risks have material impacts, but

LAC_TP reduced the loss by more than 50 percent.

significant amount of potential loss absorption capacity

is embedded in the liabilities of life insurers.

Capital shortfalls might increase in a non-linear fashion.

Source: BaFin and IMF staff calculations

German life insurers recognize EUR 136 billion of future discretionary bonuses as part of their liabilities. In the

stress test, the future discretionary bonuses are assumed to be reduced by EUR 58 billion.

-100

100

200

300

400

500

Before - With

Transition

After - With

Transition

Before - Without

Transition

After - Without

Transition

SCR Ratio Distribution

(in percent)

75th Percentile Unweighted Avg. Weighted Avg. Median 25th Percentile

100

150

200

250

Net DTL Future Discretionary Benefits

Other own funds Reconciliation reserve

Surplus funds

Own Funds and Sources of Loss Absorption Capacity

(in EUR bn)

0 25 50 75 100 125

Capital Shortfall

Loss Amount

Loss and Capital Shortfall Relationship

(in EUR bn)

GERMANY

28 INTERNATIONAL MONETARY FUND

21. With transitional measures, insurers’ capital levels appear generally sufficient,

although a minority would have difficulties in meeting the SCR under stress. Life insurers

maintain SCR ratios above 100 percent even under stress, although the weighted average SCR ratio

drops from 372 percent to 236 percent. No firm would have negative capital after the shocks, but for

13 firms (out of 75) the SCR ratio would fall below 100 percent. The total capital shortfall by value

would be small.

22. Without the transitional measures, a majority of life insurers would have difficulties in

meeting the SCR. The weighted average SCR ratio would fall from 126 percent to 48 percent under

stress. Thirty-four firms and 58 firms (out of 75) would fall below the 100 percent SCR ratio before

and after the shocks, respectively. Eight firms and 27 firms would have negative capital before and

after the shocks, respectively. The total capital shortfall would be EUR 12 billion (0.4 percent of GDP)

before shocks and would increase to EUR 39 billion (1.3 percent of GDP) after the shocks.

23. The business model is a significant determinant of insurers’ relative resilience. The tests

were conducted at the legal entity level. Individual large insurers are generally more resilient than

others, as many are part of wider groups and benefit from diversification across business lines and

geographically. Many small firms have focused on protection-type business, where profitability is

less affected by the low interest rate environment and thus have exceptionally high SCR ratios, and

appear resilient to investment-side interest rate and other market shocks. However, some medium-

size life insurers are more vulnerable to the low interest rate environment and additional market

shocks. Features such as business mix, the amount of unrealized gains, future discretionary

policyholders’ bonuses, and average guaranteed rates are the most important risk drivers.

Most insurers that did not perform well in the test have already been on BaFin’s watch list and placed under

intensive supervision, such as enhanced reporting and more frequent on-site inspections, etc.

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INTERNATIONAL MONETARY FUND 29

C. Systemic Risk and Spillovers

24. Domestically, the largest German banks and insurance companies are highly

interconnected (Figure 14). The highest degree of interconnectedness can be found between

Allianz, Munich Re, Hannover Re, Deutsche Bank, Commerzbank and Aareal bank, with Allianz being

the largest contributor to systemic risks among the publicly-traded German financials.

Both

Deutsche Bank and Commerzbank are the source of outward spillovers to most other publicly-listed

banks and insurers. Given the likelihood of distress spillovers between banks and life insurers, close

monitoring and continued systemic risk analysis by authorities is warranted.

25. Notwithstanding moderate cross-border exposures on aggregate, the banking sector

is a potential source of outward spillovers. Network analysis suggests a higher degree of outward

spillovers from the German banking sector than inward spillovers.

In particular, Germany, France,

the U.K. and the U.S. have the highest degree of outward spillovers as measured by the average

percentage of capital loss of other banking systems due to banking sector shock in the source

country. Reflecting solid aggregate capital buffers, the impact of inward spillovers on the German

banking sector is considerably more moderate, as measured by the percentage of capital loss in the

banking system due to the default of all exposures.

26. Among the G-SIBs, Deutsche Bank appears to be the most important net contributor

to systemic risks, followed by HSBC and Credit Suisse (Figure 15). In turn, Commerzbank, while

an important player in Germany, does not appear to be a contributor to systemic risks globally. In

general, Commerzbank tends to be the recipient of inward spillover from U.S. and European G-SIBs.

The relative importance of Deutsche Bank underscores the importance of risk management, intense

supervision of G-SIBs and the close monitoring of their cross-border exposures, as well as rapidly

completing capacity to implement the new resolution regime.

See Annexes VI and VII for methodology.

The interconnectedness measure is derived from the variance decomposition of the underlying vector

autoregression (VAR) of equity returns. Similarly, Bundesbank analyses based on CDS prices for a European sample

also indicate a risk transmission from insurers to banks. See Bundesbank Monthly Report July 2014.

Analysis was performed across 16 BIS reporting countries with the highest banking sector exposures to Germany.

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30 INTERNATIONAL MONETARY FUND

Figure 14. Germany: Financial Sector Interconnectedness

Domestic Interconnectedness among Publicly Traded German Banks and Insurers

Source: IMF Staff Calculations constructed with NodeXL. Results are based on the Diebold and Yilmaz (2014) using daily equity

returns from 16 July 2015 to 23 February 2016. Note: The blue and green nodes denote banks and insurance companies,

respectively. The thickness of the arrows captures total linkages (both inward and outward), and the arrow captures the direction

of net spillover. The size of the nodes reflects asset size.

Outward and Inward Spillovers of the German Banking Sector

Source: IMF Staff Calculations. Results are based on the Espinoza-Vega and Sole (2010) approach and BIS Consolidated Banking

Statistics for 2015Q1.

120

150

Australia

Austria

Belgium

Canada

Finland

France

Germany

Italy

Japan

Korea

Netherlands

Spain

Sweden

Switzerland

Outward Spillover:

Percentage of Capital Loss

Bank Exposure All Exposure

Australia

Austria

Belgium

Canada

Finland

France

Germany

Italy

Japan

Korea

Netherlands

Spain

Sweden

Switzerland

Inward Spillover:

Percentage of Capital Loss

Bank Exposure All Exposure

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INTERNATIONAL MONETARY FUND 31

Figure 15. Global Systemic Risk

Net Contribution to Systemic Risk

Systemic Risk among GSIBs

Source: IMF Staff Calculations based on the Diebold and Yilmaz (2014) methodology using daily equity returns from 11 October

2007 to 26 February 2016. Lower chart constructed with NodeXL.

Note: The GSIB list follows the November 2015 update by the FSB. Commerzbank is included in the analysis, Groupe BPCE and

the Agricultural Bank of China (ABC) are excluded due to the data limitations. The blue, purple and green nodes denote

European, US and Asian banks, respectively. The thickness of the arrows capture total linkages (both inward and outward), and

the arrow captures the direction of net spillover. The size of the nodes reflects asset size.

-25

-20

-15

-10

-5

Allianz

Hannover Re

Aareal

Deutsche Bank

Talanx

Commerzbank

Munich Re

Rheinland

Merkur

Quirin

Umweltbank

DEU Pfandbrief

IKB

Oldenburgische

Nuernberger

Cash Life

Publicly Listed Banks and Insurers in Germany

-60

-50

-40

-30

-20

-10

DeutscheBank

HSBC

CreditSuisse

JPMor

GoldmanSachs

BankOfAmerica

BNPParibas

Santander

BankOfNYMellon

Mor

anStanle

SocGen

CreditA

ricole

WellsFar

Citi

roup

Nordea

Commerzbank

StateStreet

UniCredit

UBS

RBS

Mitsubishi

Barclays

StandardChartered

Sumitomo

ChinaConstructionBank

ICBC

BankOfChina

INGBank

Mizuho

Globally Systemically Important Banks

(GSIBs)

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32 INTERNATIONAL MONETARY FUND

27. In light of its systemic importance in the financial system and cross-sectoral activities,

Eurex Clearing AG can become a source of domestic and cross-border spillovers. Eurex Clearing

AG is one of the largest global CCPs, with interlinkages to over 180 clearing members in 17 countries.

Its clearing members include 24 G-SIBs, creating potential contagion channels through interbank

markets and memberships of these G-SIBs in other CCPs around the world.

28. Eurex Clearing could withstand an extreme but plausible market shock scenario,

covering losses with pre-funded resources. The EU-wide stress test exercise initiated by the

European Securities and Markets Authority (ESMA) was ongoing during the FSAP mission. The

objective was to test the resilience of EU CCPs to historical and hypothetical adverse market

developments, including market participant’s defaults across CCPs. The preliminary results for 2014

data for Eurex Clearing indicate sufficient buffers to withstand market shock scenarios.

MACRO- AND MICROPRUDENTIAL OVERSIGHT

A. Macroprudential Policy Framework

29. Germany has revamped its macroprudential policy framework. The Financial Stability

Act, adopted in late 2012, created the Financial Stability Committee (FSC) with a central role in

macroprudential oversight, and set out additional financial stability responsibilities for the

Bundesbank.

These reforms have taken place in the context of EU-wide macroprudential policy

reforms. Notably, the European Systemic Risk Board (ESRB) was created in December 2010, and the

Single Supervisory Mechanism (SSM) was established in November 2014, the latter sharing

macroprudential powers with the respective national authorities.

30. The new German framework appears broadly appropriate for effective

macroprudential policy. Although too early to make a full effectiveness assessment, the mandate,

accountability, and tasks are reasonably clear and set out in the Financial Stability Act and

elaborated in the FSC’s macroprudential policy strategy. Furthermore, Germany has recently

established a macroprudential policy tool-kit that became operational on January 1, 2016, including:

a countercyclical capital buffer (CCB); capital buffers for G-SIBs and for other systemically important

institutions; and the systemic risk buffer. Also, a liquidity coverage ratio is being phased in, as in

other EU countries.

31. Still, there is scope to strengthen the framework, including with regards to:

 Macroprudential tools. As the real estate sector is often a source of systemic financial risk,

macroprudential tools, such as loan-to-value caps, debt-service-to income limits, debt-to-

income ceiling, and amortization requirements, can be very useful. Though the German real

estate market does not show an imminent risk of a bubble, the authorities should create such

real estate-related tools, as recommended by the FSC in June 2015 to close an important gap in

The Act also tasks the FSC with strengthening the cooperation between its members in the event of a crisis

situation but it does not envisage a formal role for the FSC in the operational crisis management decision-making.

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INTERNATIONAL MONETARY FUND 33

the macroprudential policy framework. International experience is that such tools should be

deployed early to be most effective.

 Data. Macroprudential analysis and policy are highly data-dependent. The real estate tools, in

particular, require access to granular information on household incomes, debt data on a loan-

by-loan basis and real estate prices. To strengthen macroprudential and financial sector risk

analysis, the authorities should give priority to obtaining the required data. It could also consider

amending the Federal Data Protection Law to allow judicious use of data already collected for

other purposes, while maintaining adequate privacy protection.

 Transparency and accountability. The main accountability mechanism is the FSC’s Annual

Report to the Bundestag. To give more visibility to macroprudential policy issues, the FSC should

consider publishing a record of the discussions at each FSC meeting and creating a dedicated

FSC website with access to all relevant information, broadly similar to the practice in many other

advanced economies.

B. Microprudential Oversight

Banking regulation and supervision

32. German banking supervision has undergone profound changes with the approval of

the CRD IV/CRR framework, the establishment of the European Banking Authority (EBA) and

the creation of the SSM. The legal framework has been amended to transpose the CRD IV, while

the CRR and the regulatory technical standards developed by EBA and issued by the European

Commission became directly applicable. Additionally, the ECB took over direct supervision of 21 of

Germany’s largest banks, including one G-SIB.

33. Overall, the FSAP found good compliance with international best practices when

accounting for the more stringent 2012 BCP standards, proportionality considerations and the

impact of SSM integration.

The legal framework for banking supervision is well established by

German laws with effective division of responsibilities between BaFin and Bundesbank. Banks are

required to conduct regular stress testing using both standardized and bespoke scenarios. Interest

rate risk in the banking book (IRRBB) features as a key priority for both SIs and LSIs. Supervisors

have also stepped up the frequency and intensity of interaction with banks regarding management

of liquidity risk, contingency funding plans and compliance with the new Basel III liquidity

requirements (LCR and NSFR). A range of supervisory initiatives to mitigate cyber risk, which

constitutes growing stability threat, is welcome (Box 2).

For details, see Report on the Observance of Standards and Codes—Summary Assessments, Basel Core Principles

for Effective Banking Supervision.

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34 INTERNATIONAL MONETARY FUND

Box 2. Cyber Risk and Financial Stability in Germany

The complexity and interconnectedness of banks’ digital technology is growing, increasing the

technology-related operational risk. The changing distribution channels and nature of cyber-related

incidents require the regulations and supervisory approach to adapt to a rapidly changing risk profile.

Effective management of technology-related operational risk is a fundamental element of a bank’s risk

management.

Authorities have established industry-wide initiatives on the availability, integrity, and confidentiality

of IT-infrastructure by passing the IT-Security Act.

The Act focuses on providers of critical infrastructure

required to implement and maintain appropriate organizational and technical security standards in order to

ensure its proper operation and permanent availability. A range of financial institutions is covered, while

measures include the need for a contact point; measures to protect infrastructure; and reporting.

Risk management standards for IT-related operational risk are established by MaRisk.

Banks are

required to have in place an effective operational risk management framework across the entire enterprise,

subject to ongoing testing and enhancements to keep pace with the scale, complexity and risk profile of the

business. In addition, banks are required to adhere to established industry standards for IT security, such as

ISO/EC 27 of the International Standards Organization and the IT-Grundschutz Catalogues.

Strengthening IT resilience and cyber security is a key strategic priority for bank supervisors. Several

initiatives have been implemented:

 Strengthened dedicated IT risk specialist teams to support supervision processes;

 Annual meetings with IT security professionals to raise awareness of IT-related security issues;

 Cyber risk questionnaire involving all SIs to survey good practices and areas of weaknesses; and

 Targeted IT onsite examinations conducted across the banking system.

Further work is planned in 2016, including:

 Development of specific requirements for banks’ IT risk management;

 Targeted onsite examinations to test and assess IT resiliency; and

 Thematic review of Significant Institutions (SIs).

Robust surveillance techniques are needed to keep pace with evolving cyber threats. Regular board

and management engagement and intrusive inspection are key planks in the supervisory approach.

Supervisors need to verify that banks are appropriately incentivized to increase security and IT resilience by

raising risk management standards, and to leverage collective strengths through greater global

coordination. Achieving consistent industry standards at each layer of the service point will be necessary.

____________________________________

https://www.orrick.com/Events-and-Publications/Pages/German-Parliaments-IT-Security-Act-Covers-Critical-

Infrastructure.aspx.

Minimum requirements for risk management (Mindestanforderungen an das Risikomanagement - MaRisk).

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INTERNATIONAL MONETARY FUND 35

34. Notwithstanding the extensive legal and regulatory framework, important gaps exist.

While the Banking Act establishes fit-and-proper standards for supervisory and management board

members and defines the oversight function of the supervisory board, in practice the focus of

governance is placed on the management board. The oversight by the supervisory board is very

light. The independence of internal audit and compliance is compromised as they report to the

management board with no independent reporting channel to the supervisory board. The lack of

comprehensive and granular supervisory data negatively affects all aspects of financial supervision

and risk monitoring. In the absence of supervisory approval of investments, acquisitions may occur

that increase the risk to the banking group without ex ante prudential review. There is still no sound

framework regarding management and supervision of related-party risk. More attention is also

needed to monitoring of the effective implementation of operational risk management frameworks.

35. The establishment of the SSM has fundamentally changed the supervision of German

banks, both large and small. For the SIs, day-to-day supervision is conducted by Joint Supervisory

Teams led by ECB staff and supported by supervisors from supervisory agencies from all member

states where banks have operations, involving supervisors with different backgrounds, supervisory

cultures, and languages. The coordination of these teams presents operational and motivational

challenges, which will need to be addressed by the SSM in the long run. For the two largest German

SIs, the introduction of SSM allows for a welcome benchmarking of supervisory practices with other

large banks and G-SIBs. However, the timeliness of the supervisory response seems to have been

reduced given the need to develop consistent policies and the complex ECB decision making

procedures. For the smaller German SIs, the shift from local supervision to the SSM framework

represents a deep change in terms of reporting, minimum level of engagement with supervisors,

intrusiveness, and supervisory requirements—including capital add-ons resulting from the

Supervisory Review and Evaluation Process (SREP) process.

36. Over 1500 LSIs remain under the direct supervision of BaFin and the Bundesbank,

under the general guidance and oversight of the ECB. The ECB has designated some LSIs as High

Priority for which enhanced supervisory monitoring and reporting have been adopted, and is

developing joint standards to ensure elements of the SSM supervisory manual are also applied to

LSIs. BaFin and the Bundesbank have traditionally put a great emphasis on processes for risk

management and controls, counting on the work of external auditors for the verification of

compliance, while supervisors conduct the risk assessment using this and other information

obtained through onsite inspections, reports, and direct contact with banks. The greater emphasis

on reporting and SREP, in particular on a more direct assessment of credit risk valuation, is welcome.

As a consequence, LSI supervision is changing from a more qualitative and relationship-based

approach to a more quantitative approach. However, the increased reporting and monitoring

requirements for LSIs need to be proportional to their systemic importance and available resources.

For the very small entities, it is also important that sufficient resources in the national competent

authorities (NCAs) continue to be dedicated to meeting supervisory objectives.

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36 INTERNATIONAL MONETARY FUND

37. Most of the tasks assigned to the SSM must be executed according to national

legislation, and all decisions need to be approved by the ECB’s Governing Council resulting in

a time-consuming and cumbersome decision making process. Every supervisory decision, after

consideration and approval by the Supervisory Board, is raised to the ECB’s Governing Council for

approval under a no-objection procedure. In addition, for LSIs and SIs alike, the ECB needs to apply

local legislation in each member state. For instance, licensing applications must be filed with

national authorities in compliance with national legislation, and then submitted for analysis and

decision by the ECB. All fit and proper authorizations of SIs are assessed against national fit and

proper criteria and then submitted to the ECB. Enforcement and sanctioning powers of the ECB are

also largely based on what is available under national legislation, and although the ECB has some

direct enforcement powers, it mostly needs to act by giving instructions to BaFin on measures to be

taken under German legislation. It is crucial that decision making processes in the day-to-day

supervision are streamlined to the extent possible so that timely supervisory response is not

hindered further in this already complex legal framework.

38. As the supervisory landscape evolves, it is crucial that supervisors communicate their

expectations to banks and develop guidelines and regulations that can be used to

substantiate enforceable measures. All aspects that are not harmonized within the EU—or on

which EU or German regulatory framework is silent—need to be developed into guidelines or

regulations that can both inform the banks of supervisory expectations and substantiate supervisory

action. In the German framework some of that is done through circulars, ordinances and guidelines.

Through the implementation of the SSM, harmonized standards are being introduced for SIs and the

good practices and process engrained in the internal SSM procedures should be made public in

instruments which can help substantiate supervisory measures. This is particularly relevant for

guidance related to loan portfolio management (on setting loan classification parameters and

provisioning, collateral valuation considerations, and elements of effective credit risk management),

concentration risk, country and transfer risk, related party risk, and operational risk. The coverage

and granularity of supervisory data needs to be improved rapidly.

Withdrawal of correspondent banking relationships

39. Some major German banks are withdrawing from correspondent relationships in a

number of countries. These decisions appear to be driven mainly by business and risk-return

considerations, lower risk appetite and implementation of a risk-based approach to international

standards. Not unique to German banks, they could entail disruptions to the affected countries’

economic activity. The authorities should encourage banks to assess the risks that they face in

specific situations and apply risk mitigation tailored to the risks of a specific customer or product,

with a view to preventing unnecessary curtailment of legitimate financial activities. Greater

cooperation among national supervisors is also needed, including to clarify regulatory expectations,

harmonize regulatory frameworks and facilitate cross-border information sharing on customer due

diligence.

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INTERNATIONAL MONETARY FUND 37

Financial market infrastructures—Eurex Clearing

40. Eurex Clearing is licensed both as a CCP and a credit institution resulting in a number

of financial stability safeguards. It is authorized by BaFin as a clearing house in accordance with

EMIR and at the national level licensed also as a credit institution. The banking license allows it to

take deposits, and provide lending while acting as a CCP. As a member of TARGET 2, Eurex Clearing

settles the cash leg of its euro transactions in central bank money, using its account at the

Bundesbank. It also settles the Swiss franc transactions at the Swiss National Bank (SNB). It has

access to the intraday and overnight credit facility of the Bundesbank and may have access to

further liquidity assistance at the discretion of the relevant central bank, subject to applicable legal

restrictions.

41. Eurex Clearing has coped well with volatile markets and strengthened international

standards. It has already developed a recovery plan in accordance with the Recovery and Resolution

Act. Eurex Clearing has been recognized by the Swiss authorities as a systemically important FMI to

the Swiss market and approved by the U.S. Commodity Futures Trading Commission (CFTC) as a

registered derivatives clearing organization to offer proprietary OTC clearing services to clearing

members domiciled in the U.S. However, it would benefit from strengthening its liquidity stress tests

and ensuring effective business continuity arrangement by upgrading the secondary site with

appropriate staffing arrangements. While the regulatory, supervisory, and oversight framework is

effective, the legal basis for the Bundesbank’s oversight warrants strengthening, its tasks and powers

should be made explicit in the law and intensity of on-site inspections increased.

42. Potential spillover risks related to Eurex Clearing are well contained; authorities are

encouraged to monitor global and domestic interdependencies. As the G20 regulatory reforms

lead to increased central clearing volumes,

Eurex Clearing’s sound risk management is critical to

minimize global spillovers from disruption of its operations. German authorities should monitor

interdependencies, for example through network analysis and stress testing, and are encouraged to

continue leading the international effort to increase robustness of CCPs, further enhance recovery

and resolution standards for FMIs, analyze and monitor their interconnectedness and coordinate

FMI recovery planning with other key global players in the relevant international fora.

For details, see Report on the Observance of Standards and Codes—Summary Assessments, Principles for Financial

Market Infrastructures.

With 186 clearing members, 1.8 billion contracts and transactions have been cleared in 2015 amounting to a total

value of over EUR 200 trillion, compared to EUR 159 trillion in 2010 based on the EMIR compliant reporting of Eurex

Clearing AG.

The stress testing exercise of EU CCPs and their clearing members, initiated and coordinated by ESMA, and

authorities’ participation in the Study Group on Central Clearing Interdependencies are important first steps.

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38 INTERNATIONAL MONETARY FUND

Insurance regulation and supervision

43. Since the last FSAP, the authorities have acted to mitigate the impact of low interest

rates on the insurance sector; nonetheless, vulnerabilities persist. Actions taken include the

introduction, as early as 2011, of requirements on life insurers to build reserves for future

commitments (the so-called ZZR);

legislative changes regarding distribution of unrealized

investment gains to departing policyholders; and the use of transitional measures under Solvency II

to mitigate the material impact of the new valuation basis. Insurers themselves have been changing

their product mix, and reducing guarantees on new products. Nonetheless, financial strains at

individual companies are possible, particularly those concentrating on traditional life insurance,

reflecting large accumulated books of business written over many years.

44. The regulatory and supervisory regime has been substantially bolstered by Solvency II

implementation. BaFin is taking a more risk-based approach to evaluating supervisory risks and

allocating resources. There is an increased focus on groups in the regulatory and reporting

requirements, improved cross-border cooperation through colleges of supervisors, and enhanced

monitoring of insurers’ investment activities, including regular stress testing. After a large increase,

BaFin’s supervisory resources appear appropriate, while the transition to Solvency II has involved

extensive retraining of staff and application of more principles-based approaches to governance and

risk management. However, many new regulatory tools (including a prudent person principle for

investments) are still under implementation and their effectiveness remains to be tested.

45. BaFin has identified life insurers under strain that are now subject to close oversight.

The continuing importance of national Generally Accepted Accounting Principles (GAAP) in relation

to policyholder profit participation, which is a central feature of German life insurance, makes

Solvency II implementation particularly complex in Germany. While BaFin is monitoring companies’

positions and has conducted surveys on the impact of Solvency II, uncertainty remains regarding

market reactions to the publication of new solvency indicators. The array of measures of financial

strength may hamper interpretation.

Given this multiplicity and high transparency of measures to

be published in 2017 regarding the reliance on transitional measures, a communication strategy

should be formulated with high priority to improve public understanding.

46. BaFin’s intervention and policy framework should be reinforced. BaFin should

communicate supervisory expectations based on the Own Risk and Solvency Assessment (ORSA)

review more systematically, and make full use of the provisions in the supervisory legislation to

require capital add-ons in the circumstances envisaged in Solvency II. BaFin should consider

applying aspects of its G-SII approach, on a risk-based basis, to other large insurance groups,

including large reinsurers with global reach. BaFin should continue to develop its crisis management

For details, see technical Note on “Insurance Sector Supervision.”

Since 2011, over EUR 20 billion of profits have been allocated to the ZZR on a cumulative basis at year-end 2014.

Insurers are subject to both Solvency II requirements for regulatory purposes and the continuing national GAAP

framework, based on historic cost accounting, for financial statements.

GERMANY

INTERNATIONAL MONETARY FUND 39

planning, including the acceleration of recovery planning (now applied only to the G-SII) and keep

under review the adequacy and flexibility of safety net arrangements, in particular transferability of

complex businesses with derivatives and reinsurance transactions. The authorities should continue

to improve the stress testing methodologies and conduct regular stress tests on an industry-wide

basis.

47. BaFin should require action plans where companies face difficulties in meeting

Solvency II requirements. Where companies are relying on transitional measures, insurers should

have robust and credible plans for meeting the full requirements, including under stress conditions

that may occur in the long transitional period, and by the end of the period. BaFin should take

action to restrict business or withdraw approval of transitional measures, where necessary.

Asset Management and Collective Investment Schemes

48. Germany’s regulatory framework for asset management sector is strong and

comprehensive. Full account is taken of the requirements set out in EU legislation and the

standards and principles developed by International Organization of Securities Commissions

(IOSCO), with some adjustments to reflect the specificities of the German market and priorities of

the main supervisor of the sector, BaFin.

49. The authorities have increased their supervisory engagement in recent years. BaFin is

sufficiently well-resourced that it can maintain close contact with asset managers and depositaries,

which could be intensified even further through a program of more frequent on-site inspections.

This should include BaFin staff accompanying external audits on a more regular basis. In addition,

BaFin should take into account a broader range of factors, such as the leverage employed by fund

managers and the level of interconnectedness, in its risk classification of supervised entities.

50. German asset managers and funds are subject to detailed rules on the valuation of

assets and net asset value (NAV) calculation, but additional macroprudential measures could

be considered. With respect to liquidity risk management, appropriate safeguards were put in place

to prevent a recurrence of problems experienced by certain open-ended real estate funds following

the financial crisis. Nevertheless, additional measures could further ensure stability—and should be

considered in tandem with other EA supervisors—for instance, the introduction of mechanisms, such

as swing pricing, to reduce the first-mover advantage that can exist in single-priced funds. BaFin

should also monitor the need for more detailed guidelines on the use of these tools, with a view to

contributing to relevant EU and international standard-setting work. The authorities should also

consider allowing for a broader range of tools to deal with situations of market illiquidity that could

have an impact on the ability of funds to meet redemption requests. Finally, the treatment of

material pricing of investment funds and associated rules on investor compensation merit stronger

oversight.

For detail, see Technical Note on “Fund Management: Regulation, Supervision and Systemic Risk Monitoring.”

GERMANY

40 INTERNATIONAL MONETARY FUND

51. BaFin is able to monitor developments in the asset management sector by having

access to an extensive set of data shared by the Bundesbank. Individual exposures can be

identified accurately, allowing supervisory intervention where needed. BaFin’s oversight of the sector

using quantitative data will be further enhanced as the reporting under the AIFMD becomes more

reliable. Pending the establishment of a system for the collection and exchange of data by ESMA,

BaFin should ensure it has its own system in place to assess the reported information and flag issues

to other EU supervisory authorities as necessary. BaFin should also contribute to discussions at the

European and international levels on the development of a single method of calculating leverage.

AML/CFT

52. In recent years, Germany has introduced significant reforms to enhance its AML/CFT

regime. It notably criminalized self-laundering and immobilized bearer shares, enhanced domestic

cooperation, improved the supervisory framework for designated non-financial business and

professions (DNFBPs) and the risk analysis model applied by BaFin for AML/CFT supervision. Onsite

visits to financial institutions and DNFBPs have increased. Germany is currently conducting a

national assessment of its money laundering (ML) and terrorist financing (TF) risks.

53. Overall, the AML/CFT framework appears strong, with enhancements warranted in

some areas. Germany should consider expanding the range of predicate offenses to ML so as to

include offenses—in particular tax offenses—not only when aggravating circumstances are met but

also in their absence, when the offense generates significant amounts of proceeds. Significant

sanctions by foreign regulators for non-compliance with their national AML/CFT provisions imposed

on some banks suggest the need for stronger implementation of AML/CFT obligations. Germany

should enhance AML/CFT supervision of banks with cross-border operations, and as a priority, give

additional attention to the supervision and audit review of banks’ risk assessments and control

measures. More streamlined information flow and cooperation between BaFin, ECB and the

Bundesbank would also strengthen BaFin’s AML/CFT supervision of banks’ group-wide risk

management policies and controls at the parent level. Current staffing levels at BaFin’s Department

of Money Laundering Prevention warrant strengthening. Finally, Germany should take further

measures to facilitate timely access to beneficial ownership information of legal persons.

FINANCIAL SAFETY NETS

Scope and inst itutional landscape for bank resolution and crisis management

54. The transposition of the EU BRRD into German law has significantly strengthened the

existing resolution regime in Germany. The BRRD establishes uniform rules within the EU for

recovery and resolution of banks and investment firms that are closely aligned with the FSB’s Key

For detail, see Technical Note “Anti-Money Laundering and Combating the Financing of Terrorism.”

For detail, see Technical Note on “Crisis Management, Bank Resolution and Crisis Management Frameworks.”

GERMANY

INTERNATIONAL MONETARY FUND 41

Attributes for Effective Resolution Regimes (KAs).

Preexisting broad German powers and tools have

been further enhanced by, inter alia, the introduction of bail-in, though the authorities did not

transpose the BRRD’s extraordinary government financial stabilization tools (temporary public equity

support and temporary public ownership), thus constraining their toolkit in the event of a systemic

crisis. This new framework now needs to be operationalized.

55. Institutional arrangements have undergone fundamental change with the

implementation of the Single Resolution Mechanism (SRM). In 2016, the SRB has assumed

responsibility for ensuring effective resolution of SIs along with other German banks with cross-

border operations in other EU jurisdictions. A Single Resolution Fund (SRF) was created to fund

resolution measures, and will be used for banks resolved in all SRM member states after the national

compartments of the SRF have been fully mutualized in eight years’ time. While the SSM has

established a track record over more than a year in operation, the SRM is still in a start-up phase.

The SRM decision-making structure is complex. Its efficiency should be reviewed and streamlined.

56. While the institutional framework for bank resolutions has been put in place, a

coordination mechanism for addressing a systemic crisis remains less formalized. A formal

coordination framework involving the German authorities, ECB and SRB should be developed along

with contingency plans for management of a systemic crisis in cooperation between the German

and European authorities. These plans should be tested via crisis simulation exercises.

Recovery and resolution planning

57. Authorities are making significant progress in recovery and resolution planning. Since

2013, large domestic banks have been required to have recovery plans. This requirement is now

being rolled out for additional banks, including high priority LSIs and small banks, by 2017. Similarly,

resolution planning and resolvability assessments are ongoing in all significant banks.

58. Authorities intend to rely largely on bail-in to resolve systemic banks. The EU minimum

requirement for eligible liabilities (MREL) is formally in place since 2016 and will be applied on an

institution specific basis and phased-in over time.

The framework for bail-in is strict and only

allows exemptions in limited cases. Building adequate buffers may take years in some banks. This

might constrain policy options in a systemic crisis during the transition. The authorities’ policy

options are also constrained by the non-transposition of the BRRD’s provisions on government

stabilization tools in the SRM regulation and German legislation. Based on a number of surveys, the

authorities believe that most potentially systemic banks have already issued a sufficient volume of

debt that would allow for bail-in. The authorities should continue to monitor that the available bail-

inable liabilities are adequate for large banks. Recent German legislation clarifying the subordination

of certain unsecured debt from 2017 onwards will facilitate implementation of bail-in.

These rules also cover subsidiaries, financial holding companies, mixed financial holding companies and mixed

activity holding companies.

A draft RTS by the EBA outlines the criteria that resolution authorities should apply when setting MREL.

GERMANY

42 INTERNATIONAL MONETARY FUND

59. Operationalization of resolution plans and ensuring funding of a bank in resolution is

a high priority. The authorities have identified operational challenges (e.g., the timely valuation of

assets to be transferred, continued access to financial market infrastructures) and are working to

surmount them. In some cases, actions to effect resolution may require a number of days to

implement, and the authorities should ensure they can maintain control over the bank during this

period, including by using their powers to impose a more general moratorium for a specific bank.

Authorities also need to ensure adequate funding to support banks in, and subsequent to, a

resolution decision. The available funding should be assessed during resolution planning and in the

preparation of a resolution decision. Such funding needs should preferably be covered by private

sector funding, or by public sector backstop facilities. While the resolution framework legally

precludes assuming access to ELA (which is subject to ECB approval above specified thresholds) as

part of resolution planning, the Bundesbank should consider liaising with the resolution authorities

during the preparatory phase to assess potential post resolution liquidity needs.

60. Completing a common European backstop to the SRF remains a medium term priority.

Currently, the German Loan Facility Arrangement with the SRB provides a backstop for the national

compartment in the SRF. In addition, the SRF allows for limited recourse to the SRF’s other national

compartments during the transition phase. There is no agreement yet on a common European

backstop. The EU Economic and Financial Affairs Council (ECOFIN) ministers have committed to

agreeing on this issue by the end of the SRF transitional period, i.e., 2023. A common European

backstop remains necessary to ensure that the SRF will have sufficient resources at its disposal to

fund resolution measures.

Cross-border cooperation

61. Contrary to the requirements of the Key Attributes of Effective Resolution regimes,

the resolution framework limits the participation of third country authorities in Resolution

Colleges to the role of observers. Their access to confidential information is conditional upon their

domestic regimes compliance with the required confidentiality and data secrecy provisions. In

practice, the German authorities have developed a good track record of coordination with countries

outside of the EU in Crisis Management Groups (CMGs). The authorities should continue efforts to

foster cooperation with non-EU countries, despite gaps regarding confidentiality in the European

framework.

62. Similarly, the resolution framework requires the resolution authority to take into

account the effects of a resolution decision in other EU Member States, but not the effects in

third countries. Aforementioned cooperation in Resolution Colleges and CMGs will also address

these effects. The authorities should continue their efforts to develop cooperation with third country

authorities, and, in the longer term, to pursue legislative changes—with other EU member states—to

foster cross-border cooperation at the European level.

This moratorium should be limited to the maximum time necessary in order to minimize any destabilizing effects

in the market.

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INTERNATIONAL MONETARY FUND 43

Deposit insurance

63. Funding and transparency of the deposit guarantee schemes (DGS) has been

enhanced. Deposit insurance follows the three-pillar model of the German banking sector. In the

event of a bank failure, depositors have a legal claim for reimbursement of their covered deposits up

to EUR 100,000 (in specific situations, up to a higher amount). In addition to the two statutory DGSs

(one for private banks and one for public banks), there are also two Institutional Protection Schemes

(IPS), which are formally recognized as DGSs; one covers savings banks and Landesbanken and

another cooperative banks. Legislation requires banks be able to provide information on insured

depositors with respect to their claims and for reimbursement by a statutory DGS within seven

working days. While important progress has been made, EA jurisdictions have not yet reached

agreement on an EA-wide deposit insurance scheme.

64. IPSs play important monitoring and stabilization roles for their members, but the

uneven playing field for DGSs may result in competitive disadvantages for private banks and

hinder consolidation across sectors. The IPSs have risk monitoring systems in place, and can

provide funding to restructure and resolve individual failing members as part of private sector

measures. In a systemic crisis situation, they may potentially propagate contagion within the

respective banking pillars. However, the members of IPSs do not have a legal claim on such funding

by the IPS. In the absence of IPS support, as an appropriate safeguard, covered deposits will be paid

out to the maximum of EUR 100,000 and the troubled bank will be dealt with under the general

resolution regime.

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44 INTERNATIONAL MONETARY FUND

Table 2. Selected Economic Indicators, 2013–17

January 2016 Projections

2013 2014 2015 2016 2017

Output

Nominal GDP (in EUR bn) 2820.8 2915.6 3025.9

Real GDP growth (%) 0.4 1.6 1.5 1.7 1.7

Total domestic demand growth (%) 0.9 1.3 1.3 1.8 1.9

Output gap (% of potential GDP) -0.4 -0.2 -0.1 0.2 0.4

Employment

Unemployment rate (%, ILO) 5.2 5.0 4.6 4.8 5.1

Employment growth (%) 1.0 0.9 0.5 0.8 0.7

Prices

Inflation (%) 1.6 0.8 0.1 1.0 1.5

General government finances

Fiscal balance (% of GDP) -0.1 0.3 0.6 0.0 0.0

Revenue (% of GDP) 44.4 44.6 44.7 44.5 44.4

Expenditure (% of GDP) 44.5 44.3 44.1 44.5 44.4

Public debt (% of GDP) 77.4 74.9 71.1 68.4 66.2

Money and credit

Broad money (M3) (end of year, % change) change)

2.6 4.9

Credit to private sector (% change) 0.8 0.6

10 year government bond yield (%) 1.6 1.2

Balance of payments

Current account balance (% of GDP) 6.5 7.3 8.3 8.1 7.7

Trade balance (% of GDP) 7.5 7.8 8.5 8.6 8.2

Exports of goods (% of GDP) 38.2 38.2 39.3 39.8 40.5

volume (% change) 1.3 4.2 5.3 3.7 4.3

Imports of goods (% of GDP) 30.8 30.5 30.7 31.2 32.2

volume (% change) 2.2 4.7 6.2 4.5 5.1

FDI balance (% of GDP) -0.3 -2.8 -0.6 -0.6 -0.6

Reserves minus gold (in USD bn) 67.4 62.3

External Debt (% of GDP) 150 153

Exchange rate

REER (% change) 3.3 -2.4

NEER (% change) 3.4 -1.7

Real effective rate (2000=100) 4/ 99.7 97.3 ... ... ...

Nominal effective rate (2000=100) 101.5 99.8 ... ... ...

Sources: Deutsche Bundesbank, Eurostat, Federal Statistical Office, Haver Analytics, and IMF staff.

idji

Reflects Germany's contribution to M3 of the euro area.

Table 3. Financial Soundness Indicators for the Household Sector, 2006–15

(Billions of euro, end of period, unless otherwise noted)

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Disposable income 1482 1507 1541 1525 1562 1608 1642 1672 1710 1758

Savings ratio (percent) 10.1 10.3 10.5 10.0 10.0 9.6 9.3 9.2 9.5 9.7

Debt 1567 1547 1532 1529 1534 1552 1568 1580 1600

Mortgage debt to total debt (%) 75.1 75.4 75.5 75.5 75.2 75.2 74.6 74.7 76.6

Total debt to disposable income (%) 105.72 102.64 99.40 100.29 98.25 96.48 95.47 94.49 93.57

Debt to GDP (%) 67.7 63.7 62.0 64.6 62.0 59.8 n.a. 56.2 55.1

Debt service to income (%) 4.2 4.4 4.4 3.4 3.2 2.9 n.a. 2.1 1.8

Structure of household's financial assets

Deposits in banks and currency 1499 1565 1658 1703 1770 1828 1907 1970 2056

Debt securities 275 297 267 266 254 247 238 216 198

Equities and investment fund shares 1001 1066 777 820 863 805 878 947 1017

of which:

Investment fund shares 444 467 380 416 435 395 420 450 498

Listed shares 202 204 128 163 197 173 202 233 244

Pension savings 1361 1436 1465 1544 1622 1672 1760 1847 1933

Ratio of household's fin. liabilities to fin. assets (%) 37.5 35.1 36.4 35.0 33.8 33.8 32.5 31.5 30.5

Real estate markets

Prices (index, 2007Q1=100)

Total 99.0 98.8 97.1 99.2 102.5 107.5 113.1 116.0 122.3

Apartment 100.1 99.7 97.9 100.2 102.9 108.8 113.9 116.1 122.4

New Homes 99.7 101.3 102.1 105.0 108.3 113.5 119.1 123.1 129.2

Existing Homes 97.3 95.4 91.0 92,1 96.2 100.2 106.2 108.5 115.0

Average home price of 10 main cities 99.1 98.2 97.7 98.5 101.9 106.1 112.2 116.3 122.6

Average apartment price of 10 main cities 100.8 100.9 100.7 104.1 108.0 114.0 123.5 129.5 138.0

Price to rent ratio (index)

99.7 99.5 98.9 98.4 100.0 104.5 95.6 115.0 119.1 103.2

Gap to linear trend (%)

-5.1 -5.7 -6.1 -6.1 -5.4 -2.3 1.1 4.5 8.5

Sources: BulwienGesa, Bundesbank, Destatis, ECB, Hypoport, OECD, and IMF Staff Calculations.

Source: Hypoport.

Nominal house prices to rent prices, index based in 2010. Source: OECD.

Total house price; trend from 1975-2014. Source: BulwienGesa.

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45 INTERNATIONAL MONETARY FUND

Table 4. Financial Soundness Indicators for the Corporate Sector, 2006–14

(Billions of euro, unless otherwise indicated)

2006 2007 2008 2009 2010 2011 2012 2013 2014

Capital structure

Corporate equity 1972.2 2234.4 1655.4 1785.2 2018.7 1841.2 1927.8 2433.5 2535.1

Corporate debt 1775.5 1892.8 1985.6 1939.7 1887.0 1890.7 2106.5 2091.0 2144.8

Financial assets 2336.7 2559.1 2404.9 2476.4 2380.9 2357.2 2607.4 3101.6 3192.6

Financial assets to liabilities ratio 1.32 1.35 1.21 1.28 1.26 1.25 1.24 1.48 1.49

Debt to equity ratio 0.90 0.85 1.20 1.09 0.93 1.03 0.92 0.86 0.85

Profitability

Return on equity (%) N/A N/A N/A N/A 8.84 13.05 10.82 7.54 7.17

EBITDA

0.64 0.56 0.70 0.61 0.86 0.73 0.94 0.78 0.71

EBITDA to interest ratio

7.52 6.53 6.17 4.35 7.45 7.44 8.56 7.83 8.95

Debt to EBITDA ratio

1.77 1.99 2.56 3.18 2.44 2.45 2.39 2.56 2.37

Miscellaneous indicators

Number of bankruptcies per year 16408 13599 13358 16167 15283 14553 13951 14344 13480

DAX (excl. f.i.s, end of year value) 748.3 974.2 508.3 817.6 850.7 685.1 828.1 1166.8 1371.4

DAX index (end of year value)

6596.9 8067.3 4810.2 5957.4 6914.2 5898.4 7612.4 9552.2 9805.6

Source: Bundesbank, Capital IQ, Deutsche Bourse, and IMF staff calculations.

Data is the median value of the top 50 companies by assets, IMF/MCM.

Index: December 30, 1987=1000.

GERMANY

INTERNATIONAL MONETARY FUND 46

Table 5. Financial Soundness Indicators, 2008–14

(In percent, unless otherwise indicated)

2008 2009 2010 2011 2012 2013 2014

ital Ade

uac

ulator

ital to risk-wei

hted assets 13.6 14.8 16.1 16.4 17.9 19.2 18.0

ulator

Tier I ca

ital to risk-wei

hted assets 9.5 10.8 11.8 12.1 14.2 15.6 15.4

ital to assets 4.5 4.8 4.3 4.4 4.7 5.5 5.6

Credit Ris

NPLs net of

rovisions to ca

ital 25.3 36.9 34.2 31.6 27.4 23.8

NPLs to

ross loans 2.9 3.3 3.2 3.0 2.9 2.7

FX loans to total loans 12.2 11.5 11.5 11.0 10.5 10.0 11.5

read between reference loan and de

osit rates

273.0 342.0 343.0 324.0 326.0 319.0

Sectoral Distribution of Total Loans

Loan to households 24.4 26.3 26.2 26.2 26.8 28.5 28.7

Loans to non-financial cor

orations 14.5 14.8 14.6 14.6 14.9 15.6 15.2

Geo

hic Distribution of Total Loans

German

71.2 72.9 74.9 75.7 76.8 76.8 74.6

EU-member countries 20.2 19.5 17.6 16.8 16.0 16.0 15.8

Others 8.6 7.6 7.4 7.5 7.2 7.2 9.6

Profitabilit

Return on avera

e assets (after-tax) -0.3 -0.1 0.2 0.3 0.2 0.2

Return on avera

e e

uit

(after-tax) -8.1 -2.0 3.7 6.5 5.6 3.5

Interest mar

in to

ross income 84.6 72.5 73.2 72.9 71.5 71.9

Noninterest ex

enses to

ross income 73.4 65.1 63.7 63.9 64.2 69.1

Tradin

income to

ross income 0.0 0.0 4.5 3.7 5.5 4.9

Personnel ex

enses to noninterest ex

enses 53.4 54.7 52.7 52.0 52.9 51.9

uidit

uid assets to total short-term liabilities 120.3 144.1 137.0 137.9 144.2 140.5 145.5

Customer de

osits to total (non-interbank) loans 77.7 76.5 73.6 73.6 75.7 84.5 86.9

FX Ris

Net o

ositions in FX to ca

ital 6.6 5.3 4.4 4.5 3.9 3.8

Source: Deutsche Bundesbank.

Spread in basis points.

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47 INTERNATIONAL MONETARY FUND

GERMANY

48 INTERNATIONAL MONETARY FUND

Table 6. Germany: Risk Assessment Matrix (RAM)

Source of

Risks

Overall Level of Concern

Likelihood of severe realization in 1-3

years

Expected Impact on financial stability

Protracted period of

slower growth in key

advanced economies

and sharp downturn

in China and other

EMs, leading to

slowdown of external

demand and

dampening of global

growth

Medium

Slow and incomplete implementation of

structural reforms in Europe, China and

Japan could hamper medium term

growth

Lower demand from EMs would lead to

decline in global trade, while activity in

EMs and commodity exporters would be

dampened. Oil prices would drop

further.

A hard-landing in China would further

worsen the global slow-down, create

more financial market volatility in EMs

and AEs and impact capital flows and

commodity prices.

The global downturn would impact

Germany though falls in export demand,

financial linkages, and confidence

effects.

Medium

A global recession would fuel credit and

market risk, and deteriorate asset quality.

The correction of overvalued asset prices

triggers wealth and confidence effects

which weigh on consumption and

investment. Provisioning needs for banks

would increase considerably, negatively

affecting already low profitability. Some

banks may search for yield and take up

excessive short-term risks in an

environment of higher financial market

volatility.

German banks’ direct exposures to EMs

are small, and the corporate sector can

absorb parts of demand shocks due to

strong internal buffers and low debt.

However, covered bond and lower-

quality corporate bond spreads could

increase, leading to a rise in firms’

financing cost.

These risks will be analyzed through

macroeconomic adverse scenario I

(“Global Stress Scenario”).

Reemergence of EA

sovereign bond

market volatility and

peripheral sovereign

contagion. Financial

stress in the euro area

could re-emerge

triggered by policy

uncertainty, faltering

reforms, or political

unrest.

Medium

Policy uncertainty, delays in

structural reforms as well as social

resistance to austerity programs

combined with generally lower

investor sentiment towards the EA,

could boost peripheral sovereign

default risk.

Reemergence of peripheral bond

market volatility could intensify the

bank-sovereign link, leading to

tighter financial conditions, weaker

investor sentiment and consequently

lower investment in Germany.

Medium

Tighter financial conditions could

lead to a decline in credit supply.

Increased default risk for banks

would further impair already low

profitability.

Substantial increases in peripheral

sovereign yields would cause

valuation losses in banks. While still

present, flight-to-quality effects have

diminished since 2013. Therefore

yields on sovereign papers issued by

core countries would also rise, but

less than in the periphery.

Banks would take a hit on capital

ratios, as interest and trading income

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INTERNATIONAL MONETARY FUND 49

deteriorate further. Alternatively,

banks may search for yield and take

up excessive risks.

These risks will be analyzed through

macroeconomic adverse scenario II

(“Euro Area Crisis Scenario”).

Excessive risk-taking

associated with the

low interest rate

environment.

Low

Faced with falling net interest

margin, and generally low

profitability, banks and insurance

companies may be tempted to

adopt more risky search-for-yield

strategies. The problem is

particularly acute for life insurance

companies that may no longer be

able to distribute guaranteed yields.

Search for yield may turn the recent

strength in pockets of the German

housing market into a nationwide

real estate assets overvaluation.

Changes in market microstructure

dry up certain market segments,

fueling asset price volatility.

Medium

A correction of asset prices, together

with squeezes in liquidity,

characterized by net outflows of

liquidity and loss of certain funding

sources, force financial institutions to

sell liquid assets at a loss.

Balance sheets may generally

become more risky as higher short-

term profits are traded imply

increased long-term risks.

As a consequence, credit and market

risks in banks increase, and

investment in less liquid assets fuels

liquidity risk. Increasing market

volatility induces higher uncertainty

going forward, and mark-to-market

requirements would force the

realization of losses, further weighing

on profitability.

These risks are analyzed through

specific interest rate risk tests, as well

as through combined market and

funding liquidity risk tests.

Distress in a major

financial institution

Low

Low profitability and high leverage

in one of Germany’s systemic

financial institutions may result in

distress if the sector is faced with

significant shocks.

High

The highly interconnected nature of

German SIFIs could trigger a systemic

event both domestically and globally.

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50 INTERNATIONAL MONETARY FUND

Annex I. Germany: Implementation Status of 2011 FSAP

Recommendations

Recommendations Status

Structural issues

Develop a comprehensive strategy aimed at improving the

efficiency and stability of the banking system, which

includes the following:

(a) urgently establishing viable business models for the

Landesbanken;

(b) loosening the regional constraints under which local

banks operate;

and

(d) strengthening these banks' governance to reduce

noncommercial influences.

The restructuring of the Landesbanken is under way. There

are no plans however to loosen regional constraints nor to

open up public banks to private participation, and limited

progress has been made to reduce non-commercial

influences. Notwithstanding, some progress has occurred

and HSH Nordbank has almost 10 percent private

ownership and is to be privatized by the end of February

2018 (with the option of a six-month extension subject to

approval of the EU Commission in case of a delay of the

technical implementation) or wound down. This may

happen through a sale to strategic investors or with the

participation of other Landesbanken.

Limited implementation

Prudential supervision

Continue to improve stress testing in the banking and

insurance sectors, for example, with respect to longer-term

risks, liquidity risk, and group-wide spillovers.

Banks: In 2014, 24 large banking groups participated in the

Comprehensive Assessment/EBA EU-wide stress test. The

Bundesbank’s macroeconomic top-down stress test has

been significantly upgraded, which led to a broadening of

risk factor coverage for the largest banks. Further

refinements are warranted, however, as well as

improvements in Bundesbank’s top-down surveillance tools.

The Bundesbank and BaFin recently concluded a bottom-up

exercise that addressed the profitability of banks in a low-

interest rate environment.

Insurance: The Bundesbank developed top-down

approaches to insurers. Bafin carried out bottom-up surveys

on a regular basis, both based on national accounting

standards and in preparation for introduction of Solvency II.

In progress

Rigorously ensure that any financial institution that displays

weaknesses on a forward-looking basis strengthens its

balance sheet and take managerial action.

EU CRD IV establishes the SREP, by which competent

authorities are empowered to review the arrangements,

strategies, processes and mechanisms implemented by

institutions. For significant institutions, the SREP in 2015 is

already carried out in accordance with the requirements of

the SSM Supervisory Manual by the ECB in cooperation with

the Bundesbank and BaFin. For less significant institutions,

the ECB and NCAs are currently developing joint standards.

Based on these, BaFin and the Bundesbank will adjust the

current risk assessment system for the national SREP in

2016. Supervisors have required capital but action regarding

provisions and NPLs is still evolving.

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INTERNATIONAL MONETARY FUND 51

Recommendations Status

Regarding the insurance sector, the 2014 German Life

Insurance Reform Act introduced more stringent risk-

management requirements and increased the powers of

intervention of BaFin. Stress-tests are expressly required to

include a long-term view.

In progress

Grant supervisors power to vet in advance bank

acquisitions of subsidiaries.

Neither European laws nor national laws foresee a prior

approval process for acquisitions.

Supervisory interventions may follow if an assessment

shows that acquisitions adversely affect the risk profile of an

institution or that the requirements concerning a proper due

diligence and new products/ new transaction process have

not been met.

No progress

Keep reporting requirements under review to ensure that

timely and systemic information is available on emerging

risk factors, and shorten publication lags.

Reporting requirements have been upgraded in 2014 both

through new supervisory reporting on financial information

and modernization of the German Central Credit Register.

Further developments will take into account ongoing ECB

projects.

However, frequency and granularity of information under

harmonized requirements are still insufficient for

supervision. Both, surveillance and financial stability analysis

would profit from establishing a readily available, consistent

set of data for both large and smaller banks (both

consolidated and unconsolidated), more frequent balance

sheet reporting for smaller banks with due regard for

proportionality, and more regular and granular reporting of

market risk positions, including hedges.

Partially implemented

Continue to strengthen on-site supervision.

Banking Supervision: The Bundesbank and BaFin improved

the intensity of on-site inspections and the level of expertise

in all relevant topics over the years since the last FSAP.

Inspection planning takes into account macroeconomic and

strategic issues. Further work will take into account ongoing

ECB projects. Onsite verification of several risks still to be

developed and fully implemented.

Insurance Supervision: BaFin’s insurance supervision has

increased the number of on-site inspections over the last

three years, e. g. for regular inspections / event-driven

inspections /short on-site visits from 44 (2013) to 60 (2015).

In addition, BaFin improved inspection planning,

identification of topics and best practice sharing among

staff.

In progress

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52 INTERNATIONAL MONETARY FUND

Recommendations Status

Macroprudential framework

Define the role of the Bundesbank as macroprudential

supervisor, and institute free exchange of information

between macro and microprudential supervisors.

The Financial Stability Act creates the Financial Stability

Committee, with the Ministry of Finance, the Bundesbank,

and BaFin as voting members. The Act specifies a central

role for the Bundesbank in macrofinancial oversight, and

reinforces cooperation and information sharing between

BaFin (national competent and designated authority) and

the Bundesbank, but information sharing is still constrained.

Partially implemented

Crisis management and bank resolution

Ensure the financial strength of the new bank restructuring

fund, and clarify the interaction between the restructuring

fund and the various DGS and mutual protection schemes.

The new SRF was established as of 2016. In 2016 banks

started providing their annual contributions to the SRF. The

SRF will be built up over 8 years with a target level of at

least 1 percent of EA-wide covered deposits or

approximately EUR 55 billion. During this transitional phase

the SRF will consist of national compartments, which will be

gradually merged. Germany has concluded a Loan Facility

Agreement (LFA) with the SRB under which Germany can

decide to provide a national bridge financing for its national

compartment of around EUR 15.2 billion.

A common backstop for the SRF still has to be agreed.

During the transitional period, Germany and the other euro

area Member States will provide, as a last resort, bridge

financing to their respective national compartments in the

SRF that must be repaid by banks through ex post

contributions.

The relationship between the SRF and IPS with respect to

the SRF has been clarified. The DGS can only be used in a

limited manner to finance resolution measures. The IPS will

fund restructuring of their members and this is separate

from the SRF. The latter will only fund the resolution

measures of IPS members insofar as the IPS are not used

first.

Partially implemented

Reform the DGS regime by instituting a harmonized and

legally binding deposit guarantee of EUR 100,000, backed

by adequate prefunding.

The 2015 German law implementing the EU deposit

guarantee scheme directive implements these

recommendations. However, the DGS system remains

fragmented.

Implemented

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INTERNATIONAL MONETARY FUND 53

Recommendations Status

Finalize specific strategies for exiting from the government

support to banks, and require the affected banks to

formulate strategic plans.

The government support is being wound down. There are

no SoFFin guarantees outstanding as at end 2014. The

amount of SoFFin capital measures was reduced from

EUR 17.1 billion (end-2013) to EUR 15.8 billion (July 2015).

Effective December 19, 2014, Hypo Real Estate Holding AG

sold DEPFA Bank plc, Dublin – together with its subsidiaries

– to the wind-down agency "FMS Wertmanagement AöR.”

Besides winding-down DEPFA Bank plc, Dublin, FMS

Wertmanagement AöR continues to actively reduce its

existing portfolio.

On July 16 2015 Hypo Real Estate Holding AG sold

80 % of its shares in Deutsche Pfandbriefbank AG via an

initial public offering (IPO). Thereby, the EU mandated loss

of control requirement was met before the end-2015

deadline; prior to the IPO, Deutsche Pfandbriefbank AG had

returned SoFFin's EUR 1 billion silent participation on July 6,

2015.

The wind-down agency "Erste Abwicklungsanstalt" (EAA)

decreased its exposure substantially. On February 22, 2015

EAA signed a share purchase agreement regarding the sale

of Westdeutsche ImmobilienBank AG to Aareal Group. EAA

had acquired Westdeutsche ImmobilienBank AG from

former WestLB AG in 2012. The final transfer of the shares of

Westdeutsche ImmobilienBank AG to Aareal Group took

place on June 1, 2015.

The sale of Westdeutsche ImmobilienBank AG reduced the

loans and securities in EAA's portfolio by approximately EUR

10 bn compared to year-end 2014.

The private capital increase of Commerzbank AG in April

2015 has further reduced SoFFin’s stake to about 15.6

percent.

Implemented

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54 INTERNATIONAL MONETARY FUND

Annex II. Structure of the German Banking System

The system is structured around three pillars and comprises 1,776 institutions. The

consolidation in the last five years mainly took place at local savings and cooperative banks levels

and the number of institutions has declined by more than 100 since the last FSAP.

The first pillar, 273 private commercial banks (of which 107 are branches of foreign banks),

represents the largest segment of the banking sector, accounting for 39 percent of assets. Among

the private commercial banks, the four big banks cover retail, corporate banking and investment

banking business, both domestically and internationally, and act as the principal banking partners of

Germany’s major industrial enterprises.

Some large commercial banks have undergone major cost

cutting exercise and reduced the exposure to non-core business.

The second pillar, public savings banks, includes seven independent regional Landesbanken and

425 savings banks, covering about 27 percent of banking system assets. The savings banks operate

under a regional principle, providing a range of banking services to households and small- and

medium- enterprises (SMEs). While local savings banks weathered the 2008 financial crisis relatively

well, Landesbanken, their central institutions, endured large losses due to their involvement in

structured finance and derivative products. A number of Landesbanken have undergone major

consolidation since 2011 FSAP. Asset quality remains below system average, with an NPL ratio at 6.7

percent. Moreover, the provisioning of NPLs is relatively low compared with other pillars.

The third pillar, cooperative banks, includes more than 1000 financial institutions, accounting for

about 14 percent of the banking assets. The cooperative banks are owned by their members, who

tend to be their depositors and borrowers, and usually offer core banking services to their

customers. The cooperative banks have the highest net interest margins across different pillars, and

undertook considerable consolidation since the last FSAP, in part, responding to the low interest

rate environment. The number of local credit cooperatives reduced by about 100 since end-2010,

and the two central institutions for cooperative banks, DZ Bank AG and WGZ Bank AG will be

merged effective August 1, 2016.

The remaining 20 percent of the German banking sector comprises 57 mortgage banks, building

and loan associations and special purpose banks. Mortgage banks suffered losses during the

financial crisis, and subsequently went through restructuring and resolution. Their asset size has

declined to under five percent of the banking system in 2015.

The big bank group includes Commerzbank, Deutsche Bank, Deutsche Postbank, and UniCredit.

Some rating agencies such as Fitch, consider the planned merger a supporting factor in affirming the rating of

cooperative banks in Germany.

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Annex III. Landesbanken—Recent Developments

The need for reform of the public banking sector in Germany, and specifically the

Landesbanken, intensified after the financial crisis.

Such reform was one of the principal

recommendations of the 2011 FSAP. Several institutions had to be rescued by the government.

Pressure increased for reforms in ownership, governance, and business models of the sector.

The sector has seen important consolidation since the financial crisis began. There are now only

seven independent Landesbanken, excluding Dekabank, the central asset manager of the sector. The

ownership structure varies, and will evolve further in the next few years (Table A1). The sector

deleveraged, as banks have refocused on core businesses (Annex Figure 1). Non-core assets and

participations have been reduced, foreign offices have been closed, and a number of subsidiaries

have been sold. Foreign currency activities and refinancing risks have been cut back. Dependence on

wholesale market financing has declined.

Business models are changing. Some banks are focusing on developing customer lending business

in the corporate and/or retail sectors, sometimes concentrating on specific industries. Others are

taking a broader approach, including the development of investment banking activities. Financing

patterns vary, with some banks able to rely on customer deposits for at least part of their funding,

while others continue to be supported by loans from regional savings banks and wholesale

borrowing. The result is a diversified sector with institutions of varying sizes and ranges of business

activity (Table A2).

Notwithstanding this progress, the sector still faces considerable challenges. The

Landesbanken in general are more efficient than before, but with large differences across individual

banks. Business models are evolving and have not yet been fully tested, and profitability continues

to be low even when adjusted for risk. Viable restructuring for some institutions is likely to require

further downsizing, opening of capital to private investors and further reform of governance

structures.

See, for example, Hüfner, Felix, The German Banking System: Lessons from the Financial Crisis, OECD Economics

Department Working Paper No 788, July, 2010. Also, Hilgert, Heinz, Jan Pieter Krahnen, Günther Merl and Helmut

Siekmann, On a Fundamental Reorganisation of the Landesbanks and Savings Bank Sector in Germany, Johann

Wolfgang Goethe Universität, Institute for Monetary and Financial Stability Working paper No. 44, 2011.

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56 INTERNATIONAL MONETARY FUND

Annex Table 1. Germany: Ownership Structure of Landesbanken, 2015

Bank Legal Form Ownership Share (in percent)

State Govt. Local Govt. Savings Banks Other

BayernLB

Public Law Institution (plus

holding co.) 75.0 25.0

HSH Nordbank

Limited Co. 85.4 5.3 9.3

LBBW Public Law Institution 40.5 19.0 40.5

Helaba Public Law Institution 12.2 87.8

NordLB Public Law Institution 64.7 35.3

BremerLB Public Law Institution 41.2 4.0 54.8

SaarLB Public Law Institution 74.9 25.1

Source: Association of German Public Banks

Private sector investors

NordLB.

Under the March 2016 agreement with the EC, HSH Nordbank will be privatized by end-August 2018 at the latest or

wound down.

Annex Table 2. Germany: Business Models of Landesbanken, 2015

Total

Assets '14

Central/Main

Bank for: Retail Bank Development Building Society

IFRS

(in EUR bn)

States Savings

Banks

Subsidiary Subsidiary Subsidiary

BayernLB 232.1 1 72 DKB BayernLabo

HSH Nordbank 110.1 2 14

LBBW 266.2 3 90 BW-Bank

Helaba 179.5 4 170

Frankfurter

Sparkasse WIBank

LBS Hessen-

Thuringen

NordLB 197.6 3 70 Braunschweiger LFI MV

Landessparkasse

IB Sachsen-

Anhalt

BremerLB 32.1 2 13

SaarLB 16.5 1 7 LBS Saar

Source: Association of German Public Banks.

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INTERNATIONAL MONETARY FUND 57

Annex Figure 1. Germany: Risk-Weighted Assets of Landesbanken, 2007–15

(In EUR billion)

Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

BANKING SECTOR: SOLVENCY RISK

1.Institutional

Perimeter

Institutions

included

 Around 1,500 institutions

 1776 institutions operating in Germany

Market share  28 percent of total banking sector assets

 Nearly 100 percent of total banking sector

assets

Data and baseline

date

 Balance sheet, income statement, and

portfolio data as of December 2014

 Publicly available data and reporting data.

 For small and medium banks (LSIs), the FSAP

team applied national reporting data from

various reporting templates. Specifically, the

FSAP applied bank-by-bank supervisory data

on regulatory capital and income statement,

the borrower statistics on credit risk exposure,

together with data on trading income, FX

exposure and sovereign exposure for 1,755

banks.

 Due to incomplete and/or inconsistent data for

large banks and banking groups (SIs) the FSAP

had to establish a stress testing database using

five different sources: the European reporting

templates (FINREP and COREP), publicly

available data from the 2015 EBA Transparency

Exercise, supervisory data from the

Bundesbank, and Bankscope for 21 banks. In

particular, the COREP database provided

regulatory information, while the FINREP and

the EBA database cross-validated the income

statement and regulatory information. For

those large banks that do not apply IFRS

accounting (and therefore not

INTERNATIONAL MONETARY FUND 58

Annex IV. Stress Test Matrix (STeM) for the

Bankin

Sector

GERMANY

Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

reported under FINREP), the data were

complemented by supervisory data from the

Bundesbank and Bankscope (for 1 bank).

 The cut-off date for data was December 2015

for large banks. Small and medium-sized banks

report to the Bundesbank their balance sheet

only once a year and, therefore, December 2014

had to be used. Regulatory information was as

of June 2015.

 Consolidated and unconsolidated, depending

on type of bank and reporting format/schedule.

 Full coverage of sovereign exposures for large

banks.

2. Channels of

Risk

Propagation

Methodology

 Banks’ own models

 For some scenarios, methodology and

shocks provided by Bundesbank and

BaFin (see below)

 Detailed balance sheet stress test, covering key

risk-sensitive on- and off-balance sheet

exposures. For small and medium-sized banks,

certain market risk exposures, including

sovereign paper, could not be stress tested as

the necessary detailed information is not

reported to Bundesbank. For this category of

banks, foreign exposures were also excluded

from the exercise, first, because of incomplete

risk and geographic information and, second,

because foreign exposures constitute only

around 1 percent of small and medium-sized

banks’ total assets). Large banks were analyzed

on the group/holding level, taking into account

both domestic and foreign exposures. In order

to stress test sovereign risk, net direct sovereign

exposures published by EBA were used. In one

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59 INTERNATIONAL MONETARY FUND

Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

 single case, interest rate hedges were taken into

account. For the other banks, hedges could not be

taken into consideration as that information is not

available to Bundesbank. FX shocks were applied to

net open (unhedged) positions. For both categories

of banks, trading losses were estimated by applying

scenario-specific haircuts on asset and equity

values.

 Economic sector-specific credit risk parameters

were used for calculating macro-financial

elasticities. The following sectors of economic

activity were treated individually: agriculture;

electricity and mining; manufacturing; construction;

wholesale and retail trade; transportation (incl.

shipping); financial intermediation excluding MFIs;

services; household/retail; non-profit institutions.

 Market risk shocks were either included in the

macroeconomic scenarios, or applied separately to

banks’ risk exposures. The house price shock

(assuming over three years a 10 percent reduction

in real estate values vis-à-vis the starting point)

further affected mortgage exposures through

higher loss rates (modeled via stressed LGD)

compared to other loan exposures.

Satellite Models for

Macro-Financial

linkages

 Banks own models used to translate

common scenarios into risk

parameter shifts

 For certain constrained bottom-up

tests, risk parameter shifts are

provided by

 Credit losses for large, small and medium-sized

banks were modeled via macroeconomic credit risk

models, using Moody’s KMV 12-month expected

default frequencies (EDFs).

 Sovereign risk was assessed through haircuts on

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INTERNATIONAL MONETARY FUND 60

Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

Bundesbank and BaFin (see below) sovereign exposure holdings, estimated

separately for each accounting portfolio, and

depending on duration. An instantaneous and

permanent shock was assumed, with realization

of valuation loss in first year, and no recovery in

yields.

Stress test horizon  Five-year horizon: 2015-2019.

 Three-year horizon: 2016–2018.

3. Tail shocks Scenario analysis

Constrained BU tests include the following

common shocks for all scenarios: Increase in

PDs between 60 and 155 percent; haircut on

collateral of 10% and 20%; widening of

credit spreads on trading book exposures.

 Scenario 1: Banks estimate their

performance under a scenario that

assumes a continuation of the current low

interest rate environment. Here, banks are

required to state how they would be

reacting to the shocks. Under these

assumptions, performance is then

estimated.

 Scenario 2: Banks estimate their

performance under a constrained

scenario, where the yield curve shape is

fixed at December 2014. No behavioral

response.

 Scenario 3: -100 basis points parallel shift

(drop) in yield curve as of December 2014,

“Baseline Scenario” was the IMF October 2015

World Economic Outlook.

”Global Stress Scenario” features:

 a serious recession, triggered by a tightening of

global financial conditions, accompanied by

credit cycle downturns in emerging economies;

 realization of financial stability risks delays or

stalls monetary normalization in the systemic

advanced economies, including an abrupt

decompression of asset risk premia relative to

the baseline;

 secondary market liquidity drops in all of the

systemic advanced economies as financial risk

taking unwinds.

 credit cycle downturn in emerging economies,

accompanied by a disorderly deleveraging in

China, and suppressed economic risk-taking

worldwide.

Substantial drop in private domestic demand

induced by negative investment and

consumption demand shocks, representing a loss

in confidence by nonfinancial corporates and

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61 INTERNATIONAL MONETARY FUND

Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

with behavioral response (dynamic

balance sheet)

households, which raise their saving rates and

delay expenditures. Both weigh heavily on

aggregate demand.

 House prices decline by 10 percent over three

years vis-à-vis the starting point.

 Over two (three) years, the scenario constitutes

a shock to real annual GDP growth equaling 3.8

standard deviations (3.2 standard deviations).

”Euro Area Crisis Scenario” features:

 a return of the balance sheet recession

experienced in 2011-2013, induced by a collapse

of financial risk taking, a complete dry-up of

secondary market liquidity throughout the euro

area, and renewed financial stress in the euro

area periphery, represented by the divergence

of long-term government bond yields between

the periphery, where they rise by 100 basis

points more during 2016, and the core, where

they rise by 50 basis points less.

 a pro-cyclical expenditure-based fiscal

consolidation reaction in the Euro Area

periphery to public debt sustainability concerns

there, which raises the primary fiscal balance

ratio by 2 percentage points during 2016 and

2017

 a massive selloff in stock markets due to

generally lower risk appetite, and substantial

investor sentiment shocks.

 Consistent with that, house prices decline by 10

percent over three years vis-à-vis the starting

point.

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INTERNATIONAL MONETARY FUND 62

Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

Over two (three) years, the scenario constitutes a

shock to real annual GDP growth equaling 3.5

standard deviations (3.0 standard deviations).

Sensitivity analysis

 Scenario 3: +200 basis point parallel shift

(increase) as of December 2014 yield

curve

 Scenario 4: -100 basis points parallel shift

(drop) in yield curve as of December 2014,

without behavioral response (i.e., static)

4.Risks and

Buffers

Risks/factors assessed

 Interest rate risk, credit risk, asset price

risk

 Credit risk

 Market risk (FX risk, equity price risk, house price

risk, interest rate risk, incl. sovereign risk)

Behavioral

adjustments

 Conditional on test and scenario (see

scenarios and tests described above)

 Constant balance sheet assumptions, with full

replacement of defaulted exposures. Risk

weighted assets (RWAs) are kept constant for

STA banks and stressed for IRB banks in adverse

scenarios, following the approach and formulas

foreseen in Chapter 3 of the EU CRR for the IRB

banks.

 Dividend payout (assumed at 40 percent)

conditional on positive net profit. A 30 percent

tax rate is applied to remaining net profit. Post

tax net profit is calculated towards capital.

 Invariant asset allocation, i.e., no change in

business models, lending standards, or

investment pattern in response to shocks (over

three years).

5. Regulatory Calibration of risk  Either internal parameters or determined

 For small and medium firms, point-in-time PDs

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Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

and Market-

Based Standards

and Parameters

parameters by Bundesbank and BaFin (in

constrained bottom-up tests)

 (Moody’s KMV Expected default frequencies), and

point-in-time LGDs, estimated from the borrowers

statistics.

 For large banks, point-in-time PDs and LGDs are taken

from COREP, with the exposure adjusted downwards

to account for performing exposures and those to the

non-financial private sector only. Specifically, PDs are

taken from COREP template 8.2, excluding defaulted

exposures.

Regulatory/

Accounting and

Market-Based

Standards

 National regulation and accounting

(GAAP)

 CRD IV / CRR fully loaded levels for CET1, Tier 1, and

Total Capital, including Capital Conservation Buffer

(CCB) and G-SIB and O-SII buffers. Capital shortfalls

were measured for CET1, in order to reflect the effect

of injecting high-quality capital on other capital

definitions.

 IAS 39 accounting standards (no mark-to-market for

held-to-maturity portfolio; to sovereign exposures

accounted in the available-for-sale portfolio, the AFS

Prudential Filter (60 percent) was applied. Fair value

option and held-for-trading sovereign exposures.

6. Reporting

Format for

Results

Output

presentation

 Evolution and distribution of

operating profit

 Evolution of capital ratios.

 Aggregate results according to type and size of banks.

 Impact of different result drivers, including profit

components, losses due to realization of different risk

factors.

 Capital shortfall as sum of individual shortfalls; in euro

and in percent of nominal annual GDP.

 Number of banks and corresponding percentage of

assets below regulatory minimum.

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Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

BANKING SECTOR: LIQUIDITY RISK

1. Institutional

Perimeter

Institutions included  44 German banks participating in Basel

Quantitative Impact Study (QIS)

 All 1,800 banks operating in Germany

Market share  More than 90 percent of total banking

sector assets and liabilities

 100 percent of total banking sector assets and

liabilities

Data and baseline

date

 Basel QIS data for German banks

participating in the study

 Results for 2011Q2 to 2015Q2, in 6-month

intervals

 Supervisory and regulatory reporting data as of

June and December 2015

2. Channels of

Risk Propagation

Methodology

 Bottom-up: LCRs and NSFRs as calculated

by the banks

 Basel III Liquidity Coverage Ratio (LCR)

 Basel III Net Stable Funding Ratio (NSFR)

 Bank run and dry up of wholesale funding

markets, taking into account haircuts to

liquid assets.

 Top-down: cash-flow-based, short-term liquidity

stress test, assessing resilience to multifactor

scenario. This analysis constitutes an

approximation of banks’ CRD IV Liquidity

Coverage Ratio (LCR), using supervisory and

regulatory reporting data.

3. Risks and

Buffers

Risks  Funding liquidity risk

 Market liquidity risk

 Medium-term maturity mismatch analysis

 Funding liquidity risk

 Market liquidity risk

Buffers  Counterbalancing capacity after the

application of market liquidity shocks,

stressed liquidity inflows

 Assessment of available and required

stable funding across maturity buckets

 Central bank facilities

 Counterbalancing capacity after the application

of market liquidity shocks, stressed net liquidity

outflows

 Stressed available and required stable funding

(NSFR)

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65 INTERNATIONAL MONETARY FUND

Domain Assumptions

Bottom-Up by Banks Top-down by Bundesbank and FSAP Team

4. Tail shocks

Shocks  For LCR, see: BCBS (2013), The Liquidity

Coverage Ratio and liquidity risk

monitoring tools, Basel, January 2013.

 For NSFR, see: BCBS (2014), Basel III: The

Net Stable Funding Ratio – Consultative

Document, Basel, April 2014.

 Regulation (EU) No. 575/2013 of the

European Parliament and the Council on

prudential requirements for credit

institutions and investment firms.

 BCBS (2013), The Liquidity Coverage Ratio

and liquidity risk monitoring tools, Basel,

January 2013.

 CRD IV/ CRR liquidity standards

5. Regulatory

and Market-

Based Standards

and Parameters

Regulatory standards  Basel III liquidity standards for LCR and

NSFR

 Liquidity ratios, disaggregated by type and

size of bank

 Counterbalancing capacity

 Whisker plots for different groups of

banks: total; small and medium-sized

banks; foreign banks; savings banks; and

cooperative banks.

6. Reporting

Output presentation  Liquidity ratios, disaggregated by type

and size of bank

 Counterbalancing capacity

 Box plots with whiskers at 5

and 95

percentile, and weighted average

separately for Group 1 and Group 2

banks.

 All 1,800 banks operating in Germany

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INTERNATIONAL MONETARY FUND 66

Domain Assumptions

Top-down by BaFin and FSAP Team

1.Institutional

Perimeter

Institutions included



German life insurance companies

Market share



93 percent of life insurance companies’ assets

Data and baseline date



QRT as of the end of 2014, comprehensive life survey 2015, EIOPA stress test 2014, local GAAP-

accounting, BaFin sovereign survey basis

2. Channels of

Risk

Propagation

Methodology



Solvency II Standard Formula

Stress test horizon



Instant shocks

3. Tail shocks Scenario analysis

One in 200 years event using Solvency II parameters as a basis, including:



A shift of the risk free yield curve down by 20 percent (LT) to 75 percent (ST)



A 22 to 49 percent fall in the price of equities



A 4.5 to 37.5 percent haircut of corporate bonds (with 5 year maturity)



100 b.p. higher spreads of peripheries sovereign bonds, 25 b.p. higher spread of core

sovereign

bonds and 50 b.p. for US, UK and Japan



Shocks of 25 percent for both commercial and residential real estate

Sensitivity analysis

One in 200 years event using Solvency II parameters as a basis, including:



Increased lapse rate



Decreased mortality rate relative to latest observed actuarial data

4.Risks and

Buffers

Risks/factors assessed



Interest rate, equity, property, credit risks

Behavioral adjustments



No management actions after the stress scenario assumed

5. Regulatory

and

Market-

Based

Standards

Regulatory/Accounting

and Market-Based

Standards



Solvency II own funds and SC

with and without transitional measures

6. Reporting

Format for

Results

Output presentation



Dispersion of solvency ratios: average with 25 and 75 percentile of distribution, with and

without

transitional arrangements, with additional segmentation information of large,

medium and small

insurers

67 INTERNATIONAL MONETARY FUND

GERMANY

Annex V. Stress Test Matrix (STeM) for the Insurance Sector

Domain Assumptions

Top-down by BaFin and FSAP Team



Capital shortfall to reach 100% SCR coverage ratio, system-wide

7. Key

assumptions

Conservative

assumptions



Four market scenarios are calibrated as one in 200 years event. However,

sovereign shocks are

added on the top of the scenarios, which make the entire

exercise more conservative than one in

200 years event in terms of calibration of

the Solvency II market risk standard formula.



No management actions are considered, such as de-risking. In reality, insurers

may be able to

reduce the risky position without material impacts on the

market prices.



Some insurers did not apply the volatility adjustment at the end of 2014. In

addition, spread widening in the stress scenario would result in a higher volatility

adjustment. This would have an offsetting effect on own funds as the risk free rate

used for valuing technical provisions would be increased.



Loss amount from sovereign shocks are applied without taking into account the

convexity.



Some com

anies didn't

rovide FDB fi

ures and assumed FDB e

ual to LAC TP.

Other assumptions,

which impact is either

unknown or positive



LAC_DT could be higher or lower depending on the magnitude of the stress and

the extent that

DTA is recoverable.



Reduction of policyholders’ participations does not have any negative impact on

the future profitability

of the existing policies.



LAC_TP and LAC_DT after the shocks are recognized in the same way as before the

shocks as long

as FDB and net DTL are remaining.

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Domain Framework

Top-down by FSAP Team

Interconnected-

ness and

contagion analysis

Data and

Methodology

The FSAP team applies two main approaches to examine interconnectedness and contagion, based

on cross border exposure and market data:

Espinoza-Vega and Sole (2010) methodology

 Examine cross-border banking sector exposures, using the BIS consolidated banking statistics

(2015 Q1) and regulatory capital data from FSI.

 Positions include aggregated bilateral banking and total exposures (bank, non-bank private

sector and public).

 Consider both initial credit and funding shocks to the banking sector.

Diebold and Yilmaz (2014) methodology

Analysis 1: Bank and insurance linkages within Germany

 Examine the spillover risks among publically listed German bank and insurance companies

 Use daily equity returns data from 16 July 2015 to 23 February 2016 for publically listed German

banks and insurers.

 Interconnectedness measure is derived from the variance decomposition of the VAR

Analysis 2: Interlinkages among Deutsche Bank, Commerzbank and GSIBs

 Examine the spillover risks among Deutsche Bank, Commerzbank and other GSIBs

 Use daily equity returns data from 11 October 2007 to 26 February 2016 for systemically

important international banks.

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Annex VI. Stress Test Matrix (STeM) for S

stemic Risk Anal

sis

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Annex VII. Methodology for Systemic Risk and Spillover Analysis

Contagion risks and interconnectedness are assessed using two different approaches. The first

approach applies the Espinoza-Vega and Sole (2010) methodology to examine cross-border bank

exposures, using BIS consolidated Banking Statistics. The second approach uses the Diebold and

Yilmaz (2014) methodology with daily equity returns data to examine the contagion between

publicly traded banks and insurance companies in Germany, and the spillover among Deutsche

Bank, Commerzbank and GSIBs.

Network Analysis Framework (Espinoza-Vega and Sole, 2010)

The analysis based on the network framework of Espinoza-Vega and Sole (2010) considers both

credit and funding shocks to the banking systems:

Credit shock: “Failure” of banking system A will incur credit losses to system B that has claims

against A. The credit loss rate assumption controls for the severity of credit cost upon failure. A loss

given default rate of 100 percent is assumed to capture the impact of an extreme credit shock.

 Funding shock: “Failure” of banking system A will force system B (that has claims against A) to

find alternative sources of funding. This may result in the fire sale of liquid assets by system B to

fill the funding gap. The fraction of lost funding that is not replaceable is assumed to be 35

percent (65 percent rollover) and the haircut in the fire sale is assumed to be 50 percent.

The sample consists of 16 BIS reporting countries including those with the highest banking sector

exposure to Germany.

Cross-border banking exposure data are based on BIS consolidated statistics

on ultimate risk basis. Tier 1 regulatory data are taken from IMF’s FSI Statistics. The analysis is based

on 2015Q1 data.

An initial negative credit or funding shock to a country’s financial system could be propagated

through the network of bilateral claims across countries (based on the BIS consolidated banking

statistics), and could distress banking systems in other countries beyond the direct losses from the

initial shocks.

A loss given default rate of 100 percent is also assumed in Espinoza-Vega and Sole (2010), the Italy 2013 FSAP and

the 2012 Japan FSAP. Espinoza-Vega and Sole (2010) and Wells (2004) argue that network studies should consider

higher loss-given-default estimates than typically assumed, as banks tend to face substantial uncertainty over

recovery rates in the short run. The simulation results should be interpreted as the maximum possible impact of

systemic instability. Note that collaterals and hedging instruments are not taken into account due to data limitations.

The same assumptions on the funding shock were made in Espinoza-Vega and Sole (2010). While the final

numerical results are sensitive to these assumptions; however, the relative importance of systemic countries remain

the same.

The sample consists of Australia, Austria, Belgium, Canada, Finland, France, Germany, Italy, Japan, Korea, the

Netherlands, Spain, Sweden, Switzerland, the United Kingdom and the United States.

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If any banking system incurs losses larger than their total Tier 1 capital, the system “fails.” This failure

can subsequently cause some other banking system to fail, triggering domino effects, where a

failure of a banking system in a network transmits to other banking systems.

Two sets of simulations are considered in the analysis. The first simulation applies to reporting

banks’ exposure to foreign banks, and the second one applies to the total exposure of the banking

sector.

Spillover Analysis with Market Data (Diebold and Yilmaz, 2014)

The spillover analysis using the Diebold and Yilmaz (2014) methodology first estimates a Vector

Autoregression (VAR) model with market data. The interconnectedness measure is then derived

from the Generalized Variance Decomposition (Pesaran and Shin, 1998) of the underlying VAR. In

contrast to the traditional Cholesky and other structural identification strategies, the Generalized

Variance Decomposition (GVD) does not impose any assumptions on the order of variables, instead,

it relies on a largely data-based identification scheme (“let the data speak”).

Two sets of simulations are conducted as part of the market-based spillover analysis. The first set of

simulations examines the interconnectedness between publically traded banks and insurers in

Germany, while the second studies the spillover and the contribution to systemic risks among GSIBs.

Daily equity returns, as constructed as the log difference of equity prices are used in both exercises.

The sample spans from 16 July 2015 to 23 February 2016 for the German bank-insurer analysis, and

from 11 October 2007 to 26 February 2016 for the GSIB analysis.

The FSAP team derives a set of pair-wise directional connectedness measure between financial firms,

based on the Generalized Variance Decompositions. On aggregate, the from-degree measure

captures exposures of individual firms to systemic shocks from the network (inward spillover), in a

fashion analogous to Marginal Expected Shortfalls (MES). The to-degree measure captures

contributions of individual firms to systemic network events (outward spillover), in a fashion

analogous to Delta CoVaR (see Diebold and Yilmaz, 2014). In addition, the net-degree measure (the

difference between to- and from- measures) describes the relative contribution to systemic risks

from each financial firm.

The results are based on rolling window estimations and the relative importance of each institution’s

contribution to systemic risks (the net-degree measure) is broadly stable and robust over time. The

following charts present the net contribution to systemic risks in the German financial sector (among

publically traded firms) and among GSIBs. For space considerations, only select firms with a positive

net contribution to systemic risks are presented.

The sample size for the German bank-insurer analysis was restricted by data availabilities, in particular, for the

Deutsche Pfandbrief bank. The data source is Bloomberg.

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Annex Figure 2. Net Contributions to the Systemic Risk

Source: IMF Staff Calculations based on the Diebold and Yilmaz (2014) methodology using daily equity returns from 11 October

2007 to 26 February 2016. Net spillover for each entity is computed as the difference between the outward spillover to the

financial system from the entity and inward spillover to the entity from the financial system based on variance decomposition of

the underlying Vector Autoregression (VAR) model.

Note: Results are based on the Diebold and Yilmaz (2014) approach using daily stock returns data. Net spillover for each entity is

computed as the difference between the outward spillover to the financial system from the entity and inward spillover to the

entity from the financial system based on variance decomposition of the underlying Vector Autoregression (VAR) model.

8/24/2015 9/24/2015 10/24/2015 11/24/2015 12/24/2015 1/24/2016 2/24/2016

BNPParibas DeutscheBank Santander

CreditSuisse HSBC BankOfAmerica

BankOfNYMellon GoldmanSachs JPMorgan

MorganStanley

Top Ten Net Contributors to Systemic Risks among GSIBs

Munich Re Hannover Re Allianz Talanx

Deutsche Bank Commerzbank Aareal

Net Contributors to Systemic Risks in the German Financial Sector

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Appendix I. Report on the Observance of Standards and Codes

(ROSCs)—Summary Assessments

Basel Core Principles for Effective Banking Supervision

A. Introduction

At the request of the German authorities, this assessment of the current state of the

implementation of the Basel Core Principles for Effective Banking Supervision (BCP) in

Germany was completed as a part of the Financial Sector Assessment Program (FSAP) mission

undertaken by the International Monetary Fund (IMF) during March of 2016.

It reflects the

regulatory and supervisory framework in place as of the date of the completion of the assessment. It

is not intended to represent an analysis of the state of the banking sector or crisis management

framework, which are addressed in other parts of the FSAP.

An assessment of the effectiveness of banking supervision requires a review of the legal

framework, and detailed examination of the policies and practices of the institutions

responsible for banking regulation and supervision. In line with the BCP methodology, the

assessment focused on BaFin, the Deutsche Bundesbank (BBk) and the European Central Bank as the

joint supervisors of the banking system, and did not cover the specificities of regulation and

supervision of other financial intermediaries. It is important to note, however, that to the extent that

BaFin is a unified supervisor responsible for other entities of the financial sector, the assessment of

banking supervision in Germany may provide a useful picture of current supervisory processes

applicable to other financial institutions supervised by it.

B. Information and Methodology Used for Assessment

Germany requested to be assessed according to the Revised Core Principles (BCP)

Methodology issued by the BCBS (Basel Committee of Banking Supervision) in September

2012. The current assessment was performed according to a revised content and methodological

basis as compared with the previous BCP assessment in 2011. Importantly, that the two assessments

will not be directly comparable, as the revised BCPs have heightened focus on corporate governance

and risk management and its practice by supervised institutions and its assessment by the

supervisory authority, raising the bar to measure the effectiveness of a supervisory.

The German authorities chose to be assessed against the highest standards of supervision and

regulation, choosing to be assessed and rated against both the Essential Criteria and the

Additional Criteria. To assess compliance, the BCP Methodology uses a set of essential and

additional assessment criteria for each principle. The essential criteria (EC) were usually the only

This Assessment Report has been prepared by Fabiana Melo (IMF), Jose Tuya (Consultant) and Christopher Wilson

(IMF).

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elements on which to gauge full compliance with a Core Principle (CP). The additional criteria (AC)

are recommended best practices against which the authorities of some more complex financial

systems may agree to be assessed and rated. The assessment of compliance with each principle is

made on a qualitative basis. A four-part grading system is used: compliant; largely compliant;

materially noncompliant; and noncompliant. The assessment of compliance with each CP is made on

a qualitative basis to allow a judgment on whether the criteria are fulfilled in practice. Effective

application of relevant laws and regulations is essential to provide indication that the criteria are met.

The assessment team reviewed the framework of laws, rules, and guidance and held extensive

meetings with officials of BaFin, the Bundesbank and ECB supervision, and additional

meetings with auditing firms and banking sector participants. The authorities provided a self-

assessment of the CPs rich in quality and comprehensiveness, as well as detailed responses to

additional questionnaires, and facilitated access to supervisory documents and files, staff and

systems.

The team appreciated the very high quality of cooperation received from the authorities. The

team extends its thanks to staff of the authorities who provided excellent cooperation, including

extensive provision of documentation and access, at a time when staff was burdened by many

initiatives related to the European and global regulatory changes, and still adapting to the new

European supervisory framework.

The standards were evaluated in the context of the German financial system’s structure and

complexity. The CPs must be capable of application to a wide range of jurisdictions whose banking

sectors will inevitably include a broad spectrum of banks. To accommodate this breadth of

application, a proportionate approach is adopted, both in terms of the expectations on supervisors

for the discharge of their functions and in terms of the standards that supervisors impose on banks.

An assessment of a country must recognize that its supervisory practices should be commensurate

with the complexity, interconnectedness, size, risk profile and cross-border operation of the banks

being supervised. In other words, the assessment must consider the context in which the supervisory

practices are applied. The concept of proportionality underpins all assessment criteria. For these

reasons, an assessment of one jurisdiction will not be directly comparable to that of another.

An assessment of compliance with the BCPs is not, and is not intended to be, an exact science.

Reaching conclusions required judgments by the assessment team. The team assessed the

supervisory and regulatory framework in the midst of great changes, and the assessment should

reflect the transition phase in which it took place. Nevertheless, the assessment of the current legal

and regulatory framework and supervisory practices against a common, agreed methodology should

provide the supervisors of German banks with an internationally consistent measure of the quality of

its banking supervision in relation to the CPs, which are internationally acknowledged as minimum

standards, and point the way forward.

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C. Preconditions for Effective Banking Supervision

The macroeconomic environment has been stable in recent years. Borrower-related credit risk

and stock of nonperforming loans are low, particularly when compared to other European countries.

Results of the Bundesbank Bank Lending Survey suggest that lending policies were stable in recent

years. With interest margins stable so far, banks active in the traditional banking business extended

their balance sheets and maturity transformation risk. If the low interest environment prevails, the

shrinking interest rate margin will force banks to look for alternative business opportunities

potentially raising new risks.

The Financial Stability Act provides the legal framework for the FSC, Germany’s

macroprudential institution. The FSC discusses the factors that are key to financial stability,

strengthens cooperation between the institutions represented on it, advises on the handling of

warnings and recommendations issued by the ESRB and reports annually to the lower house of

Parliament. The FSC can issue warnings and recommendations to all public bodies in Germany in

order to promptly combat any adverse developments which may cause risks to financial stability. The

addressees of these recommendations must adhere to a “comply or explain” mechanism.

As the German credit market is dominated saving and co-operative banks which typically

conduct business with retail customers and SMEs, the credit culture is traditional and

collateralization, e.g., by mortgages, prevails. More recently one can see the tendency of larger

corporates, the typical clients of the bigger banks, to fund themselves directly on the capital market.

This might be driven by an increased willingness of investors to take these risks while funding costs

of larger banks went up due to rating downgrades.

Germany has a well-developed public infrastructure, including a comprehensive legal system

covering in particular areas relevant for the banking system. These laws relate, for example, to

corporate law setting out the requirements regarding the setting up and winding down/liquidating

of joint stock companies, limited companies, partnerships, and cooperatives, their internal

governance structures, detailed accounting provisions as well as rules regarding mergers and

acquisitions.

The financial sector regulation covers all relevant areas. As a member state of the EU, large parts

of the German framework are rooted in the transposition or implementation of EU directives and

directly applicable EU regulations. Specific national rules exist where topics considered relevant are

not regulated by EU law or where EU law leaves room for additional national rules. Furthermore,

BaFin as an integrated supervisory authority is member of the European Supervisory Authorities

(EBA, ESMA and EIOPA). In this context, BaFin is obliged to cooperate with and support the work of

This section draws from other documents produced for the FSAP. A complete analysis of the macroeconomic

framework is contained in Article IV reports.

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the ESAs. This also includes the implementation of ESA guidelines and recommendations. The same

applies to the cooperation of BaFin and ECB within the SSM.

Germany enjoys a system of independent external audits and comprehensive accounting

principles and rules that are contained in the German Commercial Code (HGB). All German

public accountants are organized in the Chamber of Public Accountants (WPK), a corporation under

public law. The requirements on the profession of a certified public accountant are stringent. The

Auditor Oversight Commission (AOC), comprised entirely of persons independent from the

profession, carries out public oversight on the Chamber of Public Accountants (WPK), and all auditors

associated in the WPK.

Terms and conditions of contracts are, in general, not regulated in supervisory law but in civil

law. The Civil Code (Bürgerliches Gesetzbuch - BGB) for example sets legal framework for consumer

credits including consumer protection regulations and the act on insurance contracts

(Versicherungsvertragsgesetz - VVG) also stipulates consumer protection regulations. Recently the

German legislator adopted a new law to improve the protection of retail investors

(“Kleinanlegerschutzgesetz”). Moreover BaFin supervises compliance of financial market players with

consumer protecting provisions in supervisory laws, e.g., German Banking Act (Kreditwesengesetz –

KWG), Insurance Supervision Act (Versicherungsaufsichts-gesetz – VAG) and Securities Trading Act

(Wertpapierhandelsgesetz - WpHG

Germany has transposed the European directive on deposit guarantee schemes (DGSD) into

national law (Einlagensicherungsgesetz-EinSiG). Under the Directive, all credit institutions have to

be allocated to a statutory guarantee scheme or an institutional protection scheme that is officially

recognized as a deposit guarantee scheme. Customers of all institutions have a legal claim to

compensation for their covered deposits up to an amount of EUR 100,000.

The German Act for Recovery and Resolution of Institutions and Financial Groups (SAG) spells

out the different responsibilities and tools available in crisis management and for bank

resolution which complement the powers and measures granted by the Banking Act (KWG).

The Federal Agency for Financial Market Stabilization (FMSA) was appointed as resolution authority

on a national level. The supervisory authority reviews and assesses the recovery plan in consultation

with the Bundesbank. Banks that are deposit taking institutions as defined in section 1 (3d) first

sentence KWG also have to be members of a deposit insurance scheme which further bolsters public

confidence in the stability of the financial system.

D. Main Findings

Responsibility, Objectives, Powers, Independence, Accountability (CPs 1-2)

The legal framework for banking supervision is well established by German laws and

regulations, directly applicable EU regulation, and Single Supervisory Mechanism Regulation

(SSMR). While the division of responsibilities between BaFin and the Bundesbank regarding LSI

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supervision is well established, the framework for the SSM is evolving and there are still uncertainties

regarding the specific operational roles of each agency in the new environment. These uncertainties

reflect the complex legal and operational framework but do not to affect the overall understanding

of responsibilities by the market or authorities. The three supervisory agencies enjoy operational

independence, in the sense that there is no government or industry interference in individual

supervisory decisions. However, there is potential for indirect influence of government and industry

in the execution of BaFin’s supervisory objectives through the budget approval process and the

mandatory approval of BaFin’s internal organization and structure by the MoF. The decision making

process at the ECB is complex and does not foster effectiveness and timeliness of day-to-day

supervisory decisions (although there are processes in place for emergency decisions).

Ownership, Licensing, and Structure (CPs 4-7)

The ECB is the licensing authority, who makes decisions on the basis of applicable German and

EU laws. While criteria and procedures are well established, in general, the financial suitability of

shareholders is limited to the availability of the initial capital, and the assessment of the supervisory

board does not play a relevant role in the licensing process, although assessors noted these

elements are gradually being incorporated in the licensing process. In addition, there is no

requirement for the bank to notify the supervisor when they become aware of events that may cause

a significant shareholder to no longer be fit-and-proper. The review of fit-and-proper qualification

would benefit from expanded requirements and standards. The team welcomes the new guidelines

issued by BaFin in January 2016, which emphasize the prudential importance of the professional

qualification of the Board.

There is no need for prior supervisor approval of investments below a 10 percent threshold,

other than investments in other German institutions (significant holdings regime). This may

create situations where acquisitions occur that increase the risk to the banking group beyond

management skills and have a negative impact on the group that greatly the amount of the

investment. While the regulator requires higher capital or may be able to force the bank to unwind

the investment, it is more prudent to require ex-ante review.

Methods of Ongoing Supervision (CPs 8-10)

The transition to the SSM for SIs has had many benefits, although some aspects of the

supervision methodology are still undergoing implementation. Much has been achieved in a

short space of time and the supervision framework lays the foundation for a risk-based approach

with the SREP as the core element. Elements of the framework are still being implemented and will

take time to mature and be applied consistently across banks.

The supervisory approach for LSIs is established but evolving and scope exists for greater

verification of compliance with regulations. Onsite examinations verify adherence with MaRisk

and are undertaken by the Bundesbank and BaFin through testing and interviews of management.

The MaRisk Inspection Guide used by LSI supervisors lays the foundation for a consistent

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examination process and the use of the external auditor is also a key aspect of the supervision

architecture to confirm compliance. Annual meetings with the Management Board, analysis of the

Internal Capital Adequacy Assessment Process( ICAAP) and the risk profile form core elements of a

sound framework. However, much reliance is placed on the external audit long form report and while

rich in detail, greater emphasis is needed to verify the reliability, accuracy, and integrity of the

information used for risk assessments as inputs into a forward looking view of risk.

Supervisory reporting is not sufficiently granular to support offsite supervision. Not all data

needs are covered by EBA ITS reporting. To fill the gaps, short-term exercises and surveys are used,

such as for concentration, liquidity, and IRRBB. While the data contributes to the risk assessment

process, using peer group analysis and benchmarks is not systematic. Currently, supervisors are

challenged by differences between reporting based on the national GAAP and IFRS data which

complicates systematic and consistent comparisons between different account treatments. Technical

work is underway to address this issue. Timely and accurate data is fundamental to effective

supervision and the issues with data need to be addressed as a matter of priority.

Corrective and Sanctioning Powers of Supervisors (CP 11)

German law and SSMR provide a broad range of actions that can be taken by supervisors in

their respective responsibilities. Direct enforcement powers and sanctions of ECB are limited;

however the ECB can make use of the enforcement and sanction powers available to BaFin. Assessors

had access to evidence of such indirect actions, however the complex legal framework may make it

operationally difficult and time consuming for ECB to impose enforcement actions. The actual use of

formal powers by both BaFin and the ECB in practice is not intensive.

Cooperation, Consolidated and Cross-Border Banking Supervision (CPs 3 - 12- 13)

The collaboration and coordination framework with domestic and cross-border supervisors is

highly developed. The EU has adopted a supervisory coordination process that is based on joint

supervision through the SSM, colleges of supervisors led by the home country coordinator and

signed MOUs with third country supervisors and nonbanking sector regulators.

A consolidated supervisory approach is in place at both the SI and LSI levels. A detailed

planning approach is in place through supervisory colleges and MOUs that result in a comprehensive

review for the consolidated group. Additionally, ring-fencing powers are available to ensure that the

group can be insulated from related companies that may adversely impact the group. Banking

groups may be required to close reorganize to correct a non-transparent structure.

Corporate Governance (CP 14)

The role of supervisory boards is weak and passive with most policy, and risk management

duties and responsibilities placed on the management board. In the past few years there has

been some evolution in supervisors focus on the supervisory board within the SREP process, and a

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thematic review on Risk Governance has been conducted that resulted in recommendations

addressed to banks aimed at making the supervisory board involvement more robust. Additionally,

MaRisk is being amended and will include code of conduct requirements.

Supervisory guidance should clearly delineate that ultimate responsibility for establishing the

risk culture, developing business plans and risk appetite statement rests with the supervisory

board. The fit-and-proper process is streamlined for supervisory board members as are technical

knowledge requirements. As established by KWG, the primary responsibility for internal controls,

governance, business strategy, and internal audit is assigned to the management board.

Prudential Requirements, Regulatory Framework, Accounting and Disclosure (CPs 15-29)

While risk management standards are generally sound, the reporting line between the internal

risk control function and the Supervisory Board should be strengthened. Reporting of risk

management is through the Management Board and the CEO which is responsible for setting the

business plan and risk taking. The risk function does not report directly to the Supervisory Board but

to the Management Board and therefore the CEO. This approach may weaken the independence of

the risk management function and the CRO to raise issues as also highlighted by the SSM

methodology. In particular, the reporting line to the management body (with supervisory and

management function) was a topic assessed within the thematic review on Risk Governance and Risk

Appetite. While banks had in place formal “whistle-blowing” processes, the structure may inhibit the

independence of the CRO and the risk function to report weaknesses in the RMF. This is further

aggravated by the ex-post notification of removal of the CRO by the management board which is the

prescribed minimum of MaRisk.

Banks are well-capitalized and supervisors have the powers to impose additional

requirements. The deviations of the EU capital framework in relation to the Basel standards

regarding the definition of capital do not appear material for German banks in general, although

some may be for specific banks (such as deduction of participation in insurance). Regarding the

calculation of risk weighted assets, a few elements for which the RCAP found deviations may be

significant for Germany, such as sovereign exposures under the permanent and temporary partial

use, lower risk weights for covered bonds, and the counterparty credit risk framework. Assessors

observed some cases where these deficiencies were being addressed by banks’ internal capital

adequacy assessments and supervisory action, and it is impossible to determine that that existing

framework is not in general resulting in overstated CET1 ratios. Both the ECB and BaFin can require

banks to hold capital in excess of the minima under Pillar 2. However, the practice was not commonly

used by German authorities. The ECB has only concluded one SREP cycle so far, in which some banks

were required to implement Pillar 2 add-ons. Leverage is specifically taken into account in the SSM

SREP methodology, while BaFin has not systematically incorporated it in the analysis yet.

Supervisors have not provided guidance on loan portfolio management expectations. For

example, broad guidelines on general characteristics of various loan risk buckets; definitions of non-

performing, restructured, forborne and cured loans. Granularity of credit portfolio data is limited.

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The role of the supervisors in loan classification and supervision primarily involves a review of

policy and procedures. The focus of supervision is to provide bank management with

considerations when setting loan classification parameters and provisioning such as items to

consider for residential mortgages and commercial real estate classification triggers. Collateral

valuation considerations, such as, conservative valuations of realizable net values are important.

Loan classification and provisioning have been viewed as an accounting issue; however,

supervisors recently conducted a thematic review of loan valuation and impairment. To

implement a supervisory approach that asks supervision staff to review loan files and value loans and

determine adequacy of provisions in a market where the practice was not present, ex-ante

discussions with bankers and accountants should take place and supervisor expectations on loan

valuation and provisioning communicated. It is also important to provide supervisory staff with

training and support to be able to challenge management valuation of collateral or failure to rate an

asset as impaired. The process of developing the capacity of supervisors to challenge bank

management valuation of loans has started.

Market risk management standards are generally sound and supervisors take an active

approach. MaRisk establish the requirements for banks to implement effective risk management

frameworks to measure and manage market risk. For the larger more systemic banks with a trading

bias, greater supervisory intensiveness and intrusiveness takes place. Market risk has been a focus of

the supervisors during 2014 and 2015. In addition, a targeted review of banks’ internal models is

planned. Supervisors periodically review banks to assess that their market risk management

processes are consistent with the risk bearing capacity and the market risk management framework.

Banks with the largest trading books are subject to enhanced focus, while the remaining banks are

on a normal cycle based upon their SREP score and risk profile. Assessors observed supervisory

practice for both SIs and LSIs and verified compliance with the core principle.

IRRBB has received a significant amount of the supervisor’s attention during the last several

years and features as a key priority for both SIs and LSIs. Banks are required to measure,

calculate and report their exposure to IRRBB on a quarterly basis. Banks are also required to conduct

regular stress testing using both standardized and bespoke scenarios, especially for those banks with

more complex business models and optionality in the portfolio. Supervisors make an assessment of

IRRBB through the SREP process as well as a key topic in discussions with bank senior management.

The German authorities have also conducted short term data collection exercises in the last several

years to deepen the understanding of the systems exposure.

Concentration risk and country risk treatment warrant enhancement. The definition of

concentration risk is limited to credit exposures, and not in a broader sense including different types

of exposures. The expectations of the supervisors with respect to concentration risk and country risk

management are not clearly communicated to the banks. There is no requirement that all material

concentrations to be regularly reviewed and reported to the bank’s supervisory board. Reporting and

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monitoring of country risk and concentrations can be improved, and their inclusion in banks’ stress

tests specifically required.

The framework for transactions with related parties is weak, although the definition of related

parties is wide and detailed. The framework covers loans in a broad definition that includes off-

balance sheet exposures and leasing operations, albeit not dealings such as service contracts, asset

purchases and sales, and construction contracts. Related party loans must be granted on market

terms, but there is no requirement that individuals with conflict of interest are excluded from the

whole process of granting and managing such exposures. There is no requirement that related party

exposures are monitored and controlled separately or in aggregate. There is no regular reporting of

exposures to related parties. Supervision of related party risk is mostly carried out to external

auditors, whose analysis of related party risk is very limited. No limits on related party are imposed

by laws, regulation, or the supervisor

Supervisors have stepped up the frequency and intensity of interaction with credit institutions

regarding their management of liquidity risk, contingency plans and funding requirements.

Supervisors have built-up in-depth understanding of liquidity funding risks at individual institutions,

they periodically meet with treasury staff and receive monthly monitoring of LCR data. Funding plans

and results of stress testing are reported and evaluated periodically. The LCR adopted in EU has a

number of elements that are less stringent than the Basel agreed rule, most notably wider definition

of HQLA. German banks make use of the wider definition of HQLA, mainly of covered bonds included

as Level 1 assets. Guidance for assessing Internal Liquidity Adequacy Assessment Processes (ILAAP)

will be implemented for 2016 which will help strengthen the assessment of liquidity risk management

as part of the SREP. To this regard, SSM issued a letter in the beginning of the year on Supervisory

expectations on ILAAP and harmonized information collection on ILAAP to enhance the analysis of

ILAAP and its integration in the SREP. Benchmarks for liquidity risk indicators will be developed

during 2016.

While operational risk has undergone several enhancements since the last FSAP, more

attention is needed to ongoing monitoring of the effective implementation of operational risk

management frameworks. Dedicated IT risk specialists mainly conduct onsite examinations but also

develop supervision approaches for IT risk more generally. This team has been successful at

deepening the institutional knowledge of IT risks and vulnerabilities and identifying where standards

need to be raised. The most recent example is in the area of data centers where IT risk specialists

have attended DR testing for several of the larger LSIs.

The independence of the internal audit and compliance is undermined as they report to the

management board. The internal audit function, as an instrument of the management board, is

under its direct control and has to report to management board members. The internal auditor can

also be subject to the direct control of one management board member, who should, if possible, be

the chairperson. Additionally, the supervisory board is only informed of a replacement of the internal

auditor, compliance officer and risk officer ex-post.

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Banking supervisors do not have legal power to access external auditors’ work papers.

Although this is not an essential requirement, Germany chose to be assessed against the best

international practices, and given the heavy reliance on external auditors for reviewing not only the

reliability of financial statements but also reporting on whether the banks comply with all risk

management guidelines, this gap should be addressed.

Overall, the AML/CFT framework appears strong, but some weaknesses remain, mainly in

supervisory practices. BaFin has established a risk-based framework to discriminate banks’ risk

profiles and exposure to risks from AML/CFT. The framework is designed to help identify those

institutions where enhanced monitoring and attention is required. While the framework should help

focus supervisory attention on the highest risk institutions, inputs into the process need to be refined

to be fully risk-based. The framework is heavily reliant on the EA report to identify deficiencies or

weaknesses in risk management. Ongoing monitoring of banks’ compliance with the regulations

needs to be more systematic through the ongoing receipt of a range of inputs. Lastly, coverage of

the banking sector through onsite examinations needs to be expanded.

Appendix Table 1 offers a principle-by-principle summary of the assessment results, while

recommendations to improve compliance with the BCPs are summarized in Appendix Table 2.

Appendix Table 1. Summary Compliance with the BCPs

Core Principle Comments

1. Responsibilities, objectives and powers

While the division of responsibilities between BaFin and the Bundesbank regarding LSIs supervision seems

to be clear, the framework for the SSM supervision is evolving and there are still uncertainties regarding the

operational roles of each. These uncertainties reflect the complex legal and operational framework of the

SSM, in particular on imposition of sanctions and enforcement actions, but do not seem to affect the overall

understanding of responsibilities by market or authorities.

2. Independence, accountability, resourcing and legal protection for supervisors

The three supervisory agencies responsible for German banks enjoy operational independence, in the sense

that there is no government or industry interference in individual supervisory decisions. However, the fact

the MoF is responsible for approving minutely all of BaFin’s organizational matters may indirectly affect the

execution of supervisory priorities. In addition, while BaFin does not depend on government funding, its

budget is approved by a committee composed of government and industry representatives, chosen by the

MoF in consultation with the associations of supervised entities. Decision making process in the newly

established SSM does not foster effectiveness and timeliness of supervisory decisions

3. Cooperation and collaboration

Cooperation channels are highly developed and effective.

4. Permissible activities

Permissible activities are well defined in German legislation and the use of the word “bank”

5. Licensing criteria

The ECB, which is the licensing institution for new banks and for subsidiaries of foreign banks establishing in

Germany, and BaFin, which is the licensing institution for branches of non-EEA banks, have available a clear

set of criteria and are able to reject applications that not meet it. In general, financial suitability of shareholders

is limited to the availability of the initial capital. The assessment of the supervisory board does not play a

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relevant role in the licensing process; in particular, ensuring the professional qualification and collective

knowledge of the supervisory board was not customarily assessed. The assessors have reviewed samples of

more recent licensing files and observed there is a growing concern with these elements.

6. Transfer of significant ownership

Process identifies ultimate beneficial owners but fit and proper requirements should be strengthened.

7. Major acquisitions

Investments not exceeding 15 percent of capital do not require ex-ante consultation or approval. The

acquisition of holdings in an EU-regulated financial entity is assessed from the perspective of the target

undertaking. The acquisition by a bank of a non-EU bank is not covered by the CRR or CRDIV. This may create

situations where acquisitions occur that increase the risk to the banking group due to financial products that

exceed the bank’s risk appetite or managing ability.

8. Supervisory approach

The introduction of the SSM has had positive externalities for supervision of German SIs and LSIs. For example,

more focus on quantitative analysis and the SREP process. There are several aspects of the framework which

are still a work in progress at the time of the assessment: application of a consistent methodology to make

meaningful comparisons between banks will need time to develop as the SREP and RAS process matures. To

date, the SREP process has been mainly focused at the consolidated level and has not penetrated deep into

the organizational structure. While there is a sound understanding of group structures generally, application

of the SREP process across the group structure will help identify potential pockets of risk that deserve greater

supervisory attention and incorporated into SEPs. For larger and more complex banks this is an important part

of the assessment that will help drive a thorough analysis of risk and help identify where further

documentation is needed to better inform of the risk assessment process.

Greater emphasis is needed to verify the reliability, accuracy, and integrity of the information used for risk

assessments and prudential outcomes.

9. Supervisory techniques and tools

Overall supervisors of German banks take an active approach to using supervisory tools. The supervisory

manual and associated frameworks provide a sound basis for supervisors to perform comprehensive risk

assessments using a mix of on-site and off-site supervision activities. Annual risk assessments and the SREP

process allow for the results of offsite and onsite supervision to be integrated and combined for form a single

overall view of all material risks and the necessary measures. Supervision manuals are detailed and help guide

the risk assessment process in a systematic way. Onsite examinations were demonstrated to be an effective

tool to focus on deficiencies in risk management. There are, however, gaps in the approach for onsite and

offsite that need to be attended to. For LSI offsite supervision there is an undue reliance on the work of the

external auditor and while the annual EA report contains a significant amount of detail, a greater use of other

inputs to offsite supervision is needed in the risk assessment process.

The results of onsite examinations for SIs are not ranked in degree of severity. While there is a clear process

for the communication of findings at the conclusion of the examination process, the ultimate communication

to the bank does not prioritize findings from high priority to low. As a result, it is not always clear for banks

the prioritization of actions to address onsite findings. A ladder of severity will help ensure management and

supervisory boards are able to prioritize remedial action according to severity of onsite findings.

10. Supervisory reporting

The requirements associated with supervisory reporting are now predominantly governed by a harmonized

EU regime. However, regulatory data requirements (FINREP/CoRep) are not sufficient to meet supervisors’

need. do not meet is not uniform resulting in circumstances where some banks do not report a comprehensive

suite of data with a sufficient amount of granularity for systematic offsite analysis across peer groups using

benchmarks of a sufficiently long time series. Processes to address differences in supervisory data resulting

from different accounting treatments are in the process of being completed and at the time of the mission

this process was not consistently applied.

11. Corrective and sanctioning powers of supervisors

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German law and SSMR provide a broad range of actions that can be taken by supervisors in their respective

responsibilities. Direct enforcement powers and sanctions of ECB are limited; however, the ECB can make use

of the enforcement and sanction powers available to BaFin. Assessors had access to evidence of such indirect

actions. At the time of this mission, ECB had not directly applied any sanction or enforcement action. While

BaFin seems to have adequate set of supervisory tools at its disposal, actual use of these formal powers in

practice is not intensive. There are no laws or regulations that guard against BaFin or ECB unduly delaying

appropriate corrective actions.

12. Consolidated supervision

A consolidated supervisory approach is in place at both the SI and LSI level. A detailed planning approach is

in place through supervisory colleges and MOUs that results in a comprehensive review for the consolidated

group. Additionally, ring-fencing powers are available to ensure that the group can be insulated from related

companies that may adversely impact the group. Banking groups may be required to close reorganize to

correct a non-transparent structure.

13. Home-host relationships

Collaboration and coordination framework with domestic and cross-border supervisors is highly developed.

The EU has adopted a supervisory coordination process that is based on joint supervision through the SSM;

colleges of supervisors led by the home country coordinator and signed MOUs with third country

supervisors and nonbanking sector regulators.

14. Corporate governance

While Germany has well-developed corporate governance requirements, the oversight role of the

supervisory board is passive and its operational oversight role is limited. The fit-and-proper process is

streamlined for supervisory board members as are technical knowledge requirements.

15. Risk management process

The risk management standards for German banks are anchored in MaRisk which require banks to have

regard to all material risks calibrated against a bank’s risk bearing capacity. MaRisk has been revised on

several occasions and most recently in January 2016 to incorporate areas such as risk culture and risk data

aggregation. The standards encourage a generally sound approach to risk management. For the largest and

more complex banks, an enterprise-wide approach to risk management is often employed using more

sophisticated measurement systems and tools to assess required capital, capital allocation etc. (e.g.

economic capital models) consistent with their risk profile and systemic risk. Supervisory practice is also

generally well developed and a number of techniques are used by the supervisor to confirm and assess the

quality and effectiveness of risk management systems. Furthermore, the ICAAP is an integrated part of the

risk assessment framework for German banks. ICAAP and ILAAP guidelines have recently been released by

the ECB which will be the standard banks will be expected to adhere to going forward. To date, there have

been no published minimum standards.

The reporting of risk management is through the Management Board and the CEO which is responsible for

setting the business plan and risk taking. The risk function does not report directly to the Supervisory Board

but to the Management Board and therefore the CEO. This approach may weaken the independence of the

risk management function and the CRO to raise issues. While banks had in place formal “whistle-blowing”

processes, the structure may inhibit the independence of the CRO and the risk function to report

weaknesses in the RMF.

16. Capital adequacy

The deviations from Basel standards regarding the definition of capital do not seem to be material for

German banks in general, although some may be for specific banks (deduction of participation in insurance,

for instance).

For Germany, a few elements for which the RCAP found deviations regarding the calculation of capital

requirements may be significant, such as sovereign exposures under the permanent and temporary partial,

lower risk weights for covered bonds, and counterparty credit risk framework. Assessors observed some

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cases where these deficiencies were being addressed by banks’ internal capital adequacy assessments and

supervisory action. Nevertheless, assessors do not feel comfortable that existing framework is not in general

resulting in overstated CET1 ratios.

Both ECB and BaFin can require banks to hold capital in excess of the minima under Pillar 2; however, the

practice is not commonly used by German authorities, which in general prefer to address these through

direct discussion with the banks on the adequacy of ICAAP. ECB as a supervisor has only concluded one

SREP cycle, in which some banks were required to implement Pillar 2 add-ons. The leverage is specifically

taken into account in the SSM SREP methodology, not yet systematically so by BaFin

17. Credit risk

General guidance on credit risk exists and is monitored. Granularity of data on credit portfolios is limited

(see CP 18)

18. Problem assets, provisions, and reserves

Loan valuation is performed by external auditors with limited supervisory involvement. Loan classification

guidelines have not been issued and neither MaRisk nor the KWG define nonperforming, cured, restructured

and renewed loans. Loan classification and provisioning are viewed as an accounting issue. The supervisors

do not re-classify loans or request increased provisions and rely on capital add-on. Supervisor expectations

on loan valuation and guidelines should be communicated and discussed with bankers and auditors.

Provisioning and impairment views of the supervisor should also be discussed with the objective of issuing

conservative parameters for bank management’s broad judgment granted by IFRS.

19. Concentration risk and large exposure limits

Both ECB and BaFin focus on concentration as part of credit risk, and occasionally discuss concentration of

other types when some material risk is detected. MaRisk provides a general framework for the supervision of

concentration risk, and while the ECB internal procedures for credit concentration are aligned with the CP,

the expectations of the supervisor with respect to concentration risk management are not clearly

communicated to the banks. In addition, there is no requirement that all material concentrations to be

regularly reviewed and reported to the bank’s supervisory board.

20. Transactions with related parties

The definition of related parties is wide and detailed. The framework covers loans in a broad definition that

includes off-balance sheet exposures and leasing operations, albeit not exposures such as dealings such as

service contracts, asset purchases and sales, construction contracts. Related party loans must be granted on

market terms, but there is no requirement that individuals with conflict of interest are excluded from the

whole process of granting and managing such exposures. There is no requirement that related party

exposures are monitored and controlled separately and in aggregate. There is no regular reporting of

exposures to related parties. Supervision of related party risk is mostly carried out by external auditors,

whose analysis of related party risk is limited. No limits on related party are imposed by laws, regulation, or

the supervisor.

21. Country and transfer risks

Banks have little guidance from supervisors on their expectations regarding country risk. Standard reporting

on the basis of LrV excludes several countries. There is no specific requirement that banks MIS are able to

identify, aggregate, monitor and mitigate country risk. There is no specific requirement to include country

risk in bank’s stress testing. Assessors saw no evidence that country risk is indeed a regular part of stress

testing. While an increase in Pillar 2 or imposition of provisions would be possible if country risk

concentrations are detected, there is no specific guidance for banks on measures to provision and mitigate

country risk.

22. Market risk

The obligations in MaRisk are generally sound and establish the requirements for banks to implement

effective risk management frameworks to measure and manage market risk. Market risk has been a focus of

the supervisors during 2014 and 2015. Supervisors periodically reviews banks to assess that their market risk

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management processes are consistent with the risk bearing capacity and the market risk management

framework.

23. Interest rate risk in the banking book

IRRBB has received a significant amount of the supervisor’s attention during the last several years and

features as a key supervisory priority. Banks are required to measure, calculate and report their exposure to

IRRBB on a quarterly basis. Banks are also required to conduct regular stress testing using both standardized

and bespoke scenarios, especially for those banks with more complex business models and optionality in

the portfolio. Supervisors make an assessment of IRRBB through the SREP process and assessors saw

evidence that showed this risk featured in the SREP assessment as well as a key topic in discussions with

bank senior management.

24. Liquidity risk

Since 2007-08 German supervisors have stepped up the frequency and intensity of interaction with credit

institutions regarding their management of liquidity risk, contingency plans and funding requirements. Over

time the level of frequency of contact has moderated given considerably more stable market conditions

where calls were daily at the height of the crisis to weekly and now less frequent but periodic. Supervisors

have built-up in-depth understanding for liquidity funding risks at individual institutions through over this

period.

The LCR and LiqV requirements apply to all credit institutions as a pillar 1 minimum standard. Banks are also

required to run regular stress tests where the results are incorporated into the assumptions for contingency

funding plans. While coverage is comprehensive across all banks, the LCR adopted in EU has a number of

elements which are less stringent than the Basel agreed rule, most notably wider definition of HQLA. Given

EC1 clearly states that for internationally active banks the prescribed liquidity requirement should not be

lower than the applicable Basel Standard, and the analysis by the EBA shows relatively large impact from

these changes, the EU regulatory framework’s compliance with the EC is problematic, even if the impact of

these modifications concentrates on non-internationally active banks. Discussions with the authorities at the

time of the mission suggested that banks make use of the benefits from the modifications although the

impact has been reduced since the EBA study.

Aspects of the assessment of liquidity risk management as part of the SREP was under development at the

time of the mission. For example, benchmarks for liquidity risk indicators were developed during 2016. Also,

guidance for assessing ILAAPs will be implemented for 2016. As a result, the analysis of the ILAAP was not

fully implemented at the time of the mission and many aspects of the qualitative assessment of ILAAP had

not featured in the SREP for SIs. Supervisors are aware however of bank’s liquidity risk management

processes and have established relationships with key areas within the bank managing liquidity funding risk.

To this regard, the SSM issued a letter in the beginning of the year on Supervisory expectations on ILAAP

and harmonized information collection on ILAAP to enhance the analysis of ILAAP and its integration in the

SREP.

25. Operational risk

The area of operational risk has undergone several enhancements since the time of the last FSAP, most

notably in the strengthening of dedicated IT risk specialists. Nonetheless, there are a number of areas where

the regulations and supervisory activities need to be strengthened: data reporting, collection and use of loss

data, verification that risk management is effectively implemented and DR/business continuity.

26. Internal control and audit

The independence of the internal audit and compliance is compromised as they report to the management

board.

27. Financial reporting and external audit

Banking supervisors do not have legal power to access external auditors’ work papers. Although this is not

an essential requirement, Germany chose to be assessed against the best international practices, and given

the heavy reliance on external auditors for reviewing not only the reliability of financial statements but also

reporting on whether the banks comply with all risk management guidelines, this gap should be addressed.

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28. Disclosure and transparency

Disclosure standards are generally sound and promote transparency reflecting the substance of the Basel II

pillar 3 standards. As part of their routine activities, supervisors confirmed compliance with the standards

through both sample testing and thematic reviews.

German banks do not disclose related party exposures or transactions with related parties as part of the

Pillar 3 disclosures (EC2). Instead, related party disclosures are covered by the Commercial Code (HGB) and

will be presented as part of a credit institution’s annual report.

In relation to disclosure of data which is not end of period data, supervisors have made attempts to adjust

the frequency of disclosures in some cases, however data which is not end of period has not been made use

of in the supervisory process with any impact on outcomes of analysis (AC1).

29. Abuse of financial services

As the competent supervisor, BaFin has established a risk-based framework to discriminate banks’ risk

profiles and exposure to risks from AML/CFT. The framework is designed to help identify those institutions

where enhanced monitoring and attention is required. The framework is based on a matrix of inherent risk

and quality of safeguards. While the framework should help focus supervisory attention on the highest risk

institutions, inputs into the process need to be refined to be fully risk-based. The framework is heavily reliant

on the EA report to identify deficiencies or weaknesses in risk management. Ongoing monitoring of banks’

compliance with the regulations needs to be more systematic through the ongoing receipt of a range of

inputs into offsite surveillance especially those sources that it gathers from first-hand analysis and

verification of bank’s risk management and controls for AML/CFT. Lastly, coverage of the banking sector

through onsite examinations needs to be expanded.

Appendix Table 2. Recommendations to Improve Compliance with the BCPs

Reference Principle Recommended Action

Principle 1 Ensure new consumer protection responsibilities do not affect BaFin’s ultimate

responsibility for safety and soundness

Principle 2 Reduce scope for potential influence of industry and government in the execution of

supervisory priorities and allocation of resources at BaFin through budget and

organizational structure

Streamline SSM decision making processes for supervisory measures

Principle 5 Include systematic analysis of availability of additional resources in the licensing

process

Include systematic analysis of the collective knowledge of the management and of

the supervisory board

Enhance qualification criteria for Supervisory Board members

Principle 7 Review significant bank investments ex-ante

Principle 8 Greater focus on first hand verification of compliance with regulations.

Principle 9 Complete implementation of the supervisory framework.

Principle 10 Collect more granular data as part of routine supervisory reporting as a way to

strengthen offsite analysis using peer group benchmarks. Implement a data mapping

solution to compare IFRS and nGAAP supervisory data.

Principle 14 Strengthen supervisory board qualifications and responsibilities

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Principle 15 Strengthen reporting lines of the CRO and risk control function to the Supervisory

Board. Implement a prior notification requirement to the Supervisory Board in the

event a CRO is removed.

Principle 18 Issue guidance on loan classification and provisioning

Principle 19 Issue guidance on management of concentration risk in a broader sense (beyond

credit exposures).

Introduce requirement that all material concentrations to be regularly reviewed and

reported to the bank’s supervisory board

Monitor large exposures beyond the compliance with LE limits

Principle 20 Introduce a regime for the management, monitoring, and actual supervision of

related party risk.

Principle 21 Issue guidance on the management of country and transfer risk, including

requirements for banks’ MIS, and specific requirements for country and transfer risk

to be included in bank’s stress testing if applicable.

Enhance reporting of country and transfer risk.

Issue guidance on provisioning and mitigation for country risk.

Principle 24 Develop a greater suite of industry benchmarks for liquidity risk analysis.

Principle 25 Collect more granular data for operational risk. Place more emphasis on confirming

that operational risk management systems are effectively implemented.

Principle 26 Provide opportunity for independent reporting to supervisory board without

management board participation

Principle 27 Find workaround to gain access to external audit work papers

Principle 29 Place more emphasis on ongoing surveillance to confirm bank’s risk management

and controls for AML/CFT, especially those sources that it gathers from first-hand

analysis and verification.

E. Authorities’ Response to the BCP Assessment

a) German Authorities´ Response

The German authorities wish to express their appreciation to the IMF and its assessment teams for

this assessment since they strongly support the Financial Sector Assessment Program, which

promotes the soundness of financial systems in IMF-member countries and contributes to improving

supervisory practices around the world.

The German authorities appreciate the assessment in general. Some clearly unsatisfactory ratings are

considered as an encouragement to critically reflect current supervisory practices and to make

changes and adjustments where appropriate.

However, there are a number of recommendations where the German authorities believe that the

current regime effectively fulfils the IMF’s requirements. These are set out below:

The following comments are ordered in the sequence of the DAR text (factual corrections):

Licensing, qualifying holdings and major acquisitions (CPs 5-7)

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Regarding Principle 5 the German authorities want to point out, that although the assessment of the

members of the supervisory board is not explicitly a part of the licensing procedure the appointment

of any member of the supervisory board undergoes an assessment process by the competent

supervisor. According to section 25d (1) of the German Banking Act [Kreditwesengesetz – KWG], the

members of the supervisory board of an institution, a financial holding company or a mixed financial

holding company must be trustworthy, have the necessary expertise to fulfil their control function as

well as to assess and monitor the business of the undertaking, and devote sufficient time to

performing their duties. Pursuant to section 36 (3) sentence 1 KWG BaFin is entitled to force a bank to

withdraw a member of the supervisory board which does not fulfil these standards. According to

section 25d (2) KWG the supervisory board as a whole shall have the necessary knowledge, skills and

experience to fulfil its control function as well as to assess and monitor the management board of the

institution, group of institutions or financial holding group, financial holding company or mixed

financial holding company.

Regarding Principle 5 and 6 the authorities want to point out that BaFin has published Guidelines

regarding the licensing procedures, qualifying holding procedures and the assessment of managing

directors and members of the supervisory board. The Guidelines regarding the licensing procedures

that were published in 2007 and especially the Guidelines regarding the assessment of the managing

directors and the members of the supervisory board which were published for the first time in 2012

and 2013 contain passages regarding the term “trustworthiness” and provide an overview of the

standards applied by BaFin in so far. The Guidelines regarding the assessment of managing directors

and members of the supervisory board which were revised in 2016 will be published in English shortly

as well.

Regarding Principle 7 the authorities are convinced that although German legislation does not

provide for the authority to ex ante review and (dis)approve such participations the qualification as

materially non-compliant is not justified. Firstly, Article 89 Capital Requirements Regulation [CRR] is

directly applicable in Germany and in so far Germany does not see the possibility to apply a stricter

approach than the one set out in directly applicable Union law. Secondly, in our view the acquisition

of participating interests outside the financial sector is a business decision in which the supervisor

should not intervene. The potential risks stemming from an institutions’ acquisition and investment

policies are sufficiently limited by quantitative limits and by the fact that the institutions’ managers are

responsible and accountable for the handling and monitoring of the institutions' risks which includes

acquisitions and investments. The managers’ performance in turn is subject to review by auditors and

supervisory interventions in case the requirements are breached. Thirdly, the qualifying holding

procedures also apply for significant participations in insurance companies according to section 17 of

the German Act on the Supervision of Insurance companies [Versicherungsaufsichtsgesetz - VAG] and

other financial services institutions (i.e. investment firms) according to section 1 (1a), (2) KWG. The

requirement of a pre-approval by the competent supervisor for any significant participation in one of

these regulated entities also applies if the proposed acquirer is a bank.

Supervisory reporting (CP 10)

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The authorities cannot agree with the overall assessment. Taking into account their entire supervisory

environment, their experience with the information available and their capacity to react if necessary

promptly on banks’ situations which are not satisfactory the isolated assessment of Principle 10 is

too harsh and should be upgraded. Moreover, we would like to emphasize that the assessment does

not take future developments into account. According to the ECB regulation 534/2015 which further

elaborates Regulation (EU) 680/2014 the required information will be available next year.

Corporate Governance (CP 14)

On Principle 14, Corporate Governance, on basis of its findings the IMF concludes that the

following actions are needed to strengthen the role of the supervisory board:

 Supervisory guidance should clearly state that ultimate responsibility for

establishing the risk

culture, developing business plans and risk appetite statement

rests with the supervisory board.

 Supervisory enforcement and sanctioning programs should explicitly address

supervisory

board member liability.

 The knowledge/experience requirements for supervisory board members should be

commensurate with the complexity of the bank.

 Reporting to the board should be frequent and with sufficient detail to enable the

board

members to challenge management.

 Banking supervisors should continue to increase dialogue and discussions with the

supervisory

board on results of supervisory activities and concerns.

Reference has been made to BCP standards, requiring increased emphasis on the role of the

supervisory board’s oversight of management and the institution. According to paragraph 6, page 2,

of the Basel Principles for enhancing corporate governance of October 2010, insufficient board

oversight of senior management, inadequate risk management and unduly complex or opaque bank

organizational structures and activities failures and lapses were one of the reasons for the financial

crisis that began in mid-2007. For this reason, Principle 1 of the Basel Principles for enhancing

corporate governance of October 2010 states, that “The board has overall responsibility for the bank,

including approving and overseeing the implementation of the bank’s strategic objectives, risk

strategy, corporate governance and corporate values. The board is also responsible for providing

oversight of senior management.”

Also Principle 1 of the Basel Corporate Governance Principles for banks, published July 2015, requires

that “the board has overall responsibility for the bank, including approving and overseeing

management’s implementation of the bank’s strategic objectives, governance framework and

corporate culture.”

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However, neither the above cited guidelines nor the BCP address the “supervisory board” in specific

but the “board” in general, which is defined, according to Basel Corporate Governance Principles for

banks of July 2015 as,

“The body that supervises management. The structure of the board differs among countries. The

use of “board” throughout this paper encompasses the different national models that exist and

should be interpreted in accordance with applicable law within each jurisdiction.”

Footnote 27, page 25 of BCP states that the BCP “[…] refers to a governance structure composed of a

board and senior management. The Committee recognizes that there are significant differences in

the legislative and regulatory frameworks across countries regarding these functions. Some countries

use a two-tier board structure, where the supervisory function of the board is performed by a

separate entity known as a supervisory board, which has no executive functions. Other countries, in

contrast, use a one-tier board structure in which the board has a broader role. Owing to these

differences, this document does not advocate a specific board structure. Consequently, in this

document, the terms “board” and “senior management” are only used as a way to refer to the

oversight function and the management function in general and should be interpreted throughout

the document in accordance with the applicable law within each jurisdiction.”

Also, paragraph 7 of the Basel Principles for enhancing Corporate Governance of October 2010

points out that “the application of corporate governance standards in any jurisdiction is naturally

expected to be pursued in a manner consistent with applicable national laws, regulations and codes.”

Paragraph 15 of the Basel Corporate Governance Principles for banks of July 2015 states that the

Principles are “intended to guide the actions of board members, senior managers, control function

heads and supervisors of a diverse range of banks in a number of countries with varying legal and

regulatory systems, including both Committee member and non-member jurisdictions. The

Committee recognizes that there are significant differences in the legislative and regulatory

frameworks across countries which may restrict the application of certain principles or provisions

therein. Each jurisdiction should apply the provisions as the national authorities see fit. In some

cases, this may involve legal change. In other cases, a principle may require slight modification in

order to be implemented.”

Against this background we would like to point out that the German two tier structure differs from

the one tier structure. However, the abovementioned Basel principles in general and especially the

BCP 14 requirements have been fulfilled.

As regards the responsibilities of both boards, it seems that the interaction between the

management board and the supervisory boards and the full range of the supervisory board`s tasks

and powers in German banks have not been made sufficiently clear yet.

The German two-tier system allocates the board’s responsibilities in two institutionally independent

bodies, the management board, which has the direct responsibility for the management of the

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company, including the exercise of management control over the lower hierarchical levels, and the

supervisory board, which in turn supervises the management activities of the management board.

The basic idea is to separate the supervision in an own body, which is staffed and functionally

separate from the management board, namely the supervisory board. The aim of this separation of

responsibilities is not only to prevent that management responsibilities become so extensive that

there is not enough room for the monitoring responsibilities, but also to avoid an involvement of the

supervisory board members in management decision-making and accordingly as a final consequence

the need to monitor themselves with all resulting potential conflicts of interest. The clear separation

of management and supervisory responsibilities as well as the independence of the supervisory

board members are major advantages of this system. Requiring an ultimate responsibility for

establishing the risk culture, developing business plans and risk appetite statement rests with the

supervisory board would contravene this separation.

The role of both, the management board and the supervisory board, is not only governed by

supervisory law, i.e. the KWG, but to a large extent subject to the respective company law. In order to

facilitate a better understanding of the German two-tier structure and especially the role of the

supervisory board, the main responsibilities and powers are outlined below (where governed by

company law, using the public limited company (Aktiengesellschaft) as an example).

With respect to the management board, we firstly refer to our explanations in the Preliminary

remarks of the German specific part of the Detailed Self-Assessment on BCP 14. Furthermore, we

would like to emphasize the fact that due to corporate law it is the management board which has to

manage the company on its own responsibility (sec. 76 German Stock Corporation Act [Aktiengesetz

– AktG]). This means on the one hand performing the management tasks - or in other words the

leadership tasks - and on the other hand bearing the ultimate management responsibility. In its

leadership function, the management board is not limited to performing day-to-day management,

but also responsible for developing the corporate strategy as well as determining the corporate

policy and ensuring their implementation (cf. sec. 4.1 of the German Corporate Governance Code

(GCGC); cf. also sec. 25c KWG). The tasks of the management board also encompass the exercise of

management control in the sense of ongoing and subsequent monitoring of the performance and

success of delegated management tasks. Concerning the latter, the main responsibility of the

supervisory board is normally to assess whether such delegation is appropriately organized, e.g.,

whether the responsible individuals are properly selected and sufficiently monitored by the

management board.

With regard to the qualifications of the supervisory board members, we would like to refer to BCP 14,

EC 4, German specific part, and to highlight the fact that, when assessing whether a member of the

supervisory board has the necessary expertise, the scope and complexity of the business conducted

by the institution, group of institutions or financial holding group, financial holding company or

mixed financial holding company has to be taken into account (sec. 25d para. 1 sentence 2 KWG). We

also refer once more to BCP 14, EC 9, German specific part, with special regard to corrective

measures against supervisory board members.

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As already said in the preliminary remarks of the German specific part of the Detailed Self-

Assessment on BCP 14, the main responsibility of the supervisory board is the supervision of the

management board. For credit institutions, sec. 25d para. 6 KWG specifies that the supervisory board

shall oversee the management board, also with regard to its adherence to the applicable prudential

supervisory requirements, and shall devote sufficient time to the discussion of strategies, risks and

remuneration systems for management board members and employees. Credit institution specific

responsibilities also follow from sec. 25d para. 7-12 KWG, where the tasks of the supervisory board`s

committees are laid down.

For the purpose of supervising the management board, the supervisory board has quite significant

powers:

 The supervisory board is responsible for the appointment and dismissal of members of

the management board (sec. 84 AktG), including the service agreement and its

termination, the compensation of each management board member (cf. sec. 25d (12)

KWG in accordance with sec. 3 (2) Remuneration Ordinance for Institutions

[Institutsvergütungsverordnung – InstitutsvergVO]) as well as the representation of the

company vis-à-vis the members of the management board (sec. 112 AktG). Where

necessary, the supervisory board has to consider and to pursue claims for damages

against members of the management board (cf. sec. 116, 93 AktG). Corresponding to

the liability of the members of the management board, supervisory board members

can also be held liable personally for damages in case of infringements of their duty of

care (sec. 116 AktG).

 The management board is subject to comprehensive regular and case-specific

reporting obligations vis-à-vis the supervisory board (sec. 90 AktG). In addition, the

supervisory board may require at any time further reports from the management

board on the affairs of the company (sec. 90 para. 3 AktG). It may also inspect and

examine the books and records of the company as well as the assets of the company,

in particular cash, securities and merchandise (sec. 111 para. 2 AktG). A specificity for

all credit institutions is the right of the chairs of the risk committee and the audit

committee, or, if such committees have not been established, the chair of the

supervisory board, to make direct enquiries to both the head of the internal audit

function and the head of the risk control unit (sec. 25d para. 8 and 9 KWG).

Correspondingly, the chair of the remuneration committee (or the chair of the

supervisory board) may make direct enquiries to both the head of the internal audit

function and the heads of the organisational units responsible for the structure of the

remuneration systems (sec. 25d para. 12 KWG).

 Within the scope of its supervising function, the task of the supervisory board is also

to advise the management board in the management of the enterprise regularly. The

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supervisory board must be involved in decisions of fundamental importance to the

enterprise. (cf. sec. 5.1.1 GCGC)

 The supervisory board shall instruct the auditor as to the annual financial statements

and consolidated financial statements according to sec. 290 of the Commercial Code

(sec. 111 para. 2 sentence 3 AktG). It shall itself examine the annual financial

statements, the annual report and the proposal for appropriation of distributable

profit and shall report on the results of its examination in writing to the shareholders’

meeting (sec. 171 AktG). The annual financial statements shall be deemed to have

been approved, upon approval thereof by the supervisory board, unless the

management board and the supervisory board resolve that the annual financial

statements are to be approved by the shareholders’ meeting (sec. 172 AktG).

 While it is explicitly stipulated that management responsibilities may not be conferred

on the supervisory board, the articles of association or the supervisory board have to

determine that specific types of transactions may be entered into only with the

consent of the supervisory board (sec. 111 para. 4 AktG).

 The supervisory board shall call a shareholders’ meeting whenever the interests of the

company so require (sec. 111 para. 3 AktG), e.g. to achieve a vote of no confidence by

the shareholders’ meeting in order to revoke the appointment of a member of the

management board.

 The strategies and, where applicable, adjustments to the strategies shall be brought to

the attention of and discussed with the institution’s supervisory board (guidance

provided by AT 4.2 para. 5 Minimum Requirement for Risk Management [MaRisk], an

administrative regulation issued by BaFin).

 Risk management creates a basis for the proper performance of the supervisory

board’s monitoring functions and thus shall also include the adequate involvement of

the supervisory board (guidance provided by AT 1 para. 1 MaRisk).

Against this background, we would like to emphasize that the management board is the right body

regarding the reporting lines of the control functions. All control functions are instruments of the

management board due to its responsibility to manage the company on its own responsibility.

Therefore, the control functions report directly to the management board. The management board,

then again, is obliged to report to supervisory board. This reporting line does not mean that risk

reporting to the supervisory board is influenced in an unduly manner. Firstly, the control functions

are clearly (up to and including management board level) segregated from the operational functions

(front office) to enable the control functions to monitor and report on risk issues independently from

divisions where risks may arise. Secondly, it is not up to the management board members to decide

about form and extent of the information provided by the control functions. German supervisors

have the clear expectation that reports to the supervisory function are identical or at least

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coextensive to those that are provided to the management board in order to ensure the same level

of information for the supervisory board and the management board (please see also responses to

BCP 15).

However, to a certain extent reporting lines of the control functions to the supervisory board are also

in place. As already mentioned above, the supervisory board has direct access to the heads of control

functions, namely the CRO and the head of internal audit. According to sec, 25d (8) KWG), the chair

of the risk committee, and if no risk committee has been established, the chair of the supervisory

board, may make direct inquiries to the head of internal audit function and the head of risk control

unit. The management board shall be informed thereof. The same applies to the chair of the audit

committee and the head of supervisory board if an audit committee has not been established,

according to sec. 25d (9) KWG.

Specific guidance regarding reporting requirements to the supervisory board are also laid down in

the MaRisk. According to the guidance provided by AT 4.4.2 para. 6 MaRisk, the reports of the

compliance function shall (next to the primary reporting line to the management board) additionally

be passed to the supervisory board. Additionally, according to the guidance provided by BT 2.4 para.

4 of MaRisk’s amended version, the Internal Audit function has to write an overall report on its

performed audits on a quarterly basis and provide them to both, the management board and the

supervisory board. Regarding the reporting obligation of the risk management function, please see

the comments regarding the preliminary assessment of BCP 15.

Regarding remuneration topics, the chair of remuneration committee or, if a remuneration

committee has not been established, the chair of the supervisory board may make direct inquiries to

the head of the internal audit function and the heads of the organizational units responsible for the

structure of the remuneration systems. The management board shall be informed thereof according

to sec. 25d (12) KWG.

In this regard, it is important to point out, that all members of the respective committees are only

supervisory board members; no management board member is included.

Regarding the assessment that “Banking supervisors should continue to increase dialogue and

discussions with the

supervisory board on results of supervisory activities and concerns” we do not

understand on which basis this assessment has been made. We believe that the dialogue between the

German banking supervisors and the respective institution`s bodies is commensurate with the role of

each board.

Consequently, we do not think that the findings made by the IMF are sufficiently justified.

Considering the content of the Basel Core Principles, we are convinced that the requirements relating

to the “board” are addressed correctly against the background of the German two-tier system.

Therefore, we are convinced that the German system is compliant with the requirements of Principle

14.

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Prudential Requirements, Regulatory Framework, Accounting and Disclosure (CPs 15-29)

Comment on the Assessment of BCP 15 Risk management process: We do not share the view of

the IMF that the existing dual system of the legal structure in German companies and banks (strict

separation of the management board and the supervisory board) and the resulting implications for

their tasks in Germany leads to a weakening of independence of the control functions (risk

management function, compliance function, internal audit function) within the institutions in general

and with regard to the risk management function in particular. The responsibility of the supervisory

board according to German company law is clear: it is in the responsibility of the supervisory board

to observe and monitor the business management of the management board. Furthermore, the

supervisory board must not perform business management tasks. This fact implies some

modifications concerning the reporting requirements (reporting lines) and the organisational and

operational structure in which the risk management function is embedded. For more details

concerning the specific role of the supervisory board and the resulting implications see response to

BCP 14.

To begin with, it has to be emphasized that all control functions, including risk management

function, are instruments of the management board (due to their responsibility for the business

management) and therefore organizationally subordinated to the management board. This is why

the risk management function reports initially to the management board. The fact that it is in the

responsibility of the management board (not automatically the CEO but usually the CRO – when the

CRO is member of the management board, as it is the case in the most largest institutions in

Germany – or the management board member where the risk management function is subordinated)

to report to the supervisory board (at least quarterly) does not mean (and should not lead to the

conclusion) that risk reporting to the supervisory board could be influenced in an unduly manner.

Two facts in this context are particularly important: Firstly the risk management function is clearly (up

to and including management board level) segregated from the operational function (front office) to

enable this function to monitor and report on risk issues independent from those divisions of the

institution where risks arise. Secondly, it is not left to the discretion of the management board

members in what form and to what extent risk related information is reported to the supervisory

board. German supervisors have the clear expectation (and review if these expectations are met by

institutions, especially in the context of onsite inspections) that risk reports to the supervisory

function to be identical or at least coextensive to those which are presented to the management

board in order to ensure the same level of information for the supervisory board and the

management board. The compliance with this requirement are reviewed during ongoing supervision

and on-site inspections.

In addition, the chair of the supervisory board (or the chair of the audit committee if such a

committee exists, see also section 25d (9) KWG in connection with section 25d (7) KWG) has direct

access to the head of the risk management function and can call for further information. The fact

that the management board shall be previously informed is a direct implication of the organisational

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and disciplinary subordination of those staff members and does not imply that the chair of the

supervisory board cannot discuss with the head of risk management in confidence (without presence

of a management board member). Please note that large institutions are required to implement the

head of risk management function exclusively on management board level (“CRO”). In those cases

the CRO has always the access to supervisory board (and vice versa) at all times.

For these reasons it is sufficiently ensured that the risk management can act independently and can

provide both management board and supervisory board with risk information without any influence

of the management board.

With regard to the required notification of the supervisory board in cases where the head of the risk

management function is removed (for removals of the head of compliance and head of internal audit

there are identical requirements; see guidance provided by AT 4.4.1, AT 4.4.2, AT 4.4.3 MaRisk) we

would like to point out that this notification is not only required ex-post but a sufficient time before

the removal in order to enable the supervisory board to discuss those issues with the management

board. German supervisors have addressed this topic in the draft of a revised version of the MaRisk

(consultation process was opened in February 18th 2016) and will amend the respective sections of

the MaRisk to make clear that the notification has to be given due in advance and under

specification of the reasons of the removal.

Comment on Assessment of Principle 18: Based on the experience and the results of AQR from

2014, BaFin is aware that there has to be a stronger focus on questions in terms of valuation. For that

reason, BaFin established a new division, BA 53, Financial Accounting and Valuation Practices, with

the task to get a better understanding of the institutions’ valuation practices, the underlying

assumptions and the calculation of provisions.

In this way, BaFin aims for a deeper insight into the institutions’ processes and their valuation

methods to discuss the institutions’ appraisals in terms of a prudential perspective. Based on the

various banking practices, a guidance for the supervisor might be a helpful tool. Nevertheless, a

conflict with existing accounting legislation should be avoided. In this regard, the new division will

explore a possible balanced way forward. Nevertheless, we expect that challenging the institutions

results and comparisons might lead to an increase of quality of valuation methods and its results.

Additionally BaFin and BBK implemented a supervisory approach for LSI in 2015 (PAAR – Prudential

Assessment of Adequate Risk-Provisioning) and set up a supervisory training program which was

enrolled in 2015. Regarding that it is a completely new inspection approach for BBK there are no

public issued guidelines yet, however there are comprehensive internal guidelines for inspectors

available. This safeguards to keep room for adjustments in this early stage of this new inspection

approach.

On SSM-level there is an on-site methodology for credit risk available and detailed information for

loan valuation and provisioning are yet to be finished.

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Regarding Principle 19 we would like to point out that the CEBS Guidelines on the management of

concentration risk under SREP (GL 31) still are applicable and establish a framework on the EU level

which relates to Art. 81 Capital Requirements Directive [CRD]. Without explicit mentioning the

definition of these Guidelines, all aspects referred to in the Core Principle as footnote are covered. At

the same time, the definition is congruent with the guidance provided by the MaRisk (see AT 2.2,

para Annotations).

Furthermore, the MaRisk definition of intra-risk concentrations includes market-risks aspects (market,

currencies) as well as funding risk concentrations. The requirement to analyse regularly the access to

relevant refinancing - even in the event of tight markets - clearly points in this direction (BTR 3.1. Tz.

4).

Regarding the regular review of all material concentrations by a bank´s supervisory board we cannot

agree with the statement that there is no such requirement: MaRisk do require a special reporting

about risk concentrations and their potential consequences (see AT 4.3.2., para 4). Besides, according

to AT 4.3.3 para 1 stress tests have to be extended on risk concentrations. The results of the stress

tests have to be reported as well and shall therefore cover the assumed risk concentrations

additionally.

According to the guidance provided by BTR 1 para 7a MaRisk the risk report on credit risk has to

contain information regarding the development of the credit portfolio. Risk concentrations as well as

large exposures (Para 7b) have to be considered. The risk reports are generally sent via the

management board in identical or at least coextensive form to the supervisory board so it is ensured

that the supervisory board gets the same information as the management board in a timely manner.

Regarding Principle 20 the statement that there is no regular reporting of exposures to related

parties is correct, but it doesn’t mean that German supervisors never obtain information on loans to

related parties. According to section 34 (2) No. 4 of the Audit Report Regulation

[Prüfungsberichtsverordnung – PrüfbV], stricter (single-loan-based) reporting requirements apply

where loans to related parties must be regarded as noteworthy because of their size or the way they

are structured or because indications of conflicts of interests occur. Furthermore, in case of reaching

or exceeding certain thresholds (large loans according to section 14 KWG and large exposures

according to Article 394 CRR), exposures to related parties have to be reported to the supervisor,

too.

In addition, granting exposures to related parties is part of the institution’s credit granting and

surveillance process. Therefore, not only section 15 of the KWG, which, among other things, defines

transactions with related parties and regulates the unanimous decision by all general managers of

the institution in advance of the credit granting, but also all the other provisions as section 18 KWG

or the guidance provided by the MaRisk have to be respected. Consequently, related party exposures

have to be monitored and controlled and there is no need for a separate regulation in this context.

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Even if there is no separate legal limit for exposures with related parties, the large exposure limit

according to Article 395 of the CRR is applicable. Besides, according to section 15 (2) KWG, BaFin can

impose limits on exposures to related parties on a case by case basis.

Finally, regarding the definition of related party transactions or the relevant provision, the supervisor

can always decide on a case by case basis if there are some doubts.

Regarding Principle 21 we have difficulties in understanding the basis for your assessment that

banks would have little guidance on country risk. Country risk as part of credit risk is subject to the

guidance provided by MaRisk standards to credit business like “normal” credit risk. Country risk

includes an economical and a political aspect which of course has to be analysed. According to BTO

1.2 para 3 MaRisk all important aspects of a credit engagement have to be fleshed out (not only at

the time of the granting of the loan but also during the ongoing monitoring), whereby country risks

are to be considered in an appropriate way. The bulk of German banks operate regionally and are

usually not engaged in foreign exposures (with the exception of some EU sovereign bonds) so that

country risk is rather in exceptional cases an essential risk in the LSI-context. According to the

national Guidelines on the supervisory assessment of bank-internal capital adequacy concepts

(published in December 2011) unrealised losses in relation to hidden burdens which have occurred

with European sovereign bonds in the near past must be considered.

In addition, reporting requirements regarding country risk follow from the guidance provided by BTR

1, para 7 MaRisk: according to lit. a information must be given on the development of the credit

portfolio, inter alia broken down by countries. If significant positions with country risk exist, a special

presentation of these risks is necessary (see para 7c).

Finally, regarding the verification of internal limits we would like to mention that auditors of

Bundesbank also examine the limit system in the context of their audits and whether country risks

are appropriately taken into account and limited, of course (the guidance provided by MaRisk

emphasizes that country risks as part of the credit risk have to be regarded). However as mentioned

above, this is a rather exceptional case with LSIs as most LSIs don´t have significant country risks.

Regarding Principle 25: We disagree with the classification because it is not clear where Germany

does not comply with the Basel framework.

We agree that there might be room for improvements, which is always the case. But the benchmark

has to be the BCP requirement and not what seems to be desirable.

However, we do not agree that the findings justify a verdict of material non-compliance. The Basel

text is fully covered by the CRR and the guidance provided by the MaRisk. OpRisk management,

disaster recovery and BCP are regular topics of bank examinations, in dedicated operational risk

audits as well as in examinations with a broader or different scope where it is implicitly covered. As a

material risk, operational risk is covered by the guidance provided by MaRisk examinations by

default. It is also touched upon in market and credit risk examinations where boundary issues are

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concerned. Moreover, in our opinion some of the requests of the IMF assessors went beyond what

the Basel text asks for. We would therefore like to ask for clarification on the conclusion of the

assessors. For any details with respect to the individual ECs, please refer to our statements below.

Concerning the findings of EC1, Bundesbank has both supervisors dedicated exclusively to

operational risk as well as quantitative and qualitative experts with a lot of experience on operational

risk examinations. Bundesbank furthermore offers in-house trainings for supervisors on operational

risk that covers both regulation and presentations from bank practitioners.

Concerning the findings of EC3, we disagree that the use test does not receive sufficient attention

during AMA examinations. AMA banks are thoroughly examined before given accreditation and the

monitoring of KRIs and other risk management instruments is part of our ongoing supervision. The

four elements of an AMA and their use are also an explicit part of AMA first-time inspections and a

common part of follow-up inspections. In the past, AMA examinations have rendered 12 findings

with respect to the integration of the AMA into day-to-day management and an additional 36

findings with respect to the four data elements.

While a benchmarking of losses is currently not performed by Bundesbank, such an exercise is in

progress by ECB (DG IV). Please be mindful that the (desirable) supervisory collection of loss data for

BIA-banks would exceed BCBS requirements. We agree that a cross-sector analysis of operational

risks is not performed; however, this is not envisaged by the Basel text either. We also see no basis

for such an analysis as the Basel text does not require small banks to systematically collect loss data

and we consider the BIA capital requirement to be not risk sensitive enough to allow for

comparisons.

The assessors criticize that the frequency, scope and depth of operational risk examinations could be

enhanced. In the past we have had dedicated operational risk exams for large banks, which have

each lasted several weeks with teams of more than 6 people. While the frequency of follow-up AMA

assessments varies from bank to bank, our largest bank is examined on at least a yearly basis. All

other banks that do not have an approved AMA are regularly examined for compliance with BTR 4

MaRisk, which regularly results in findings with regard to the banks' operational risk management. In

total, MaRisk examinations have yielded more than 90 operational risk findings since 2013. We are

hoping for a statement from the assessors what is considered an adequate frequency, scope and

depth for operational risk examinations.

Concerning EC4, the assessors state that there are “no provisions within the regulations to establish

minimum expectations with respect to testing, review and approval by board of DR and BCP plans.”

However, the German banking act clearly states in section 25a that "risk management shall comprise,

in particular, (...) the definition of an adequate contingency plan, especially for IT systems.” Further in

section 25c, the banking act states that "As part of its overall responsibility to ensure a proper

business organization of the institution pursuant to section 25a (1) sentence 2, the management

board of an institution shall ensure that the institution has in place the following strategies,

processes, procedures, functions and frameworks:

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adequate contingency plans pursuant to section 25a (1) sentence 3 number 5 for contingencies

affecting time-critical activities and processes; as a minimum, the management board shall ensure

that regular contingency tests are carried out in order to verify the suitability and effectiveness of the

contingency plan and the results are communicated to the respective responsible staff.” Between

2012 and 2014, Bundesbank has conducted more than 50 audits with a focus on DR and BCP (MaRisk

AT 7.3) that have resulted in 71 findings.

The assessors also criticize that in relation to DR and BCP, the MaRisk contains high level guidance

and does not prescribe minimum standards for the frequency, scope or nature of DR and BCP testing

and that banks are obliged to follow industry standards instead. In addition, the assessors criticize

that there is scope for the JST to pay greater attention to the assessment of DR and BCP planning

and the results of DR tests. In addition to the banking act and the MaRisk which are more principle

based, it should be mentioned that all Bundesbank supervisors are given guidelines on how to

examine DR and BCP and that we have done roadshows and in-house training to create awareness

for this topic. Furthermore, industry standards are not only defined by regulators but also by

independent bodies such as the federal office for information security (BSI) which sets ISO norms

among others.

Regarding EC6, the assessors criticize that loss data from AMA SI banks should be collected and

compared. Once again, we reference to the on-going SSM exercise. It should also be noted that large

loss events are discussed with JSTs on a regular basis and that management awareness is created

through the regular reporting of operational risk losses and scenarios. While a cross-sector

comparison for Germany might seem desirable, we still see no legal basis to ask this from the

supervisors.

It is also not correct that MaRisk does not contain a level of specificity for the collection and

classification of operational risk data. MaRisk specifically states in its BTR 4 that “It shall be ensured

that any material operational risk is identified and assessed at least once a year.” The upcoming

revisions of the MaRisk guidance will also include the requirement to use loss databases.

In total, further clarification where exactly Basel rules are violated would be useful so we can further

improve our supervisory approach.

Regarding the assessment of BCP 26, we would like to refer to the comments regarding the

assessment of BCP 14 and 15.

In addition, we would like to point out, that in contrary to the statements in the assessment, the

internal audit function and the compliance function have alternative reporting lines to the

supervisory board.

According to sec. 25d (8) and (9) KWG, the chair of the risk committee and internal audit committee

respectively or, if the respective committee has not been established, the chair of the supervisory

board may make direct inquiries to the heads of the both control functions. Additionally, according

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to the guidance provided by BT 2.4 para. 4 of MaRisk’s amended version, the Internal Audit function

has to write an overall report on its performed audits on a quarterly basis and provide them to both,

the management board and the supervisory board.

Since the internal audit function is an instrument of the management board, the function is obliged

to report directly to this body in the first instance (BT 2.4 MaRisk). However, if management board

members might be involved, the internal audit function has to report directly to the supervisory

board. According to BT 2.4 para. 5 MaRisk, in case the audit reveals serious findings concerning

members of the management board, the internal audit function shall inform the chair of the

supervisory board if the management board fails to meet its reporting obligation or if it fails to

adopt appropriate remedial measures.

As already pointed out in the comments to BCP 14, the compliance function is also an instrument of

the management board regarding the specific responsibility of this body. For this reason, the

compliance function has to report to the management board directly. But in addition, according to

the guidance provided by AT 4.4.2 para. 6 MaRisk, the reports of the compliance function shall

additionally be passed to the supervisory board (and the internal audit function).

Finally, we do not share the view that the supervisory board is informed of a replacement of the

internal auditor, compliance officer and risk officer ex-post only. According to the guidance provided

by MaRisk, the supervisory board shall be notified, if the head of the risk control function (AT 4.4.1

para. 5) and the compliance officer (AT 4.4.2 para. 7 MaRisk) and the head of internal audit function

(AT 4.4.3 para. 6 MaRisk) respectively is replaced. It is clearly not required to provide any of this

information ex-post but instead in a sufficient time before the removal so that the supervisory board

is able to discuss these issues with the management board. The draft of the revised version of the

MaRisk (consultation process was opened in February 18th 2016) will be clearer in this regard. In

future, if the head of the risk control function (AT 4.4.1 para. 6 revised version) and the compliance

officer (AT 4.4.2 para. 7 revised version) and the head of internal audit function (AT 4.4.3 para. 6

revised version) respectively is replaced, the supervisory board shall be notified in advance in a timely

manner, stating the reasons for the replacement.

Therefore, we are convinced that Germany is compliant with the BCP 26 guidelines.

b) ECB´s Response

The ECB welcomes the assessment prepared by the IMF based on the “Basel Core Principles

(BCP) for Effective Banking Supervision” in the context of the Germany FSAP. In general, the

ECB concurs with the views expressed in the report, as they generally reflect in a very balanced and

thoughtful manner the reality of the SSM and take due account of the complexity of the matter. The

ECB highlights the excellent cooperation with the IMF mission team and the German authorities all

throughout the process.

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The ECB strongly supports the IMF in its objective to promote globally best supervisory

practices via FSAPs, as this is fully in line with the SSM’s objective of ensuring that banks

across the euro area are supervised according to the same high standards. More specifically,

SSM banking supervision does not have a national focus, but takes a European perspective, allowing

the ECB to compare and benchmark banks across institutions and identify problems at an early

stage. In addition, it combines the experience and expertise of 19 national supervisors, enabling the

ECB to draw on the best national practices. Finally, SSM banking supervision is shielded against

undue influence from different stakeholders.

The ECB also welcomes that the report acknowledges that in 2015 the European banking

supervision took a great step towards harmonised and unbiased supervision by conducting a

euro area-wide Supervisory Review and Evaluation Process (SREP) according to a common

methodology. For the first time, all significant institutions in the euro area were assessed against a

common yardstick. Quantitative and qualitative elements were combined through a constrained

expert judgment approach, which ensured consistency, avoided supervisory forbearance and

accounted for institutions’ specificities.

Notwithstanding the general positive view on the report, the ECB considers that the

assessment of BCP 25 on operational risk does not fully take into consideration the initiatives

undertaken by the SSM, by means of the actions of the Joint Supervisory Teams, to measure

and assess these risks in significant institutions. The ECB is of the view that, while recognizing that

of course there is still room for improvement, the progress made so far and the initiatives that are

still ongoing to improve the supervision of operational risk were not fully recognised in the

assessment. Most notably, the SSM supervisory assessment guidance, which, while tailored to more

advanced risk management practices as applicable under AMA, in practise also provides BIA banks

with guidance on this matter. In addition, operational risk issues are addressed in the specific risk

control assessments that are part of the regular supervisory activity of the JSTs. In this regard, for

example, questions relating to adequate risk management processes, potential data weaknesses or

risks resulting from technical or human errors are covered in JSTs’ assessments not only for

operational risk itself but also when analysing credit, liquidity or market risk, as well as in governance

risk control assessments.

Regarding the remarks included in the report that there should be more supervisory focus on

ensuring reported data quality, including the verification that risk management policies exist

and are effectively implemented, the ECB indicates that the JSTs – following the SSM Supervisory

manual – undertake quantitative and qualitative assessments to determine respectively the actual

level of exposure to this risk and the internal risk controls established by the banks. These

assessments are included in the RAS assessment and in the monitoring reports that are produced at

least once per year, which are complemented with additional supervisory assessments for AMA

banks. In addition, JSTs perform specific assessments, the so-called ‘deep dives’, and cover these

issues through on-site inspections.

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Finally, it is also worth to be noted that the SSM undertook a number of reviews – notably on

CyberCrime, BCBS 239 and cybercrime incident reports – and is currently in close contact with

key service providers to assess preparedness to risks related to systemic threats.

The ECB will duly consider the observations and recommendations included in the report to

further improve the quality of the SSM banking supervision.

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Report on the Observance of Standards and Codes: CPMI-IOSCO

Principles for Financial Market Infrastructure

A. Executive Summary

Eurex Clearing observes the CPSS/IOSCO Principles for Financial Market Infrastructures

(PFMIs). In particular, it has a sound, coherent, and transparent legal basis. Its governance

arrangements and composition of Boards and management are well defined, and the Boards are

adequately staffed to promote the safety and efficiency of the central counterparty (CCP) while

supporting the stability of the financial system through a conservative approach to risk appetite. It

has developed a comprehensive and adequate risk management framework to address financial,

business, and operational risks. The participant default rules and procedures are comprehensive and

adequate. Participant assets as well as Eurex Clearing’s collaterals are safely kept in regulated central

securities depositories and deposited at central banks accounts.

While Eurex Clearing has managed well to cope with volatile markets and strengthened

international standards, it is encouraged to enhance some functionalities to further contribute

to its soundness and to financial stability. In particular, cross-managerial responsibility at the level

of heads of departments should be abolished in order to eliminate the appearance of potential

conflict of interest. Moreover, it is crucial to ensure effective business continuity arrangement by

strengthening the secondary site with appropriate arrangements in order to allow swaps of

operations between the primary and secondary sites on a business-as-usual basis.

The regulatory, supervisory, and oversight framework is comprehensive and effective. The

authorities’ objectives, policies, and roles are well defined and made public. Nevertheless, the legal

basis in the German law for the Bundesbank’s oversight function over CCPs should be strengthened.

Given the increasing systemic relevance of Eurex Clearing as a global CCP at a time where clearing

obligations enter into force, enforcement of supervisory and oversight framework can be further

improved by being more proactive and increasing the intensity of on-site inspection.

B. Methodology used for Assessment

The assessment of Eurex Clearing against the CPSS/IOSCO Principles for Financial Market

Infrastructures (PFMIs) was undertaken in the context of the IMF’s Financial Sector

Assessment Program (FSAP) Update for Germany, November 2015.

Prior to the mission, Eurex

Clearing conducted a comprehensive self-assessment following the methodology of the PFMIs

published in 2012. The assessors also benefited from discussions with BaFin, the Deutsche

Bundesbank, as well as market participants. The assessors also benefited from discussions with ESMA

The assessment was performed by Elias Kazarian of the IMF’s Monetary and Capital Markets Department, and

Marguerite Zauberman, IMF expert.

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and the European Central Bank (ECB). The mission would like to thank the German authorities, Eurex

Clearing management and staff, and other stakeholders for their cooperation and hospitality.

C. Institutional and Market Structure

Eurex Clearing is a global CCP that clears a broad range of both listed and over-the-counter

(OTC) products. It offers fully automated and straight-through post trade services to the derivatives

markets Eurex Deutschland and Eurex Zürich, the Frankfurt Stock Exchange, the multilateral trading

systems of Eurex Bonds GmbH and Eurex Repo GmbH, the Irish Stock Exchange as well as clearing

services for OTC interest rate derivatives (EurexOTC Clear), as well as clearing services for transactions

in cash equities, bonds, repos, derivatives, secure funding, securities financing and transactions. This

comprises a trade management functions, comprehensive risk management services, and collateral

management tools.

Eurex Clearing maintains accounts at multiple central securities depositories (CSD) and

International CSDs (ICSDs). It reports to the trade repository REGIS-TR in order to fulfill the

reporting requirements out of European Market Infrastructure Regulation (EMIR). Eurex Clearing

does not have any link to other CCP.

Eurex Clearing serves more than 186 clearing members, located in 17 European countries, at

end-2015.

As of end-2015, Eurex Clearing processed approximately 1.8 billion transactions with a

total value of cleared transactions of EUR 200,949 billion and an average daily value of transactions

amounting to EUR 794 billion, and held a Clearing fund of EUR 3.8 billion.

D. Main Findings

Eurex Clearing has a well-founded legal basis, and its governance arrangements and risk

management framework promote safety and efficiency, and support financial stability. Its

rules, procedures and contracts are clear and consistent with German laws and regulations. It is

managed by highly skilled professionals and its Executive Board ensures that major decisions reflect

appropriately the interests of its participants and relevant stakeholders. The Executive Board and

Supervisory Board are advised by several Committees. Eurex Clearing has a comprehensive risk

management framework. It pays considerable attention to identify, monitor, and mitigates its risks.

This framework, periodically reviewed by the Executive Board, involves its clearing members in

designing its policies and provides various incentives for members to monitor the risk they pose to

Eurex Clearing.

Eurex Clearing has established a comprehensive risk management framework for credit and

liquidity risks. This framework is based on collateral requirements and credit limits to maintain the

credit risk within acceptable parameters and maintains sufficient financial resources to cover losses

resulting from the default of the two largest clearing members. To cover its current and future

exposures, Eurex Clearing has developed multiple layers of defense, including pre-funded clearing

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fund, calibrated to cover losses resulting from the default of the two largest clearing members, and a

dedicated amount of Eurex Clearing equity.

Eurex Clearing has adequate risk management arrangements and developed comprehensive

recovery plan. It developed policies, procedures, and systems to identify, monitor, and manage its

business risks, including losses from poor execution of business strategy, negative cash flows, or

unexpected and excessively large operating expenses. Eurex Clearing holds sufficient liquid resources

to cover potential business losses and sufficient own funds for a winding down or the recovery of its

own business during a period of 6 months. Eurex Clearing has developed a comprehensive recovery

plan in line with ongoing international best practice aimed at ensuring continuation of critical

operations. The plan, which was approved by the authorities, identifies CCP’s critical activities and the

measures to be undertaken in order to ensure business continuity of these activities.

Eurex Clearing has effective and sound procedures to reduce custody risk. It has rules and

procedures that enable the segregation and portability of positions of a Clearing Members’

customers and the collateral provided to Eurex Clearing with respect to those positions, and

publishes the appropriate disclosure document. Furthermore, it assesses the robustness and sound

accounting practices, safekeeping procedures, and internal controls that fully protect these assets.

While Eurex Clearing has a robust operational risk management framework, it should

strengthen the functionality of the secondary site. Eurex Clearing’s business continuity plan is a

group-wide policy covering Deutsche Börse Group. However, the critical services for Eurex Clearing

are defined separately, which was approved by the Eurex Clearing Executive Board. Eurex Clearing

conducts annually workspace and staff unavailability tests, during business hours. It also involves

clearing members, external providers and relevant institutions with which interdependencies have

been identified in the BCM Plans in the testing process. In order to ensure the continuity of critical

functions, it should establish a fully-fledged secondary site cloning the primary site with appropriate

staffing arrangements which would allow swaps of operations between the primary and secondary

sites.

Eurex Clearing’s participation is risk based. Market participants are required to have sufficient

financial resources and operational capacity to meet their obligations and minimize the risks toward

Eurex Clearing. The admission requirements are clearly defined in the Clearing Conditions and

available on Eurex Clearing website. Furthermore, Eurex Clearing has in place rules, procedures, and

agreements to identify and monitor and manage risks arising from clearing members’ customers.

Eurex Clearing has in place adequate processes for taking into account the needs of its

participants and the markets it serves. In particular, it has set up several specialized committees

with its market participants as an integral part of its consultation process. It also defined goals and

objectives that are measurable and achievable, such as in the areas of minimum service levels, risk

management expectations, and business priorities. Moreover, it has clear and comprehensive rules

and procedures that are fully disclosed to participants to allow the assessment of their rights,

obligations, and related risks.

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Eurex Clearing is regulated and supervised by several authorities, including BaFin, the Deutsche

Bundesbank, and the Federal Agency for Financial Market Stabilization. BaFin is the regulatory

authority responsible for the supervision. Furthermore, BaFin is designated as a National Competent

Authority for the supervision of Eurex Clearing, as defined by European Market Infrastructure

Regulation (EMIR). According to the German Banking Act, the Bundesbank shall, as part of the

ongoing supervision process, conduct off-site and onsite-inspections. As a financial market

infrastructure, it is also subject to the Bundesbank’s oversight. In addition, it falls within the scope of

the Recovery and Resolution Act. The regulatory and supervisory objectives and policies are clearly

defined and publicly disclosed. Eurex Clearing has been recognized by the Swiss authorities as a

systemically important FMI to the Swiss market, and an MOU has been signed by BaFin/Bundesbank

and the SNB/Switzerland Financial Markets Regulator. In February 2016, Eurex Clearing was approved

by the U.S. Commodity Futures Trading Commission (CFTC) as a registered derivatives clearing

organization to offer proprietary OTC clearing services to clearing members domiciled in the U.S. The

German authorities and the CFTC signed an MOU for cooperation and exchange of information in

the supervision and oversight of Eurex Clearing.

Appendix Table 3. Eurex Clearing Summary Compliance with the CPMI-IOSCO Principles for

FMIs—ROSC

Principle

Comments

1. Legal basis Eurex Clearing’s legal framework supports the enforcement

of its clearing models, novation and open offer, netting

procedures, collateral arrangements, set-off, and close-out

netting. There are adequate rules for addressing the event

of a clearing member default, as well as Eurex Clearing

default. Clearing transactions when final are protected

from insolvency procedures. Eurex Clearing’s actively

identifies and mitigates risks arising from its activities

across jurisdictions.

2. Governance Eurex Clearing is managed by highly skilled professionals

and its Executive Board ensures that major decisions reflect

appropriately the interests of its participants and relevant

stakeholders. The Executive Board and Supervisory Board

are advised by several Committees. The most important

Committees are for both the Supervisory and the Executive

Board, the EMIR Risk Committee, and for the Supervisory

Board, the Audit and Risk Committee, focusing on risk

management of Eurex Clearing’s daily operation, and

overall risk appetite and compliance, respectively.

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3. Framework for the comprehensive

management of risks

Eurex Clearing has a comprehensive risk management

framework. It pays considerable attention to identify,

monitor, and mitigates its risks. This framework,

periodically reviewed by the Executive Board, involves its

clearing members in designing its policies and systems

and provides various incentives for them to monitor the

risk they pose to Eurex Clearing. A recovery plan covering

orderly wind-down is prepared, reviewed annually, and

submitted to relevant authorities. For the sake of

transparency, Eurex Clearing should prepare in addition

and publish a consolidated document of its risk

management framework.

4. Credit risk The credit risk framework is based on collateral

requirements and credit limits to maintain the credit risk

within acceptable parameters and maintains sufficient

financial resources to cover losses resulting from the

default of the two largest clearing members. To cover its

current and future exposures, Eurex Clearing has

developed multiple layers of defense, including pre-

funded clearing fund, calibrated to cover losses resulting

from the default of the two largest clearing members, and

a dedicated amount of Eurex Clearing equity.

5. Collateral Eurex Clearing has established a list of eligible collateral,

which have to meet stringent eligibility criteria, including

high credit quality, minimum market risk, high liquidity,

immediate accessibility and valuation. Furthermore, it has

comprehensive risk management procedures to reduce the

impact of procyclicality and wrong way risk, and defined

dedicated concentration risk thresholds which are

applicable to all counterparties.

6. Margin The margining framework is a multifaceted and time

critical that takes into account a variety of factors in order

to accurately calculate margins. It has the power and

operational capacity to make intraday margin calls and

payments to participants. It regularly reviews and validates

the adequacy of the overall margin methodology. For the

ongoing revision and improvement of the model, Eurex

Clearing regularly seeks the advice of its Risk Committee,

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which is composed by clearing members and authorities’

representative.

7. Liquidity risk Eurex Clearing has a robust framework to manage its

liquidity risk, which is designed to ensure that Eurex

Clearing is able to effect payment and settlement

obligations in all relevant currencies as they fall due.

Furthermore, the potential simultaneous default of the two

largest clearing members needs to be covered at all times

(liquidity Cover-2 stress test). However, it should more

frequently conduct liquidity stress tests taking into account

potential losses from price volatility or fire sale of securities

holdings.

8. Settlement finality Finality of clearing transactions is achieved in Eurex

Clearing system. It is based on the German civil code for

irrevocability and on the basis of the insolvency law for

enforceability, and supported in the Clearing conditions.

However, Eurex Clearing conditions should, for the sake of

clarity, explicitly reflect how the moment of irrevocability

and the moment of entry of a clearing transaction are

specified in German law.

9. Money settlements Eurex Clearing uses mainly central bank money for the

settlement of cash transactions. The central bank model is

used for Euros and Swiss Francs, accounting for more than

90 percent of total liquidity transactions. For other

currencies, US Dollar and British Pound, Eurex Clearing

relies on commercial payment banks. Eurex Clearing has

rigorous risk management procedures to assess and

monitor commercial settlement banks.

10. Physical deliveries Not applicable

11. Central securities depositories Not applicable

12. Exchange-of-value settlement systems Eurex Clearing is not an exchange-of-value settlement

system. However, it has mechanisms in place that ensure

the elimination of principal risk. Eurex Clearing settlement

process is supported by a delivery-versus-

payment/receipt-versus-payment (DvP/RvP) settlement

eliminating principal risk.

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13. Participant-default rules and procedures Eurex Clearing has effective and clearly defined rules and

procedures to manage a participant default. These rules

and procedures are designed to ensure that Eurex Clearing

can take timely action to contain losses and liquidity

pressures and continue to meet its obligations. The

procedures involve clearing members who are well

prepared through simulation exercise and participation in

Default Management Committee to assist Eurex Clearing in

the management of the Default. Eurex Clearing conducts

regular default simulations and fire drills.

14. Segregation and portability Eurex Clearing has rules and procedures that enable the

segregation and portability of positions of a Clearing

Members’ customers and collaterals. Customer collateral is

held separately from both clearing member’s collateral and

Eurex Clearing own assets. Eurex Clearing offers three

clearing models which provide for different levels of

segregation, either an individual client segregation model

or an omnibus segregation model.

15. General business risk Eurex Clearing has adequate risk management

arrangements. It developed policies, procedures, and

systems to identify, monitor, and manage its business risks,

including losses from poor execution of business strategy,

negative cash flows, or unexpected and excessively large

operating expenses. Eurex Clearing holds sufficient liquid

resources to cover potential business losses and sufficient

own funds for a winding down or the recovery of its own

business during a period of 6 months.

16. Custody and investment risks Eurex Clearing holds its own and its participants’ assets at

supervised and regulated entities. Furthermore, it assesses

the robustness and sound accounting practices,

safekeeping procedures, and internal controls that fully

protect these assets. Moreover, effective and sound

procedures are in place that allow prompt access to its and

participants’ assets. Eurex Clearing investment strategy is

consistent with its overall risk management strategy and

fully disclosed to its participants.

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17. Operational risk Eurex Clearing has established a robust operational risk

management framework. This framework is comprised of

appropriate systems, policies, procedures, and controls to

identify, monitor, and manage operational risks. Eurex

Clearing has set up a secondary processing site that has IT

capacity, resources, and functionalities to ensure the

continuity of critical functions but is not a fully-fledged

secondary site cloning the primary site, in particular, with

appropriate staffing arrangements which would allow

swaps of operations between the primary and secondary

sites.

18. Access and participation requirements Eurex Clearing’s participation requirements are risk based

and transparent. Eurex Clearing assesses its admission

requirements continuously, monitors compliance with its

participation requirements on an ongoing basis, and has

clearly defined and publicly disclosed procedures for

facilitating the suspension and orderly exit of a participant

that breaches, or no longer meets, the participation

requirements.

19. Tiered participation arrangements Eurex Clearing has in place rules, procedures, and

agreements to identify and monitor and manage risks

arising from clearing members’ customers. The rules allow

it to gather basic information about indirect participation

in order to identify, monitor, and manage any material

risks to its activities. An important tool to monitor the risks

in relation to undisclosed clients of clearing members is

the obligation to record transactions related to

undisclosed clients on a dedicated account. In addition,

different minimum requirements for the Clearing Fund

contribution are applicable depending on the type of

clearing membership.

20. FMI links Eurex Clearing does not have any link to other CCPs. It is

connected to designated settlement and payment systems

for the settlement of securities and cash that result from

Eurex Clearing’s activities. The risk management framework

ensures the safety and soundness of these connections.

21. Efficiency and effectiveness Eurex Clearing has in place adequate processes for taking

into account the needs of its participants and the markets

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it serves. It has defined goals and objectives that are

measurable and achievable, such as in the areas of

minimum service levels, risk management expectations,

and business priorities.

22. Communication procedures and standards Eurex Clearing uses internationally accepted

communication procedures and standards. It uses SWIFT

ISO 15022 for communication with other Financial Market

Infrastructures. For the derivatives markets, FIXML, an

internationally accepted standard, is used to communicate

with participants.

23. Disclosure of rules, key procedures, and

market data

Eurex Clearing has clear and comprehensive rules and

procedures that are fully disclosed to participants to allow

the assessment of their rights, obligations, and related

risks. In particular, Eurex Clearing publicly discloses the

prices and fees associated with the services provided for

clearing. It has reviewed its methodologies and risk

management practices against the PFMIs and the results

are published in the Disclosure Document on the Eurex

Clearing website.

24. Disclosure of market data by trade

repositories

Not applicable

Appendix Table 4. Germany: Prioritized List of Recommendations for Eurex Clearing

Principles Issue of Concern Recommended Action

Relevant

Parties

Timeframe for

Recommended

Action

Managemen

t of Risks

Enhancing transparency

of Eurex Clearing’s risk

management framework.

Potential conflict of

interest between two

heads of departments

Consolidate in an

overarching document

Eurex Clearing’s risk

management framework.

Consider eliminating cross-

managerial deputizing at

the level of heads of

departments, in particular,

between head of CCP Risk

Management and that of

Eurex Clearing 6 months

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Clearing Product Design

and Supervision

P7:

Liquidity risk

Business-as-usual

liquidity stress test are

conducted only quarterly

Consider conducting

business-as-usual stress

tests more frequently

Eurex Clearing 6 months

P8:

Settlement

Finality

Eurex Clearing conditions

do not reflect on timing

of finality, although

finality of clearing is

achieved in German law.

For sake of clarity, reflect in

the Clearing Conditions

explicitly how the moment

of irrevocability and the

moment of entry of a

clearing transaction are

specified in German law.

Eurex Clearing 3 months

P17:

Operational

Risk

Eurex Clearing business

continuity arrangement

includes a hot secondary

site to ensure effective

business continuity.

However, not all

members of the back-up

business team are

present at the secondary

site all the time; some

will work via remote

access or can be called in

if needed.

As a CCP systemically

important in multiple

jurisdictions, Eurex Clearing

should ensure the

presence of a secondary

business team on the

premises of the secondary

site to allow swaps of

operation between the

primary and secondary

sites during business-as-

usual.

Eurex Clearing 12 months

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Appendix Table 5. Authorities’ Summary Compliance with the CPMI-IOSCO Responsibilities—ROSC

Recommendation

Comments

A. Regulation, supervision, and oversight of

FMIs

The authorities have clearly defined and publicly disclosed the

criteria used to identify FMIs that should be subject to

regulation, supervision, and oversight. Full consistency with

the PFMIs is achieved by the policy-based central bank

oversight authority on the top of supervisory authority, based

on EMIR and the accompanying regulatory technical

standards, and complemented by the German Recovery and

Resolution Act concerning recovery planning.

B. Regulatory, supervisory, and oversight

powers and resources

Authorities have the powers and resources consistent with

their relevant responsibilities, including the ability to obtain

timely information and to induce change or enforce corrective

action. BaFin and the Deutsche Bundesbank have different and

complementary mandates. However, the German law does not

explicitly provide the Deutsche Bundesbank oversight power

consistent with this responsibility over CCPs nor disclose its

activities in the field. Therefore, the legal basis in the German

law for the Bundesbank’s oversight function over CCPs should

be strengthened.

C. Disclosure of policies with respect to FMIs The policies of BaFin, the Deutsche Bundesbank, and FMSA (as

resolution authority), are clearly defined. They are outlined in

the laws and legally binding policy statement concerning their

role, objectives and regulations applicable. These policies are

publicly available and disclosed on the relevant authorities’

websites.

D. Application of the principles for FMIs The PFMIs for CCPs have been adopted by the regulatory,

supervisory, and oversight authorities. BaFin implemented

these principles, as a rules-based approach through EMIR and

accompanying technical standard, and for recovery of CCPs

through the German Recovery and Resolution Act. The PFMIs

have also been adopted by the Deutsche Bundesbank, as

overseer, through the adoption by the ECB of a policy

statement for the conduct of Eurosystem oversight in relation

to all types of financial market infrastructures, among which

CCPs.

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Appendix Table 5. Authorities’ Summary Compliance with the CPMI-IOSCO Responsibilities—ROSC

Recommendation

Comments

E. Cooperation with other authorities BaFin, the Deutsche Bundesbank, and the FMSA, cooperate

with each other, both domestically and internationally. In the

European context, this is achieved through college

participation. At the international level, this cooperation is

formalized by MOUs. Although it is considered a good

practice, there is presently no staff exchange program with

other relevant authorities.

Appendix Table 6. Germany: Prioritized List of Recommendations for Authorities

Responsibility Issue of Concern Recommended Action

Relevant

Parties

Timeframe for

Recommended

Action

Resp B:

Regulatory,

Supervisory, and

Oversight

The overseer’s legal

basis for its oversight

responsibility lacks

specificity

Strengthening the legal

basis for the Bundesbank’s

oversight function over

CCPs in the national law in

order to clarify its powers

consistent with this

responsibility.

Bundesbank 12 months

Resp E:

Cooperation

with other

authorities

Enhancing

understanding of the

foreign regulatory

environment where

Eurex clearing

authorities have

cooperation

arrangements in effect

or in preparation

Establish a short-term staff

exchange program with

other jurisdictions relevant

authorities where Eurex

Clearing authorities have

cooperation arrangements

in effect or in preparation.

BaFin,

Bundesbank

Immediately

E. Authorities’ response to the CPMI-IOSCO Assessment

The German authorities BaFin, Deutsche Bundesbank, and FMSA, thank the IMF assessment team for

their valuable work and detailed study on the application of the CPMI/IOSCO Principles for Financial

Market Infrastructures regarding Eurex Clearing.

The German authorities indicate that on 1 February 2016, between the completion of this report by

the IMF assessment team and its publication, Eurex Clearing was registered with the U.S. Commodity

Futures Trading Commission (CFTC) as a Derivatives Clearing Organization (DCO). Shortly before, on

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25 January 2016, BaFin and Deutsche Bundesbank signed a Memorandum of Understanding with the

CFTC to enhance the existing supervision arrangements of cross-border clearing organisations.

As a consequence, CFTC, BaFin and Deutsche Bundesbank will cooperate even closer in order to

ensure the sound supervision of Eurex Clearing. We envisage a tightened cooperation with the CFTC

including but not limited to the exchange of information both on ad hoc basis and upon request,

periodic and ad hoc meetings and joint on-site visits.

The German authorities take note of the areas of concern where the IMF identifies room for

improvement. With regard to operational risk (Principle 17), the German authorities would like to

emphasize that Eurex Clearing has a secondary site with hot backup-arrangements in place. Even

though not all members of the business team at the secondary site are present on a permanent

basis, the members of the team can be called in on short notice or fulfil their duties via remote

access, as appropriate. The German authorities are convinced that these arrangements fully observe

the regulatory requirements on operational risk management.

With respect to Responsibility E, the enhanced cooperation with the CFTC will add to the

understanding of the foreign regulatory environment both for the German and the US authorities. In

addition, Deutsche Bundesbank and BaFin are in close contact with the Monetary Authority of

Singapore (MAS), including by meeting in person on a regular basis, with regard to CCP supervision.

In general, the German authorities cooperate closely with other CCP supervisors to strengthen and

widen their expertise in CCP-supervision (e.g. Eurex Clearing and LCH.Clearnet Ltd., a CCP supervised

by the Bank of England, recently conducted a multi CCP fire drill with the supervisory authorities

from the United Kingdom and Germany acting as sponsors).