Financial Regulation in Germany FESSUD Working Paper 55fessud.eu/wp-content/uploads/2013/04/Financial-Regulation-in-Germany... · part of a series of papers that outline the development

This project has received funding from the European Union’s Seventh Framework Programmefor research, technological development and demonstration under grant agreement no 266800

FESSUDFINANCIALISATION, ECONOMY, SOCIETY AND SUSTAINABLE DEVELOPMENT

Working Paper Series

No 55

Financial Regulation in Germany

Daniel Detzer and Hansjörg Herr

ISSN 2052-8035

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Financial Regulation in Germany

Daniel Detzer and Hansjörg Herr

Affiliations of authors:

Institute for International Political Economy, Berlin School of Economics and Law

(www.ipe-berlin.org)

Abstract: The paper is looking at the historical development of financial regulation in

Germany. It is part of a series of papers that outline the development of financial

regulation in other European countries such as France, Italy, Estonia, Slovenia, Hungary

and Spain, and culminates in a synthesis aiming to understand what has changed in the

regulatory structures of different countries because of the decisions made in the Single

European Act and had the aim to create a single market also in the sphere of financial

markets and what approaches have been taken to implement the long list of EU Directives

following the act. This study is structured according to different areas of financial

regulation and takes within each area a chronological approach detailing the main

changes in each policy area. However, in the first part (section 1), a general overview of the

German regulatory system is given and the main overarching changes are described. The

second part (sections 4 – 14) focuses on policy areas that were heavily influenced by EU

legislation. In the third part largely national regulations are analysed (section 15).

Thereafter a short look at the currently constructed banking union is taken. The last

section concludes.

Key words: Financial Regulation, Banking Regulation, Germany

Date of publication as FESSUD Working Paper: September, 2014

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Journal of Economic Literature classification: G18, G28, G38, K20

Contact details:

Daniel Detzer, [email protected]; Hansjörg Herr, [email protected]

Berlin School of Economics and Law, Badensche Str. 50 – 51, 10825 Berlin

Acknowledgments:

The research leading to these results has received funding from the European Union

Seventh Framework Programme (FP7/2007-2013) under grant agreement n° 266800.

For helpful comments we would like to thank Natalia Budyldina, Barbara Schmitz and

Tatjana Kulp. Remaining errors are, of course, ours.

Website: www.fessud.eu

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Table of ContentList of Abbreviations.................................................................................................................6

1 Introduction.......................................................................................................................8

2 A general overview about financial regulation in Germany...........................................10

3 The institutional structure of financial supervision in Germany – a short overview ofthe main developments..........................................................................................................17

4 Liberalisation of capital movements ..............................................................................23

5 Cross-border competition and permitted activities.......................................................26

6 Capital requirements......................................................................................................33

The national period...................................................................................................336.1

The introduction of Basel I .......................................................................................376.2

The introduction of Basel II ......................................................................................466.3

Reforms after the crisis and Basel III ......................................................................516.4

7 Supervision on a consolidated basis ..............................................................................66

8 Supervision of financial groups and conglomerates .....................................................70

9 Large exposures .............................................................................................................74

10 Investment services........................................................................................................82

11 Deposit guarantee ..........................................................................................................90

12 Crisis management schemes.........................................................................................98

13 Accounting ....................................................................................................................112

14 Corporate governance ..................................................................................................131

15 National regulations .....................................................................................................139

Antitrust enforcement and competition policy ...................................................13915.1

Asset restrictions ................................................................................................14115.2

Conflict of interest rules .....................................................................................14215.3

Customer suitability requirements.....................................................................14515.4

Interest rate regulations.....................................................................................14715.5

Liquidity requirements........................................................................................14715.6

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Restrictions on geographic reach.......................................................................15315.7

16 The Banking Union – a German perspective................................................................155

The current state of the Banking Union .............................................................15516.1

The debate in Germany .......................................................................................15816.2

17 Conclusions...................................................................................................................167

18 Sources .........................................................................................................................170

19 Appendix........................................................................................................................185

Liberalisation of capital movements ..................................................................18519.1

Cross-border competition and permitted activities ...........................................18619.2

Capital requirements ..........................................................................................18819.3

Supervision on a consolidated basis...................................................................19519.4

Supervision of financial groups and conglomerates..........................................19719.5

Large exposures..................................................................................................19919.6

Investment services ............................................................................................20219.7

Deposit guarantee...............................................................................................20519.8

Crisis management schemes .............................................................................20719.9

Accounting...........................................................................................................21319.10

Corporate governance.........................................................................................21719.11

National regulation .............................................................................................22019.12

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List of Abbreviations

AT1 additional tier-1 capitalBaFin Bundesanstalt für Finanzdienstleistungsaufsicht, Federal Agency for

Financial Market SupervisionBAKred Bundesaufsichtsamt für das Kreditwesen, Federal Banking Supervisory

OfficeBAV Bundesaufsichtsamt für das Versicherungs- und Bausparwesen, Federal

Supervisory Office for Insurance and Home LoansBAWe Bundesaufsichtsamt für den Wertpapierhandel Federal Securities

Supervisory OfficeBRRD Banking Recovery and Resolution DirectiveCEBS Committee of European Banking SupervisorsCET1 common equity tier-1 capitalCRD-IV Capital Requirements Directive IVCRR Capital Requirements RegulationEAD Exposure at DefaultEEC European Economic CommunityEU European UnionFSB Financial Stability BoardFMSA Bundesanstalt für Finanzmarktstabilisierung, Federal Agency for Financial

Market StabilisationFRUG Finanzmarktrichtlinie-Umsetzungsgesetz, Act Implementing the Markets in

Financial Instruments Directive and Implementing Directive of theCommission

G-SIIs global systemically important institutionsIAS International Accounting StandardsIFRS International Financial Reporting StandardsIMM Internal Model MethodIRB internal rating-based approach p.45IRB internal risk-based approach p.46IRC incremental default and migration risk chargeLCR liquidity coverage requirementLGD loss given defaultM effective maturityMAD Market Abuse DirectiveMAK Mindestanforderungen an das Kreditgeschäft, Minimum requirements for

the Credit Business of Credit InstitutionsMaRisk Mindestanforderungen an das Risikomanagement, Minimum Requirements

for Risk ManagementMiFID Markets in Financial Instruments Directive

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NFSR Net Stable Funding RatioO-SIIs other systemically important institutionsPD probability of defaultRechKredV Verordnung über die Rechnungslegung der Kreditinstitute, Pursuant to the

Order concerning the accounting of credit institutionsSM Standardised MethodSME small- and medium- sized enterprisesSoFFin Special Fund for Financial Market StabilisationSPV Special Purpose VehicleSRB Single Resolution BoardSRM Single Resolution MechanismSSM Single Supervisory MechanismT2 tier-2 capitalUS United StatesUS-GAAP United States Generally Accepted Accounting PrinciplesVaR Value at Risk

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1 Introduction

After the financial crisis in 2008 a variety of reforms of the regulatory framework for banks

and financial markets were introduced. In September 2009 the G20 meeting in Pittsburgh

decided to introduce comprehensive regulations in the sphere of financial markets. The

Basel III recommendations from 2010 included tightened equity holdings of banks and for

the first time regulatory tools aimed at liquidity holdings of banks. Substantial parts of

Basel III are or are planned to be introduced in the the European Union (EU) and other

industrial countries. The EU also is in the process of establishing a banking union with

common supervision, an EU-wide winding-up regime for over-indebted banks, and,

eventually, common or at least harmonised deposit insurance schemes. Through the CRD

IV (Capital Requirements Directive) package from 2013 the Basel III rules were initiated in

the EU quite fast. In the United States (US) the Dodd-Frank Act from 2010 introduced many

regulatory reforms. At the same time other national governments started their own

reform projects, too. Currently most of the reforms aim directly at solving those problems

that were unveiled during the Financial Crisis and the following Great Recession. However,

this reactive regulatory approach leaves the general structure of the financial system

unchanged. According to the Levy Institute, “[…] the current approach to regulation seeks

to remedy the present moment by applying to existing financial institutions and their

existing business models a series of cosmetic changes. […] Effective proposals can only

emerge from analysis of the longer-term structural changes.” (Levy Institute, 2012, p. 7).

This study contributes to identifying those long-term changes which made the financial

system so fragile that a relatively small segment in the world financial market, the

subprime mortgage market in the US, led to the deepest financial crisis since the 1930s.

The paper is looking at the historical development of financial regulation in Germany. It is

part of a series of papers that outline the development of financial regulation in other

European countries such as France, Italy, Estonia, Slovenia, Hungary and Spain, and

culminates in a synthesis aiming to understand what has changed in the regulatory

9


structures of different countries because of the decisions made in the Single European Act

which came into effect in 1987 and had the aim to create a single market also in the

sphere of financial markets and what different approaches have been taken to implement

the long list of EU Directives which followed the Act.

This study is structured according to different areas of financial regulation and takes

within each area a chronological approach detailing the main changes in each policy area.

However, in the first part (section 1), a general overview of the German regulatory system

is given and the main overarching changes are described. The second part (sections 4 –

14) focuses on policy areas that were heavily influenced by EU legislation. In the third part

largely national regulations and policy areas less heavily affected by EU legislation are

analysed (section 15). Thereafter a short look at the currently constructed banking union,

as the most recent EU reform project, is taken. Here, we try not to describe the features of

those new supervisory and regulatory structures in detail but rather to give an overview

about the main concerns, criticisms and opinions in Germany on this topic. The last

section concludes. To get an overview about the main developments in each policy area,

the reader is referred to the tables in the appendix.

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2 A general overview about financial regulation in

Germany1

In Germany, banking regulation was established relatively late during the banking crisis in

1931 when Chancellor Heinrich Brüning established it by emergency decree. In 1934 the

Law of the German Reich on Banking2 was implemented, whereby all credit institutions

were put under supervision. The Banking Act3 established in 1961, which is still the central

law governing banking today, was based on this law (Lütz 2002, pp. 116 – 33). The law

established the Federal Banking Supervisory Office4 (BAKred) as a new supervisory

authority on a federal level. It shared supervisory tasks with the Bank of the German

states5, the predecessor of the Deutsche Bundesbank, the German central bank. It was

central to the German banking regulation that it was restricted to set certain standards,

like liquidity or capital requirements, but that direct intervention into banks’ business

decisions remained limited. Limits on banking activities, portfolio composition, interest

rate regulations or branching restrictions were not important in Germany or were

abolished much earlier than in other countries (Detzer et al., 2013, pp. 115-36).

Germany has always followed the universal banking principle; hence, there are only few

restrictions on types of financial service activities banks can pursue. At the same time the

Banking Act has a very encompassing definition of banking so that many financial service

activities, which are not regarded as banking in many other countries, have been

monopolised by the banking sector. This limits the development of non-bank financial

actors to certain restricted areas (for example building and loans, insurance, securities

1 The overview in this section is an extended version of a similar overview given in Detzer (2014).

2 Reichsgesetz über das Kreditwesen

3 Gesetz über das Kreditwesen

4 Bundesaufsichtsamt für das Kreditwesen

5 Bank deutscher Länder

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industries) that are governed by special laws. Due to their restrictions on assets and

liabilities, those actors do not compete with the main business areas of banks. This

encompassing regulatory framework limited regulatory arbitrage and development of a

shadow banking system in Germany (Vitols, 1995).

While banking was regulated tightly, financial market regulation was underdeveloped.

After World War II security exchanges were organised regionally and were largely self-

regulating. While the German federal state governments6 were the formal supervisory

authority for their respective stock exchanges, they pursued a policy of non-interference in

capital markets (Lütz, 2002, pp. 79-89). The regulatory framework was characterised by a

lack of transparency and accountability, low protection of minority shareholders and no

binding rules against insider trading. Additionally, German accounting rules were geared

towards creditor protection (Detzer et al. 2013). Capital markets were dominated by a few

big private banks, which had a strong position in most of the self-regulating bodies of the

German exchanges. Their power allowed them to stabilise the regional structure by

distributing business among the different exchanges. The corresponding higher costs had

to be borne by customers in the form of higher fees and commissions (Lütz 2002, pp. 79-

89).

Until the 1990s the German financial system in spite of its character as a bank based

universal system was characterised by an extremely low level of investment banking.

Compared with the US or Great Britain capital markets were overall unimportant. Also on

the international level German banks were not important.

Prior to the 1990s the regulatory framework remained relatively stable. The stability of the

existing system was supported by the big banks and the Bundesbank. Also the other

sectors of German financial system, public banks (Sparkassen) and cooperative banks,

had no incentive to push for changes. The big banks had lucrative businesses in providing

6 Bundesländer

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long-term finance to large German corporations and were, therefore, not interested in

changing the existing framework (Lambsdorff, 1989). The other banks dominated local

markets. Also, in terms of financial innovation7 Germany was rather a laggard, copying

financial innovations created largely in the Anglo-Saxon countries. Until the mid-eighties

the German banks did not show much interest in new financial products. One of the

reasons for this could be found in the prevailing universal banking principle. In dual

banking systems investment banks try to take over some of the loan and participation

business of commercial banks by issuing new products such as securitised loans. Such a

pressure for financial innovation does not exist in universal banking systems (Franke,

1998). The Bundesbank resisted liberalisation and the introduction of many financial

innovations due to concerns about the effectiveness of monetary policy and minimum

reserve requirements and a spread of short-termism. For example, for a long time and

with the partial help of Gentlemen’s Agreements, it limited the widespread use of foreign

DM8-bonds, certificates of deposits, zero-coupon bonds, and variable interest rate loans

and resisted the introduction of new financial actors such as money market funds (Franke,

1998). The main regulatory changes during this time were due to weaknesses in the

existing regulatory framework discovered during crises occurring in single institutions,

like the default of the Bankhaus Herstatt in 1974 due to foreign exchange speculation or

the near default of the Bankhaus Schröder, Münchmeyer & Hengst due to large loan

losses (Detzer et al., 2013, pp. 115-36).

7 However, one has to distinguish here between technology-driven innovation (payment systems, ATMs, …)and modality driven innovation (derivatives, securitization, …) where the former are mostly useful, while thelatter at least when used wrongly and with wrong incentives can be harmful or benefit the financialinstitutions at the expense of other societal groups (see Shirakawa, 2011). Germany was rather laggingbehind on the latter, while one of the strengths of the German system was its ability to offer cost-efficient,safe and fast payment and security transaction services (Franke, 1998) which suggests capacities intechnological innovation.

8 Deutsche Mark

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Starting in the 1970s, but having their major impact in the 1980s and the 1990s, three

developments affected the structure of the German system of financial regulation. Within

Germany the support of the bank-based system through the big banks decreased.

Traditionally, there were strong links between the big banks and the large German

industrial companies. Financial institutions formed the core of a dense network of cross-

shareholdings among the big German corporations. Additionally, those financial

institutions were members of many supervisory boards. By acting as house banks for

those large firms and by providing long-term and stable financing to them the big banks

occupied a profitable field of business (Detzer et al., 2013, pp. 73-91). However, starting in

the 1970s the demand of big firms for external finance declined. Lower fixed investment

compared to the post-war years and high retained earnings in the non-financial corporate

sector were the main reasons. Additionally, international banks as well as the

Landesbanken, which are the head organisations of the savings banks, started to compete

for business with the big banks. Simultaneously, the big firms increased their financial

independence from the banks overall by establishing their own finance departments or in-

house banks and by increasingly using financial markets directly to acquire external

finance (Deeg, 1999, pp. 73-122). Initially the big banks, confronted with these

developments, tried to increase their business with small and medium-sized companies,

but then, starting in the mid-eighties, began pushing for the development of security

markets where they could earn fees instead of interest income. Their efforts took the form

of the initiative ‘Finanzplatz Deutschland’ (Germany as a financial centre)which was

founded in 2003, was active until 2011 and was supported by lobby organisation of the

financial system, the German Ministry of Finance and the German Bundesbank. Big

German firms and the German government both supported the development of financial

markets (Perina, 1990). Compared with the decades after World War II this was a

fundamental change. Those efforts led to major changes in German financial regulation,

particularly in securities and securities market regulation. The authorisation of new

14


financial innovations started in the 1980s. The following four Financial Market Promotion

Acts9 between 1990 and 2002 increased investor protection and criminalised insider

trading and allowed new financial actors like money market funds and later hedge funds

to evolve. It also set the regulatory framework for a market for corporate control. To sum

up, the regulatory structure was changed in such a way that it got more favourable for the

development of financial markets (Deeg, 1999, pp. 73-122).

At the same time attempts to coordinate and harmonise financial regulations at the level

of the European Economic Community (EEC) as a whole impacted the German system of

financial regulation. Starting in 1977 directives were introduced to gradually harmonise

regulatory frameworks among member states and to create a single market for financial

services. The First Banking Co-ordination Directive (77/780/EEC) set minimum licensing

requirements. After only minor changes through EEC legislation in the areas of

consolidation and accounting in the following year, a major step was taken with the

Second Banking Coordination Directive, which had to be fully implemented until 1992. It

introduced the European Passport for banks. This allowed a bank licensed in one member

state to conduct business in any of the other member states, while supervision remained

under the responsibility of the home country. This required further harmonisation in other

areas. Hence, parallel to the implementation of the European Passport capital

requirements were harmonised on the basis of Basel I. Subsequently, many directives

adopted similar measures in a range of areas such as large exposure rules, investment

services, deposit insurance, financial conglomerates and crisis management and only a

few fields in banking and financial market regulation remained purely national (Heinrich

and Hirte, 2009).

Also, the Bundesbank as one of the main factors slowing down financial innovations and

securing high standards in banking regulation lost partially its capacity and willingness to

affect this process. Many of the transactions the Bundesbank wanted to inhibit in Germany

9 Finanzmarktföderungsgesetze

15


were conducted abroad by subsidiaries and daughters of German banks and restrictions in

Germany led investors to pursue their business in financial centres like London or

Luxembourg. Certain restrictions, for example, in the issue of securities, inhibited the

invasion of foreign banks and allowed the German banks to secure themselves lucrative

business in some areas. According to Franke (1998), the Bundesbank was aware of those

problems but prioritised its target of monetary stability. Only in 1985 after an internal

paper of the Bundesbank stated that the German banks were sheltered by prevailing

regulation from the ‘draught’ of international competition a major change took place. The

paper stated that the Bundesbank was supporting monopoly rents for the banking industry

and that the prevention of financial innovations in Germany drove residents to use foreign

financial markets. Thereafter, Franke (1998) observed a shift in the policy stance of the

Bundesbank. It supported the reciprocal strengthening of foreign banks in Germany, the

abolishment of the coupon tax in 1984 and of the stock exchange tax in 1991. It was also in

favour of liberalising the issue of bonds for which government approval was necessary. All

over, the Bundesbank came to the conclusion that new financial innovations, such as

derivatives and securitisations do not to a large degree inhibit its monetary policy (Franke,

1998). Also, in the area of banking supervision the Bundesbank was rather conservative,

advocating stricter rules where it saw them fit. However, in the 1990s its influence on

legislation in this area diminished in favour of the EU and other international committees.

This way it could less often pursue its agenda aiming at rather strict regulation (Franke,

1998).

Summing up: Until the 1980s the Bundesbank as well as the German government followed

a policy of relatively strictly regulating the financial system including financial innovation

and new types of financial institutions. This changed moderately in the 1980s and gained

speed from the 1990s on. The wave of deregulations in the banking industry, more capital

market friendly regulations and the support of financial innovations as well as the aim to

make Germany an internationally important financial centre reflected a change in German

16


government policy. Especially after 1998 under the red-green coalition under Chancellor

Gerhard Schröder the deregulation of financial markets together with labour markets

became an economic and political project which was supported by the finance industry and

also the Bundesbank. The big private banks wanted to go global and take part on the high

profits earned in the booming financial markets with myriads of innovations. Also some of

the Landesbanken as central institutions of saving banks wanted to get part of the

seemingly big cake in the booming financial markets. The Bundesbank no longer resisted

the deregulation of financial markets and, as many other central banks in the world, may

have started to believe in the doctrine of efficient financial markets which became

mainstream in that time.

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3 The institutional structure of financial supervision in

Germany – a short overview of the main developmentsIn Germany until 2002 financial supervision was split among different institutions. There

were supervisory offices for each of the three main financial fields – insurance, securities

trading and banking. Since 2002 a newly founded single supervisory authority has been

overseeing all three fields. In banking supervision the Bundesbank has been involved

additionally. In 2013, the Financial Stability Committee was also established to cover

macro-prudential supervision. Besides those bodies on a federal level, there are

supervisors on the level of the German states and for special purposes. The following

section will give a short overview about the developments of the actors and the

institutional structure of financial supervision in Germany.

The supervision of the insurance sector has the longest history in Germany. Already in

1902 the Imperial Supervisory Office for Private Insurance10 was established. After a

couple of changes during the Weimar Republic and the seizing of control by the Nazis in

1939 insurance supervision broke down at the end of World War II. Only in 1951 a Federal

Supervisory Office for Insurance and Home Loans11 (BAV) was established again. In 1973

the supervision of building and loan association was transferred to the Federal

Supervisory Office for Banking, so that it was only responsible for insurance business.

A comprehensive banking supervision was only established after the banking crisis in

1931. Before this, only individual groups of institutions (such as public savings banks or

mortgage banks) or certain types of business (such as securities deposit or stock

exchanges) had been supervised. By an emergency decree in 1931 an observing banking

authority was first established. A more encompassing supervision was established in 1934

10 Kaiserliches Aufsichtsamt für Privatversicherung

11 Bundesaufsichtsamt für das Versicherungs- und Bausparwesen

18


with the Banking Act of the German Reich,12 which marked the starting point for a general

codified banking supervision. A federal supervisor for banking13 was established at the

German Reichsbank, the central bank at that time, where all concerned authorities were

represented. As an executive body a Commissioner for banking was appointed for the

implementation of the passed regulations. When the Reichsbank lost its independence14 in

1939 the supervisory tasks were transferred to a supervisory office for banking

established at the Ministry of Economic Affairs.

After the end of World War II banking supervision was decentralised in the western

occupation zones and the responsibility was transferred to the newly founded German

states. A special committee for banking supervision with a coordinating role was

established. Since the 1950s a revision of the Banking Act was discussed. The revised

Banking Act was introduced in 1962. Against the will of some of the German states it

centralised banking supervision at a federal level at the Federal Supervisory Office for

Banking15 (BAKred) (BaFin, 2014).

According to §6 of the Banking Act it was entrusted with the supervision of the banks and

had the task to counteract abuses in the banking system, which endanger the safety of the

assets entrusted to the credit institutions, interfere with the orderly conduct of banking

business, or may have substantial disadvantages for the economy as a whole. For this task

it was allowed to enact regulative standards for the conduct of banking business through

general orders. This particularly included rules regarding capital and liquidity. In addition,

the Ministry of Economic Affairs can transfer some of its regulatory rights to BAKred

(Deutsche Bundesbank, 1961). Since the beginning, the Bundesbank played an important

role in the supervision of banks. According to §7 of the Banking Act the Bundesbank and

BAKred were supposed to cooperate. This included certain participation rights of the


13 Aufsichtsamt für das Kreditwesen

14 The Reichsbank gained official independence in 1922 due to pressure of the allies.

15 Bundesaufsichtsamt für das Kreditwesen

19


Bundesbank when new laws or regulations were established, but also a role in the on-

going supervision of banks (Deutsche Bundesbank, 1961). In practice, the Bundesbank was

always highly involved in all areas of banking supervision. With its network of state central

bank branches16 and its substantial amount of collected information it took over most of

the day-to-day supervision and reporting. This included performing on-site inspections,

running the reporting system, and analysing received reports and annual accounts of the

banks (Krupp, 2001).

In the following decades the powers and rights of the BAKred were extended. This

included the extension of the types of institutions falling under its supervision as well as

the strengthening of its investigation and intervention powers (BaFin, 2014).

In practice, regulatory rules were developed in a cooperative manner. When new rules

were established in certain areas, head organisations of the banks had a right to be heard,

and there was also close cooperation between the concerned ministries, committees and

market participants in other regulatory areas. After the establishment of standards and

rules, it was often left to the market participants to ensure compliance to the rules

through their respective associations. This practice of delegating, on the one hand,

allowed the BAKred to fulfil its tasks with relatively limited financial resources and

manpower, while on the other hand, led to a relatively high distance between the BAKred

and the regulated institutions. Since the end of the 1970s, when international and

European influence on German banking regulation increased, there was a trend towards

more differentiated supervision, which the banking associations were less able to

perform. Therefore, the BAKred assumed an increasing range of supervisory tasks. At the

same time the German banking sector needed the BAKred as a representative in

international and European bodies. Therefore, the banking associations lost their

importance, while governmental supervision became more relevant (Frach, 2008).

16 Landeszentralbanken

20


Supervision of the securities sector was only established on a federal level in 1995 with the

Second Financial Market Promotion Act17. It, for the first time, assigned supervisory

powers of German securities markets to a Federal Agency – the Federal Securities

Supervisory Office18 (BAWe). Its supervisory tasks and powers were based on the

Securities Trading Act19, which was also established with the Second Financial Market

Promotion Act. It was supposed to ensure the integrity and transparency of capital

markets. This included combating and prevention of insider trading, monitoring ad-hoc

disclosure and other disclosure duties. Later on, it also became responsible for the

supervision of takeovers, market manipulations and director’s dealing. It has to be

distinguished from the supervision of stock exchanges, which is still in the responsibility of

the German states (BaFin, 2014).

At the end of the 1990s a discussion about reforming the supervisory structure started.

Supervision was regarded as weak. This was partially due to the agencies bad equipment

with financial and human resources. But the lack of cooperation between the agencies

was a main point of criticism as well. A newly founded forum for financial supervision at

the end of 2000, which was coordinated by the Bundesbank, did not improve the situation.

Due to all those problems the Bundesbank started promoting a single supervisory

authority integrating all three areas of supervision under its auspice. With the start of the

European Monetary Union in 1999 and its loss of importance in monetary policy the

Bundesbank was looking for new or extended fields of activity. After lengthy disputes

between the Bundesbank, the existing supervisory agencies, and the concerned ministries

a single supervisory authority was established in 2002– the Federal Agency for Financial

Market Supervision20 (BaFin) (Frach, 2008). It was put under legal and professional

17 Zweite Finanzmarktförderungsgesetz

18 Bundesaufsichtsamt für den Wertpapierhandel

19 Wertpapierhandelsgesetz

20 Bundesanstalt für Finanzdienstleistungsaufsicht

21


supervision of the Federal Ministry of Finance. However, regarding its decision-making

and its day-to-day supervision it was independent from political interference. The new

authority was structured according to the three former fields of supervision and included

departments for each – securities, banking and insurance supervision. Cross-departments

were supposed to ensure cooperation and coordination between the different fields.

While the Bundesbank did not succeed in incorporating supervision into its institutional

structure, it kept its important position in the supervisory process. The main argument to

involve the Bundesbank in supervision was that it enabled banking supervisors to show

some local presence through its different subsidiaries and head offices all over Germany.

Through the reform the allocation of supervisory tasks was codified and regulated in more

detail. Before, the division of tasks was arranged by an agreement between the

Bundesbank and the BAKred. While the range of tasks did not change compared to the

former agreement between the two institutions, the codification enhanced the status of

the Bundesbank as a banking supervisor and within the Bundesbank banking supervision

became a more prominent field (Frach, 2008).

During the financial crisis after 2007 additional bodies were added to the institutional

structure. In October 2008 the Federal Agency for Financial Market Stabilisation (FMSA)21

was established to organise the bail-out of banks in trouble and to restore trust in

financial markets again. It was established under the supervision of the Ministry of

Finance and is responsible for the Financial Markets Stabilisation Fund22 and for the later

established Restructuring Fund. It is also responsible for the establishment and

supervision of Bad Banks23 (Becker and Peppmeier, 2013).

21 Bundesanstalt für Finanzmarktstabilisierung

22 Finanzmarktstabilisierungsfonds

23 For more details see the section on crisis management schemes.

22


The Committee for Financial Stability24 was established at the Ministry of Finance in 2013

and assumed the responsibility for macro-prudential regulation. It is composed of three

representatives from the Bundesbank, the Federal Ministry of Finance and the BaFin,

respectively. Additionally, the Chair of the Management Committee of the FMSA

participates but does not have any voting rights. The Committee is supposed to debate the

issues related to financial stability, enhance the cooperation between the institutions

included in the Committee, discuss the handling of warnings and recommendations of the

European Systemic Risk Board and has to provide a report on the situation to the

parliament on a yearly basis. Most importantly however, it has the capacity to give

warnings and recommendations to all public bodies to ensure early action on

developments threatening financial stability. If it does so, a ‘comply-or-explain’

mechanism applies (Deutsche Bundesbank, 2013).

All over, the supervisory structure in Germany has changed from a system that depended

more on self-regulation to one that puts more emphasis on state regulation. Additionally,

Germany followed the general trend to an integrated single supervisory authority. Also,

the strong involvement of the central bank in the supervision of banks is an important

characteristic of the German supervisory system.

24 Ausschuss für Finanzstabilität

23


4 Liberalisation of capital movements

Germany introduced full convertibility of the Deutschmark for residents and foreigners in

1958. In 1961 the Law on Foreign Trade and Payments25 was enacted and introduced the

principle of freedom of capital movements. The government, in accordance with the

Bundesbank, was however allowed to enact restrictions on capital movements under

certain conditions. While capital exports stayed largely liberalised since, the freedom of

capital imports was restricted for certain periods. The international position of the

Deutschmark led to capital inflows, which put the exchange rate under upward pressure.

The authorities tried to reduce the inflows by using temporary measures to ease the

pressure. The most important instruments used were authorisation requirements for

certain financial investments by non-residents, ban of payment of interest on deposits of

foreigners, coupon tax on non-residents’ interest income of domestic bonds and a cash-

deposit requirement for borrowings abroad (see Figure 4.1).

The last quantitative restrictions were abolished in 1981, when the authorisation

requirements for the purchase of money market papers and bonds were removed. The

coupon tax, which discouraged investment of foreigners in German financial assets, was

removed in December 1984. Therefore, Germany had liberalised its capital account

relatively early (Deutsche Bundesbank, 1985a).

In 1988 the directive 88/361/EEC26, which demands full liberalisation of capital movements

between Member States of the EEC (European Economic Community), was passed and had

to be implemented in principle until 1990. For Germany, which pushed for this

liberalisation, the new rules were largely an obligation to continue not to control

international capital flows. It was already in compliance with the directive when it was

passed (Abdelal, 2007).

25 Außenwirtschaftsgesetz

26 Council Directive 88/361/EEC of 24 June 1988 for the implementation of Article 67 of the Treaty.

24


However, with the increased activity of sovereign wealth funds in the 2000s, set up by oil

exporting countries (e.g. Arab countries or Russia) and later also by large current account

surplus countries like China, and their investment in German companies, a discussion

about their impact and about possible investment restrictions was triggered. There were

different proposals how German companies could be protected. One proposal was about

an own German sovereign wealth fund to protect German companies from foreign

takeovers. This idea was, however, dismissed. Another proposal was made by the

Christian Democratic Party (SVR, 2007). The proposal was finally implemented with the

Thirteenth Act amending the Foreign Trade and Payments Act and the Foreign Trade and

Payments Regulation27. The legislation is applicable to investors from outside the EU and

EFTA who wish to acquire 25 per cent or more of the voting rights of a German company.

The Federal Ministry of Economics and Technology may decide to initiate a review of the

investment. In cases where the acquisition threatens Germany’s public policy or public

security it can be restricted. The reasons for a restriction are oriented on the EC Treaty

and the case law of the European Court of Justice. The sectors recognized by existing

rulings are telecommunications, electricity or strategic services (Bundesministerium für

Wirtschaft und Technologie, 2013).

Figure 4.1: Record of important measures for controlling international capital flows in Germany

1958December

1959May

1960June

1961September

1965March

1968

Introduction of full convertibility of the Deutsche Mark for residents and non-residents.

Removal of the ban on the payment of interest on foreign deposits with domestic bank and the authorisation requirement for non-residents’ purchases of money market paper and the taking up of foreign loans with maturities of up to five years

Ban of the payment of interest on foreign deposits with domestic banks, on the sale of domestic money market paper to non-residents and on securities transactions under repurchase agreements between residents and non-residents.

Foreign Trade and Payments Act came into force; adoption of the principle of basic freedom of foreign trade and payments; nomaterial change to the existing state of capital transactions

Introduction of coupon tax on non-residents’ interest income from domestic bonds.

27 Dreizehntes Gesetz zur Änderung des Außenwirtschaftsgesetzes und der Außenwirtschaftsverordnung,18.04.2009

25


November

1969February

December

1971May

1972March

June

July

1973January

February

June

1974February

September

1975September

1980March

November

1981March

August

1984December

2009April

Introduction of the authorisation requirement for the acceptance of foreign funds by domestic banks in so far as it does not servethe proper handling of merchandise, services and capital transactions with foreign countries.

Removal of the authorisation requirement for the acceptance of foreign funds by domestic banks.

Removal of the ban on the payment of interest on foreign deposits with domestic banks, on the sale of domestic money marketpaper to non-residents and on securities transactions under repurchase agreements between residents and non-residents.

At the beginning of the dollar crisis reintroduction of the authorisation requirement for the sale of domestic money market paperof non-residents and for the payment of interest on foreign deposits with domestic banks.

Introduction of the cash deposit requirement for borrowings abroad. Exceptions are, in particular, credits in connection with theuse of customary terms of payment and credits related to specific goods and services supplied. The cash deposit ratio is initially40% with an exemption limit of DM 2 million.

Introduction of the authorisation requirement for non-residents’ purchases of domestic bonds from residents.

Raising of the cash deposit ratio to 50% and reduction of the cash deposit exemption limit to DM 500,000.

Reduction of the cash deposit exemption limit to DM 50,000.

Extension of the authorisation requirement for the purchase of domestic securities by non-residents to equities. Introduction ofthe authorisation requirement for residents’ borrowing abroad.

Introduction of the authorisation requirement for the assignment of domestic claims to non-residents.

Raising of the cash deposit exemption limit to DM 100,000 and reductions of the cash deposit ratio to 20%. Restriction of theauthorisation requirements for the sale of domestic securities to non-residents to bonds with (remaining) maturities of up to fouryears and removal of the authorisation requirement for residents’ borrowing abroad.

Removal of the cash deposit requirement and the authorisation requirement for the assignment of domestic claims to non-residents.

Removal of the authorisation requirement for the payment of interest on non-residents’ deposits with domestic banks and furtherrelaxation of the authorisation requirement for the purchase of domestic bonds by non-residents.

Allowance of the possibility of assigning official borrowers’ notes to non-residents.Authorisations for the purchase of domestic bonds with (remaining) maturities of more than two years are normally granted.

Authorisations for the purchase of domestic bonds with (remaining) maturities of more than one year are normally granted.

The purchase of any domestic bonds and money paper by non-residents is normally approved.

Removal of the existing authorisation restrictions on the purchase of domestic bonds and money market paper by non-residents.

Act governing the abolition of coupon tax on interest received by non-residents from domestic bonds, with retroactive effect fromAugust 1984.

Thirteenth Act amending the Foreign Trade and Payments Act and the Foreign Trade and Payments Regulation allows the GermanMinstry of Economics and Technology to restrict investments from outside the EU and EFTA which acquire more than 25 per cent ina German company under certain conditions.

Source: Deutsche Bundesbank, 1985a; Bundesministerium für Wirtschaft und Technologie, 2013

26


5 Cross-border competition and permitted activities

Regarding banking activities on the EC-level there were relatively early initiatives to

realise the freedom of establishment for banks. However, differences in existing national

banking laws and depositor protection were substantial obstacles to these initiatives. A

first very encompassing proposal that came close to a European Banking Act was not

feasible, so that eventually a more gradual approach was taken. Here the first step taken

was the First Banking Directive from 197728. It defines credit institutions and lays out

minimum criteria for their licensing. Additionally, it demands the existence of independent

and adequate own funds, at least two directors with adequate responsibility and

experiences and the existence of a business plan (Heinrich and Hirte, 2009). Since the

existing banking regulation in Germany already complied with the demanded

requirements, changes on the national level were not necessary (Büschgen, 1998).

Later on in 1989 these minimum requirements were complemented by a coordination of

minimum capital requirements by banks with the Own Funds and the Solvency Directive

(see section 6). Further harmonisation of minimum requirements was achieved with the

Second Banking Directive29 in the same year. It introduced regulations regarding the

minimum initial capital, the disclosure of the identity and the size of the capital stake of

shareholders and partners and the participation of credit institutions in non-financial

firms (Heinrich and Hirte, 2009).

The harmonisation attempts of the directive made some changes in the German Banking

Act necessary, which were introduced with the Act for the Amendment of the Banking Act

and of Other Banking Regulations30, which included the fourth amendment of the Banking

28 First Council Directive 77/780/EEC of 12 December 1977 on the coordination of the laws, regulations andadministrative provisions relating to the taking up and pursuit of the business of credit institutions

29 Second Council Directive 89/646/EEC of 15 December 1989 on the coordination of laws, regulations andadministrative provisions relating to the taking up and pursuit of the business of credit institutions andamending Directive 77/780/EEC

30 Gesetz zur Änderung des Gesetzes über das Kreditwesen und anderer Vorschriften über Kreditinstitute,21.12.1992

27


Act. Until this amendment there was only a reliability control for bank’s directors.

According to the new version the owners that hold a substantial stake (10 per cent of

capital or voting rights) are also investigated. This is supposed to ensure the protection of

creditors, but also to prevent money laundering. A control takes place when an institution

applies for licensing and later when there are substantial changes in the ownership

structure of the institution. The supervisory authority can refuse the granting of the

license if the owners of substantial capital shares do not meet the requirements

necessary for a solid and prudent management of the institution. Additionally, if the

institution is part of a group and imbedded in a way that undermines an efficient

supervision, the licensing can be refused. If someone intends to acquire a substantial

stake or wants to increase an existing stake above the thresholds of 20, 33 or 50 per cent

of capital or voting rights, the authorities need to be informed, which can refuse the

purchase if the requirements are not fulfilled. For existing stakes, the authorities can

prohibit the exercising of the voting rights.

The amended Banking Act also limited the shareholdings of banks. Before, the Banking

Act had already some provisions, aiming at keeping the banks liquid, which limited the

holding of fixed investment and shareholdings to the amount of liable capital. The new

provision tightened those rules and did not allow deposit taking institutions to hold capital

shares above 15 per cent of liable capital in one single non-financial company. The total of

significant shareholdings is not allowed to exceed 60 per cent of liable capital. If an

institution exceeds those limits it has to back the exceeding amounts up with equity.

However, a relatively long transition period until 2002 was granted. Additionally, the

amended Banking Act demands an initial capital of 5 million ECU31 (about 10 million DM)

for all deposit taking credit institutions (Deutsche Bundesbank, 1993).

31 The European Currency Unit (ECU) was a basket of the currencies of the EC member states, used as theunit of account of the European Community. It was replaced by the Euro on the first of January 1999.

28


However, the most relevant part of the directive was not the further harmonisation of the

minimum requirements, but that it introduced the European Passport for banks as a

further step towards the freedom of establishment for banks and the free movement of

banking services. This meant for German credit institutions which “received” the

European passport that they were allowed to offer services and open branches in other

EC-countries without special permission. They are in principle supervised by the German

authorities (principle of home-country control). The branches do not need allotted capital

anymore and also do not need to adhere to the solvency and equity regulations of the host

country. Instead the whole institution is supervised by the home country’s authorities.

However, since some areas of regulation were not harmonised (e.g. liquidity

requirements), the banks are still subject to the rules prevailing in the host country in

those areas. For the German authorities that meant that they also had to allow foreign

credit institutions with the European Passport to open branches and offer services under

the same conditions.

German banks that want to open a branch in another EC-country simply have to declare

this to the BAKred and the Bundesbank. If they fulfil the requirements for the European

passport the BAKred will notify the host country’s authorities. The establishment of the

branch then does not need any further permission (§24a of the Banking Act). The same is

true if a credit institution from another EC-country wants to open a branch in Germany

(§53 b). With § 53 c rules for the granting of similar conditions for non-EC country credit

institutions under certain conditions were established (Deutsche Bundesbank, 1993).

The Investment Service Directive32 from 1993 aimed at creating a level playing field

between universal banks and investment firms on a European level. While universal banks

in Germany were under supervision and had to adhere to the specific rules of the Banking

Act, investment firms in Germany did not adhere to any specific regulation, but only to the

32 Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field

29


general regulations of the Trade, Commerce and Industry Regulation Act33. With the new

directive, the concepts of home-country control and of the European passport also applied

to investment firms. For this, it needed to be ensured, that also investment firms fulfilled

certain minimum regulatory requirements. Those were also included in the directive.

The directive was implemented by the Act for the Implementation of EC Directives

Regarding the Harmonization of Bank- and Security Related Regulations34. For the

implementation of the directive into German law some changes in the Banking Act were

necessary, so that now investment firms were also put under the supervision of the

BAKred. Therefore, some new definitions became necessary. The Banking Act now

distinguishes between banking business and financial services business. The concept of

the financial service institution was newly introduced. Those institutions are enterprises,

which provide financial services on a commercial basis or on a scale which requires a

commercially organised business undertaking (and are not doing banking business).

There are certain differences to which activities qualify for a financial service institution in

the Banking Act and which are regarded as an investment firm in the Investment Services

Directive. For the classifications and the differences see Figure 5.1. Overall, that means

that the definition of a credit institution according to the German Banking Act is broader

than in the EU-Legislation and includes also brokerage services, not only in securities but

in financial instruments in general. The activities of Non-EEA deposit broking35, money

transmission services, and foreign exchange bureaux qualify an enterprise already as a

financial service institution according to the banking act and go beyond the activities

covered in the investment services directive. They were mainly included to banish dubious

firms operating in the grey capital market.

33 Gewerbeordnung

34 Gesetz zur Umsetzung von EG-Richtlinien zur Harmonisierung bank- und wertpapieraufsichtrechtlicherVorschriften; 22.10.1997

35 The brokering of deposit business with enterprises domiciled outside the European Economic Area

30


The Capital Adequacy Directive from 1993 ensured that a level playing field regarding

capital requirements of financial service institutions and credit institutions was created.

Additionally, some amendments in the Banking Act made sure that financial service

institutions have sufficient initial funds. Financial service institutions, which trade in

financial instruments for their own account, and securities trading banks require ECU

730,000 of own funds; investment brokers, contract brokers and portfolio managers need

ECU 125,000 and if they are not authorised to acquire ownership or possession of

customers’ money or securities in the course of providing financial services they only need

ECU 50,000. Investment and contract brokers can instead prove that they have taken out

an appropriate insurance policy. Then they do not receive the European Passport,

however. Financial services institutions that are not investment firms are not required to

hold a minimum capital.

Already operating financial services institutions were granted a transitional period until

2003 to acquire the necessary capital.

Securities trading houses are additionally required to have a level of funds that is at least

one-quarter of their overheads in the last annual accounts. This aims the purpose of

ensuring orderly liquidation of a loss making securities house (Deutsche Bundesbank,

1998).

31


Figure 5.1: Differences between credit institutions and financial services institutions

Credit institutions as defined in the Banking ActFinancial services institutions

as defined in the Banking Act

Deposit-taking credit

institutionsSecurities trading banks

Deposit business and

lending business

Discount business

Safe custody business

Investment business

Purchasing of receivables

Guarantee business

Giro business

Prepaid card business

Network money business

Investments firms as defined in the Investment Securities

Directive

Non-EEA deposit broking

Money transmission

services

Foreign exchange bureaux

Brokerage services

Underwriting business

Investment broking

Contract broking

Portfolio management

Own-account trading

Source: Deutsche Bundesbank, 1998

With the Fourth Financial Markets Promotion Act36, among other things the E-Money

Directive37 was also implemented. While certain types of E-money business (prepaid card

business, network money business) were already addressed and put under supervision of

the banking authorities with the sixth amendment to the Banking Act in 1997, the

implementation of the E-money Directive established a new category of credit institutions

– so called E-money institutes. These E-money institutes are subject to less stringent

regulations if they confine their business to only issuing electronic payment units.38 With

the E-money directive the European Passport applied now also to E-money institutes. The

Bundesbank argues that because of the fact that foreign E-money institutes now compete

with domestic institutions the principle of full supervision had to be abandoned and the

prudential supervisory exemptions had to be granted to domestic institutions as well.

Their minimum initial capital requirement was set at 1 million euro. The own funds

36 Gesetz zur weiteren Fortentwicklung des Finanzplatzes Deutschland (ViertesFinanzmarktförderungsgesetz); 21.07.2002

37 Directive 2000/46/EC of the European Parliament and of the Council of 18 September2000 on the taking up,pursuit of and prudential supervision of the business of electronic money institutions

38 See for example the section on asset restrictions for the investment limitations

32


requirement demands that E-money institutes hold a minimum of own funds of 2 per cent

of the liabilities due to outstanding electronic money. In this case therefore the

harmonisation attempts coupled with the European passport led to less strict rules for

German institutions (Deutsche Bundesbank, 2002a).

When the Capital Requirements Regulation (CRR) and the Capital Requirements Directive

IV (CRD-IV) was introduced in 2014 the CRR directly applies to credit institutions and

investment firms. However, as the definitions are narrower in the CRR than in the German

Banking Act, not all German financial institutions and service providers would fall under

the new regulations. Since Germany sees in its relatively encompassing definitions a well

working instrument against the spread of shadow banking, the CRD-IV Implementation Act

is changed so that all institutions that fell under the regulation of the Banking Act also

need to apply to the new regulations of the CRR. However, there will be some exceptions

for a number of special institutions such as guarantee banks, housing enterprises with

saving facilities and certain financial service institutions (Deutsche Bundesbank, 2013a).

33


6 Capital requirements

Generally, in Germany §10 of the Banking Act demands banks to hold adequate own funds

and defines which balance sheet positions are eligible as own funds. It further instructs

the banking supervisory authority in accordance with the Bundesbank to enact principles

in the form of administrative orders defining what is regarded as adequate. This was done

in Principle I, which was later replaced by the Solvency Regulation. Generally, both

regulation prescribe banks to hold own funds in relation to their risk positions. First they

quantify the ratio of equity to risk-bearing positions and then describe how to calculate the

size of those positions, e.g. which positions to include and how to weight them. In the

following the development of capital regulations in Germany will be described.

The national period6.1

Capital requirements have a long tradition in Germany. The law of the German Reich on

Banking39 of 1934 already had provisions which allowed for the enactment of capital

requirements. However, there had never been any guidelines enacted. In 1951 the Bank of

the German States40 compiled a range of guidelines, including capital requirements, which

the banks had to fulfil if they wanted to use the central bank as a refinancing facility.

Despite the fact that the guidelines were not legally binding, the commercial banks at

large adhered to them.

When in 1961 the Banking Act was established it included a provision that allowed the

Federal Banking Supervisory Office to enact binding capital requirements in consultation

with the Bundesbank. This was done for the first time in 1962 with the introduction of

Principle I. Principle I required the banks to hold equity in relation to its assets, so that the

amount of assets was limited to 18 times a bank’s capital (= capital requirement of 5.5 per

cent). There was no risk weighting, but some positions could be excluded, e.g. loans to


40 Bank Deutsche Länder, the central bank before the Bundesbank

34


domestic and foreign local and federal governmental entities or some specific

collateralised loans (Deutsche Bundesbank, 1962).

Balance sheet positions eligible as regulatory capital were quite narrow and had to fulfil

three principles: they had to be fully paid up, capable of meeting current losses and

permanently available to the bank (Deutsche Bundesbank, 1988). Therefore, the following

positions could be included in the capital base: paid-in capital, open reserves, capital

contributions of dormant partners; net-profits could be added if it was decided that they

would stay within the company, net-losses had to be subtracted. A special provision

allowed cooperative banks to add to their regulatory equity their members’ uncalled

liabilities up to a maximum of 50% of the amounts of paid-up member shares and

reserves (Deutsche Bundesbank, 1962).

In a first revision of the Banking Act in 1965 formerly excluded public mortgage banks41

were then included to the regulation. Also, the regulation started using risk weights for

the first time. The formerly excluded loans collateralised with real estate, and ship

mortgages were included. However, due to their lower risk they had to be included only

with 50 per cent of their value. Also loans backed by a public guarantee now only had to be

included with half of their value (Deutsche Bundesbank, 1964).

Later in 1969 the range of banks that had to adhere to the equity requirements was

extended again. Now, credit guarantee associations and Institutions that focused on

financing of loans for partial payment, often in consumption goods42 also had to fulfil

Principle I. More important, the risk weighting was refined so that loans to other domestic

banks and to foreign banks only had a weight of 20 and of 50 per cent respectively.

Contingent claims also got a risk weight of 50 per cent. Considerations about currency and

41 Öffentlich Rechtliche Grundkreditanstalten

42 Teilzahlungskreditinstitute

35


transfer risk43 led the authorities to including foreign public entities with a weight of 100

per cent into the calculation of risk-weighted assets (Deutsche Bundesbank, 1969a).

Therefore, the supervisory capital requirements for a loan were relatively early scaled by

the type of business (e.g. loan or guarantee) and by the type of debtor (foreign or domestic

bank, public authority). Additionally, certain types of collateral could reduce the

supervisory capital requirements.

The collapse of Bankhaus Herrstatt KG in 1974 due to currency speculations unveiled a

couple of weaknesses in the German banking supervision. The most pressing issues were

addressed in the Second Amendment of the Banking Act in 1976. Among other things the

new Principle Ia was introduced. According to it banks had to calculate the difference

between liabilities and receivables in foreign currencies expressed in Deutsche Mark. The

sum of those open positions was limited to 30 per cent of the banks equity. Later in 1980 it

was amended to also include open positions in gold, silver and platinum (Bitz and Matzke,

2011). For the first time price risks were included in banking regulation.

The introduction of the Third Amendment of the Banking Act in 1985, changed the

eligibility criteria for equity slightly. The equity conception was still oriented along the

three principles introduced above. Accordingly, demands from savings banks to

acknowledge the public guarantee44 in the form of an addition to their liable capital was

rejected since the guarantee did not fulfil the principle of being fully paid in and available

for current losses. Additionally, it was argued that it would be difficult to quantify such an

addition and that it would put the savings banks at a competitive advantage. In line with

those arguments the allowance for cooperative banks to add their members’ uncalled

liabilities, when calculating their regulatory equity was reduced. Before they could add

43 E.g. the risk that conversion of a currency is restricted by a foreign country.

44 Gewährträgerhaftung

36


those uncalled liabilities up to a maximum of 50% of the amounts of paid up member

shares and the reserves. This had to be reduced within the next ten years to only 25%.

Additionally, the authorities tightened the rules for eligibility of capital provided by

dormant partners to make sure it was available for current losses and would be available

permanently. The legislator resisted to include subordinated liabilities, even though they

were acknowledged in other countries as liable capital, since those did not participate in

current losses and might be difficult to roll over when the capital market situation

deteriorates. The only concessions the legislator made to the demands of new eligible

forms of equity was jouissance right capital45, if it was ensured to participate in current

losses and did not receive pay-outs during times of bad performance (Deutsche

Bundesbank, 1985).

In October 1990 the Principles I and Ia were renewed. The main reason for this was the

exorbitant growth of off-balance sheet operations in derivative markets. Until then

Principle I did only apply to risks from book credits and equity holdings. In its amended

form the risk stemming from counterparty failures arising from business in financial

swaps, forward contracts and option rights also had to be backed with equity. Compared to

loans where the entire principle may be lost the counterparty risk from these derivative

trades is merely a cover loss. A cover loss is a bank’s risk of a counterparty defaulting and

being forced to close the now newly open position again after market conditions changed

to the disadvantage of the bank. While for ordinary loans normally the balance sheet

position is taken as a basis for the calculation of capital requirements, such a basis is not

available for derivative trades. Therefore, the calculation of credit equivalents is

necessary. In anticipation of the implementation of the EC-Solvency Directive the

authorities allowed for two different methods of calculation: the original exposure method

and the marking to market method. Both methods distinguish between interest rate

45 Genußrechtskapital; a form of capital that combines elements of equity and debt capital.

37


contracts, currency contracts and contracts that involve other price risks (share- and

index-linked contracts). Overall, Principle I was extended from being mainly concerned

with credit risk to dealing with counterparty risks in general.

Principle Ia was also extended to limit price risks from transactions which were seen as

particularly risky because they involved very little or no capital input (leverage effect).

From now on, it also limited the interest rate risk arising from interest rate forward

contracts and interest rate options as well as other price risks arising from forward

contracts and options involving other risks (mainly share- and index-linked contracts). The

total of those risks was limited to 60% of equity (Deutsche Bundesbank, 1990).

The introduction of Basel I6.2

In 1992 the Solvency Directive46 and the Own Funds Directive47 which were largely built on

the Basel I recommendations were translated into German law with the Act for the

Amendment of the Banking Act and of Other Banking Regulations48, which included the

fourth amendment of the Banking Act and a reform of Principle I.

The changes of Principle I mainly included an extension of the on- and off-balance sheet

positions and transactions that had to be backed by capital. The risk positions included:

asset items

“traditional” off balance-sheet transactions, such as guarantees, letters of credit,

lending commitments

financial swaps

forward contracts and option rights.

46 Council Directive 89/647/EEC of 18 December 1989 on a solvency ratio for credit institutions

47 Council Directive 89/299/EEC of 17 April 1989 on the own funds of credit institutions

48 Gesetz zur Änderung des Gesetzes über das Kreditwesen und anderer Vorschriften über Kreditinstitute;21.12.1992

38


Therefore, almost all asset items as well as most relevant uncompleted transactions were

included in Principle I.

Regarding asset items, the most relevant change was that held securities were then also

included and had to be backed with capital-like regular book loans. Additionally, tangible

assets (bank premises and equipment) had to be backed by capital, despite the fact that

there is no default risk in those positions. This was done to prevent an evasion in such

assets and also to cover risks that cannot be captured easily. “Traditional” off-balance

sheet items were differentiated according to their credit risk. Full-credit risk positions,

e.g. guarantees, needed to be taken at face value and then weighted according to the

counterparty risk, while other positions in lower-risk categories are only taken at 50, 20 or

0 per cent of their face value. The backing of counterparty risks from financial swaps,

forwards, options (cover loss) was in anticipation of the EC-directive already introduced in

1990. However, in addition to the interest and currency contracts demanded by the

directive, Principle I included contracts with other price risks as well (Deutsche

Bundesbank, 1993a).

Also, the risk weights for different counterparties, types of transactions and certain

collateralised loans were adapted according to the directives. Further, the minimum

capital coefficient was raised from 5.56 to 8 per cent of the risk-weighted assets (Deutsche

Bundesbank, 1993a).

The main change that was introduced with the fourth amendment of the Banking Act was a

broadening of the eligible capital base that banks could use to cover their regulatory

requirements. This can be seen as a major change in the overall direction of capital

regulation in Germany since the new rules did allow for including positions as capital that

did not conform to the three principles mentioned earlier. Already during the preparation

of the Basel guidelines of 1988 on which the EC-directive was eventually based, the

Bundesbank made clear that it was opposed to such a softening of capital requirements. It

39


could not, however, prevent a relative softening compared to the prevailing German rules.

Therefore, the fourth amendment divided own funds into core and additional capital. The 8

per cent of the risk-weighted assets now had to be backed with core and additional capital,

whereby the eligible additional capital could not be higher than the core capital. Therefore,

the minimum amount of core capital was 4% of the risk-weighted assets (Deutsche

Bundesbank, 1993). Figure 6.1 shows the composition of core capital. According to the

directive, the items included were only those available to the institution for unrestricted

and immediate use to cover risk or losses as soon as they occur. Therefore, the core

capital largely conforms to the three principles valid in Germany before the fourth

amendment.

Figure 6.2 shows the positions that can be included as additional capital since 1993.

Those elements can be regarded as of lower quality compared to core capital since they

are either not visible on the balance sheet, not directly liable or repayable. The additional

capital contains some positions which have not been acknowledged as regulatory capital

until then, e.g. contingency reserves, unrealised reserves49 and subordinated liabilities. In

particular, the recognition of the unrealised reserves was raised in parliamentary

discussions. The Bundesbank was generally opposed to allowing the acknowledgement of

unrealised reserves since it expected pro-cyclical effects. The argument was that the

growing capital base in good times allowed banks to extend more loans, while in bad times

a fall in asset values and therefore in bank equity may lead to a credit crunch. During the

parliamentary discussions lobbying by the banks with the main argument that too strict

rules would put them at an international competitive disadvantage led to a relatively soft

rule compared to the original proposal. To be able to include unrealised reserves as

additional capital, banks needed to hold at least 4.4 per cent of risk-weighted assets as

core capital. The maximum of eligible additional capital consisting of unrealised reserves

49 Unrealised reserves occur when the market value of an asset is above its value in the balance sheet.

40


was then 1.4 per cent of risk-weighted assets. Banks had to subtract 55 per cent from the

amount of unrealised reserves for possible changes in value and for possible tax charges.

Therefore, the translation of the directive into German law led to major changes in the

capital requirement regulations in Germany. Besides broadening the assets to be

included, it led to a softening of the established eligibility criteria for regulatory capital

(Deutsche Bundesbank, 1993).

Figure 6.1: Composition of core capital

1. Paid-up capitalless own sharesless cumulative preferential shares

2. Published reserves3. Approved transfers to reserves4. Assets contributed by silent partners5. Fund for general banking risks pursuant to

section 340 g of the German Commercial Code

= core capital (gross)less lossesless intangible assets

= core capital (net) – not less than 4% of risk assetsSource: Deutsche Bundesbank, 1993

Figure 6.2: Additional capital since 1993

1. Contingency reserves pursuant to section 340 f of theGerman Commercial Code

2. Cumulative preferential shares3. Unrealised reserves4. Reserves pursuant to section 6b of the German Income Tax Act5. Capital represented by participation rights (section 10 (5)

of the German Banking Act)6. Subordinated liabilities (Not more than 50 % of

the core capital)7. Commitments of members of creditInstitutions organised as cooperative societiesSource: Deutsche Bundesbank, 1993

41


In 1995 the supervisory authorities in Germany issued the Minimum Requirements for the

Trading Activities of Credit Institutions50. They replaced the already existing Minimum

Requirements with the Internal Control Rules for Foreign Exchange Transactions51 and the

Minimum Requirements for Security Trading52 and extended them so that all trading

activities were included, in particular money market and precious metal transactions and

trading in derivatives. Within those requirements, the risk management guidelines for

derivatives of the Basel Committee were also implemented. This meant among other

things that banks had to establish risk-management systems for their trading activities.

This included systems for the internal measurement of the risk of trading positions. While

in the beginning those measurement systems were largely constructed for internal use, it

was already planned that they may be used for the determination of supervisory capital

requirements for the market risks of certain positions later on (Deutsche Bundesbank,

1996).

The structure of banking regulation in Germany was further affected by the

implementation of the Capital Adequacy53 and the Financial Services54 Directives from

1993, which again were based on a recommendation of the Basel Committee. Additionally,

some elements of the Second Capital Adequacy Directive55 from 1998 were already

implemented. It was implemented by the Act on the Implementation of Directives for the

50 Mindestanforderungen an das Betreiben von Handelsgeschäften

51 Mindestanforderungen für bankinterne Kontrollmaßnahmen bei Devisengeschäften

52 Mindestanforderungen an das Wertpapiergeschäft

53 Council Directive 93/6/EEC of 15 March 1993 on the capital adequacy of investments firms and creditinstitutions


55 Directive 98/31/EC of the European Parliament and of the Council of 22 June 1998 amending CouncilDirective 93/6/EEC on the capital adequacy of investment firms and credit institutions

42


Harmonization of Bank and Security Related Regulations56. There were four main changes

relevant for capital requirement regulation in Germany. A change of eligible own funds for

regulatory purposes, the introduction of the trading book, the introduction of capital

requirements for market price risks, and the permission to banks to use internal risk

models for the determination of capital requirements for certain risks. The changes took

place via the sixth amendment of the Banking Act and the amendment of Principle I and Ia

(Deutsche Bundesbank, 1998a).

Figure 6.3: Composition of own funds (section 10 of the Banking Act)

Tier 1 capital (core capital)+ Tier 2 capital (additional capital)- Deduction positions1

= Liable capital+ Tier 3 capital²

= Own funds1 Deductions of participating interests (sections 10 and 12 of

the Banking Act); breaches of the large exposure limits(sections 13, 13a and 13b of the Banking Act).

² Tier 3 capital is only eligible to the extent that it does notexceed 2.5 times the tier 1 capital not needed to coverbanking book counterparty risks or for other purposes(e.g. as capital backing for large exposures) (unused tier1 capital)

Source: Deutsche Bundesbank, 1998a

Provisions governing own funds have changed in two ways. First, an automatic adjustment

mechanism was introduced. Until then the eligible own funds of a bank were determined

by the previous annual accounts of this bank. After the sixth amendment of the Banking

Act, banks have to determine their actual capital base constantly. Hence, if they, for

example, raise additional capital represented by participation rights, this is immediately

accounted for as additional capital without a formal recognition of the supervisory

authority. This new rule is valid for most parts of the own funds.

56 Gesetz zur Umsetzung von EG-Richtlinien zur Harmonisierung bank- und wertpapieraufsichtrechtlicherVorschriften vom 22.10.1997

43


Additionally, own funds have been extended by tier-3 capital. Net-profits of the trading

book and short-term subordinated liabilities are basically recognised as tier-3 capital

(Deutsche Bundesbank, 1998a). Figure 6.3 shows the new composition of own funds

according to the amended Banking Act.

While the Financial Service Directive (see section 5) was mainly aiming at creating a level

playing field for investment firms and banks and, therefore, adapted authorisation

procedures and prudential rules for investment firms to the rules valid for banks, the

capital adequacy requirement introduced the same capital requirements for the same

business no matter if it was done by banks or by investment firms. The business of

investment firms is largely related to securities transactions. Banks now have to put this

type of business in a so-called “trading book” while the rest of a bank’s business remains

in the so-called “banking book”. All own-account positions in financial instruments,

marketable assets and equities taken on by the institution with an intention of profiting

from price variations in the short term have to be included in the trading book. Own funds

requirements for the trading book are then equally valid for banks and investment firms.

However, there are some exemptions. If the share of an institution’s trading book business

is below 5 per cent of its entire on- and off-balance sheet business, it can be exempt and

use the banking book rules also for its trading book positions. It is then called a non-

trading book institution (Deutsche Bundesbank, 1998a).

Until 1998 banks only had to back their counterparty/credit risks with capital (Principle I).

Principle Ia did only limit the positions with market price risks as a ratio of own funds. This

was changed. Principle Ia was abandoned and market price risks had then to be backed up

by their own funds according to Principle I.

Here it is important to distinguish between trading and non-trading book institutions. Both

have to determine the counterparty risk of their trading and banking book positions as

before. Additionally, for foreign exchange and commodity positions both now have to

44


determine the market price risk. Trading book institutions additionally need to determine

the market price risk of their other trading book positions as well. For the determination

of the market risks, institutions have a choice between using a standardised method or

internal risk models. This avoids multiple calculations for internal and supervisory

purposes and so saves costs. Additionally, the Bundesbank argues that this avoids

problems of the standard methods like the misallocation of credit due to misguiding

incentives. If institutions decide to use internal models, the supervisory authority needs to

check the models before their use and can ask for higher capital charges, if they do not

fulfil all requirements.

The market price risks can be covered with tier-3 capital from non-trading book and

trading book institutions. Additionally, trading book institutions are allowed to back some

of their counterparty risks from the trading book with tier-3 capital. An overview of the

exact relationships is given in Figure 6.4.

Lastly, the newly established financial service institution now also has to adhere to

Principle I. (Deutsche Bundesbank, 1998a)

With the Fourth Financial Markets Promotion Act57, which was introduced in July 2002,

some changes were made in the Banking Act relevant for capital requirement regulation.

Principle I was changed from an administrative order58 to a statutory regulation59. This was

done since it was ambiguous whether EC-directives could be implemented with the help of

administrative orders. Additionally, the demarcation of trading and banking books was

enacted in the form of a statutory regulation for more flexibility in its adaption. The new

regulation also included commodity positions into the trading book. Until then those were

57 Gesetz zur weiteren Fortentwicklung des Finanzplatzes Deutschland (ViertesFinanzmarktförderungsgesetz); 21.07.2002

58 Verwaltungsvorschrift

59 Rechtsverordnung

45


explicitly excluded. However, this was required by the Second Capital Adequacy Directive60


Figure 6.4: Capital charges for counterparty risks and market price risks under Principle I

Non-trading book institutions Trading book institutions

Risks Counterpartyrisks

Market pricerisks

Counterparty risks Market price risks

Trading book risk positions

Capturedpositions

Banking andtrading bookrisk assets

Banking andtrading bookforeignexchange andcommoditiespositions

Bankingbook riskassets

Trading bookcounterpartyrisk positions

Interest andequitypositions

Banking andtrading bookcurrency andcommoditiespositions

Calculationmethod

Standardisedmethod

Standardisedmethod orinstitutes’internal riskmodels

Standardised method Standardised method orinstitutes’ internal risk models

Requiredbacking

Liable capitalof 8% of theweighted riskassets

Own funds tothe tune of thecapital chargesfor market pricerisks

Liable capitalof 8% of theweighted riskassets

Own funds to the tune of the capital charges formarket price risks and/or trading bookcounterparty risks

Requiredoverallcapital ratio1

At least 8% At least 8%

1 Overall capital ratio = Eligible own funds_______________________Weighted risk assets + 12.5 x capital charges for market risk positions x 100

Here, eligible own funds are available liable capital, i.e. not needed for other purposes (e.g. to cover breaches of largeexposure limits), and the eligible tier 3 capital is used. Tier 3 capital thus may only be taken into account provided it isused to support market risks. It is necessary to multiply capital charges for market risk positions by a factor of 12.5 inorder to make them comparable to risk assets.


In December 2002 the BaFin published the Minimum requirements for the Credit Business

of Credit Institutions61 (MaK). It substantiated the general requirement of a proper

business organisation, of adequate internal control mechanisms, and adequate rules for

the management, the supervision, and the control of risks. Institutions were, among other

60 Directive 98/31/EC of the European Parliament and of the Council of 22 June 1998 amending CouncilDirective 93/6/EEC on the capital adequacy of investment firms and credit institutions

61 Mindestanforderungen an das Kreditgeschäft

46


things, required to establish a proper risk classification system. Despite the fact that the

MaKs did not ask for Basel II compliant internal rating systems, it was sensible for banks

that later wanted to use the internal rating-based approach of Basel II to already fulfil the

more specific and demanding requirements of Basel II (Gövert, Pfingsten and Sträter,

2004).

The introduction of Basel II6.3

On an international level work on Basel II was already ongoing for a while. In 1999 the first

and in 2001 the second consultation papers were published by the Basel Committee. After

a couple of additional papers and quantitative impact studies the final version of Basel II

was published in June 2004. The EU Commission translated the contents of Basel II into

the directives 2006/48/EC62 and 2006/49/EC63. Those had to be implemented until 2007 and

2008. In Germany this was done by the Act Implementing the Revised Banking Directive

and the Revised Capital Adequacy Directive,64 which changed the Banking Act. Additionally,

the Large Loans Regulation65 and the Minimum Requirements for Risk Management66

were changed, and the Solvency Regulation67 was introduced, which replaced Principle I.

In the Banking Act, the main change regarding capital requirements was the introduction

of the so-called modified available capital. Modified available capital is the new key

indicator for solvency regulation and therefore for the calculation of capital adequacy.

62 Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking-up and pursuit of the business of credit institutions

63 Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 on the capitaladequacy of investment firms and credit institutions

64 Gesetz zur Umsetzung der neu gefassten Bankenrichtlinie und der neu gefasstenKapitaladäquanzrichtlinie; 22.11.2006

65 Großkredit- und Millionenkreditverordnung

66 Mindestanforderungen an das Risikomanagement

67 Solvabilitätsverordnung

47


Compared to the liable capital consisting of core and additional capital the modified

available capital has some additional add-ons and deductions displayed in Figure 6.5.

Figure 6.5: How to calculate modified available capital

Liable capital pursuant to section 10 (2) sentence 2 of the German Banking Act

- Items pursuant to section 10 (6a) of the Banking Act, taking due account of thededuction of at least 50% from core (tier 1) capital

Shortfalls for value adjustments and expected loss amounts forIRB exposures pursuant to section 10 (6a) no. 1 and 2 of the Banking Act

Securitisation exposures to which a 1,250% risk weight is appliedand which the institution does not recognise when calculating risk-weighted exposure values

Free delivery exposures for which the payment has not yet been effectivelyrendered five days past due

- Qualified participating interests pursuant to section 12 (1) sentence 4 of the Banking Acttaking due account of the deduction of at least 50% from core (tier 1) capital

- Large exposure excess amounts in the banking book pursuant to section 13 and section 13aof the Banking Act and capital charges for loans to management pursuant tosection 15 of the Banking Act, taking due account of the deduction of atleast 50% from core (tier 1) capital

- Large exposure excess amounts from borrower-related trading book andoverall business positions pursuant to section 13 (4) and (5) of the Banking Actwhich are backed by liable capital

+ the eligible value adjustment excess for IRB exposures in additional (tier 2) capital pursuantto section 10 (2b) sentence 1 No 9 of the Banking Act

= Modified available capital pursuant to section 10 (1d) sentence 2 of the Banking ActSource: Deutsche Bundesbank, 2006

Principle I, which until now was the main reference substantiating the required adequacy

of capital of the Banking Act, was replaced by the new Solvency Regulation. Banks had to

apply it starting in January 2007. However, they also had the option to apply Principle I for

one more year. The main changes introduced were capital requirements for operational

risks and new calculation methods for credit risks.

Until the introduction of the Solvency Regulation only market and credit risk were

explicitly covered. Other risks were considered covered by the 8% solvency coefficient,

48


implicitly. Of particular importance among those other risks was operational risk,68 which

according to the new solvency regulation has to be explicitly determined and covered by

capital. Banks can use three different methods for the calculation of operational risk:

Basic Indicator Approach Standardised Approach Advanced Measurement Approaches

Basis for the calculation is the three-year average of the so-called relevant indicator,

which consists of certain position of the profit and losses accounts (net interest and net

commissions received, trading result and other operating income). The basic indicator

approach multiplies the ‘relevant indicators’ across the board with 15 per cent, while in

the standardised approach the relevant indicators are divided into 8 areas of business,

which have weights between 12 and 18 per cent. The BaFin can allow an institution to use

advanced measurement approaches. It is then allowed to use own risk calculation models,

if they conform to certain requirements.

The standard approach for the calculation of credit risk was replaced with two options.

Institutions can use a standardised approach and an internal rating-based approach (IRB).

The standard approach is based on external ratings of rating agencies. Only ratings of

agencies that are recognised by the supervisory authorities can be used. Different risk

weights (see Figure 6.6) are applied and depend on the external rating of the debtor. For

unrated positions and for certain types of loans (e.g. mortgage and retail business) risk

weights are applied throughout without considering external ratings. With the new

regulation the risk weight for retail business was reduced to 75 per cent (100 per cent in

Principle I). This also applied to loans to small- and medium-sized enterprises below 1

million euros. Also the risk weight for claims secured by residential real estate property

68 Losses caused due to inadequateness or failure of internal processes, of human and systems or externalfactors.

49


was reduced from 50 per cent to 35 per cent. The EU directive had a choice between two

options in regards to the risk weight of banks. Either the risk weight of banks was

determined by the external rating of that institution or the rating was derived from the

rating of the country of domicile. The bank was usually rated one rating class worse than

the country of domicile’s rating. Germany used the second option (Deutsche Bundesbank,

2006).

Figure 6.6: Credit assessments and risk weights in the standardised approach*

Ratings

Risk weight in %

SovereignsBanks Option 1(derived rating)

Banks Option 2(own rating) Non-banks ABS1

AAA to AA- 0 20 20 20 20

A+ to A- 20 5050

50 50

BBB+ to BBB- 50

100100

100

BB+ to BB-100 100

150

B+ to B-150

1,250

Below B- 150 150 150 1,250

unrated 100 100 50 100 1,250

* The notations follow the methodology used by one institution, Standards & Poor’s. The Ratings of other external creditassessment agencies could equally be used.1 Asset-backed securities.

Source: Deutsche Bundesbank, 2001, p. 20

As an alternative to the standard approach banks can use internal ratings. This is the so-

called internal risk-based approach (IRB-approach). To calculate the actual risk from an

exposure, different risk components have to be considered. First, the probability of default

(PD), which is estimated for each different type of claim and debtor, has to be determined.

If a borrower defaults on his loan, the actual loss is defined by different additional

components. If there are, for example, sufficient guarantees and collaterals, a default

does not automatically mean that the whole principal is lost. Therefore, the expected loss

at the time of a default has to be calculated. This figure is called loss given default (LGD).

50


This variable is usually expressed as a fraction of the expected exposure to the borrower

at the time of default (Exposure at Default, EAD). Furthermore, the residual maturity of a

loan called effective maturity (M) plays a role as a risk component in the IRB approach


Banks have a choice between using a simple IRB approach and an advanced approach. For

the simple approach they only need to estimate the probability of default of the rating

classes themselves, while for the other components standard values provided by the

supervisor are used. In the advanced approach all components are determined by banks’

internal models (Deutsche Bundesbank, 2006).

For the calculation of credit equivalent amounts of risk exposures in derivatives, the range

of calculation approaches was extended. In addition to the original exposure method and

the mark-to-market methods introduced in 1990 the Standardised Method and the

Internal Model Method can be applied. In the Internal Model Method credit equivalent

amounts are calculated using an internal risk model that assesses the dispersion of future

positive market values of derivatives based on modelled market price movements. This

approach can also be used for the calculation of the assessment base for counterparty

credit risk arising from non-derivative transactions with collateral margin calls as well as

risks arising from other repurchase transactions and securities or commodities lending or

borrowing transactions. Those would have otherwise been counted as on- or off-balance

sheet transactions. The Standardised Method is a standardised version of the Internal

Model Method and is easier to implement. An institution is only allowed to use the Internal

Model Method after the approval by the supervisory authorities.

In the new approaches the range of recognised risk-reducing collateral is extended

compared to those in Principle I. In the standard approach most financial collateral can be

used (and mortgages are already recognised as an own category). Institutions that use an

IRB-approach can also reduce their calculated risk with collateral in the form of

51


assignments of claims or physical assets. Institutions using the advanced approach can

use all types of collateral as long as they are able to determine reliable estimates of the

asset values.

While the treatment of securitisation transactions was not clearly regulated and was

subject to individual agreements with the supervisory authorities, the new solvency

regulation took over the encompassing regulation regarding capital requirements of

securitised positions from the directives (Deutsche Bundesbank, 2006).

The capital requirements for market risks remained largely unaffected by Basel II and the

capital requirements directive. Only a new standard approach was introduced, which

regulated capital requirements for positions not properly taken account for in the existing

approach (e.g. financial transactions which refer to weather variables, CO2-Emissions, or

macroeconomic variables). The new method is based on historical simulations (Deutsche

Bundesbank, 2006).

Reforms after the crisis and Basel III6.4

In April 2008 a consultation paper already proposed amendments to the directives

2006/48/EC and 2006/49/EC. It aimed at correcting some problems that came up after one

year of practical implementation of the new rules in 2007. Therefore, the amendment of

the rules was not originally a consequence of the financial crisis. However, during the

drafting process first insights from the crisis influenced the contents of the final version of

the Directive 2009/111/EC,69 which became known as CRD II. It was implemented in

Germany by the Act Implementing the Amended Banking Directive and the Amended

Capital Adequacy Directive70 from 2010 and the Regulation Further Implementing the

69 Directive 2009/111/EC of the European Parliament and of the Council of 16 September 2009 amendingDirectives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certainown funds items, large exposures, supervisory arrangements, and crisis management

70 Gesetz zur Umsetzung der geänderten Bankenrichtlinie und der geänderten Kapitaladäquanz-richtlinie;24.11.2010

52


Amended Banking Directive and the Amended Capital Adequacy Directive from the same

year71. Besides the securitisation and large exposure rules, the capital requirements were

also affected. While in Germany rules on the characteristics of hybrid capital, such as

capital contributions of silent partners and jouissance right capital, to be eligible as a

regulatory equity have been in existence for some time, on the EU level only with the CRD

II such definite rules were established. Accordingly, the German rules needed to be

adapted. The German rules were based on the capital instrument’s form. The EU rules

instead follow a principle-based approach which focuses on the qualitative characteristics

of the respective instrument. Differences in the actual quality in terms of permanence and

loss-bearing capacity are reflected in different upper limits for the acknowledgement of

the respective capital form (BaFin, 2011). Altogether, total hybrid capital of the highest

quality can make up a maximum of 50 per cent of core capital. Hybrid capital with a fixed

repayment date or with an incentive for repayment can make up a maximum of 15 per cent

of core capital, hybrid capital without fixed repayment date but a simple right of

termination up to 35 per cent and hybrid capital that can be converted into equity at the

bank’s demand up to 50 per cent. For already issued hybrid forms of capital, which have

been acknowledged under the old rules, a transition period applies. They will be fully

acknowledged until 2020. Only then will they be phased out gradually until 2040. Besides

this there were some technical changes regarding the allowance of life insurance policies

as collateral and regarding the determination of risk weights of investment fund share in

the IRBA approach (Deutsche Bundesbank, 2009).

As a further reaction to weaknesses uncovered during the financial crisis the 2010/76/EU72

known as CRD III was passed. It included further reforms regarding equity requirements

and remuneration policies. In the area of capital requirements the most relevant change

71 Verordnung zur weiteren Umsetzung der geänderten Bankenrichtlinie und der geändertenKapitaladäquanzrichtlinie; 05.10.2010

72 Directive 2010/76/EU of the European Parliament and of the Council of 24 November 2010 amendingDirectives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for re-securitisations, and the supervisory review of remuneration policies Text with EEA relevance

53


occurred in the area of market risk models where the crisis unveiled enormous

weaknesses73. Additionally, there were changes for re-securitised assets and some new

disclosure requirements. The changes were implemented with the Second Regulation

Further Implementing the Amended Banking Directive and the Amended Capital Adequacy

Directive74. Most affected by changes regarding the trading book will be a small number of

mainly big banks, which use own risk models for the determination of risk and capital

requirements of the trading book, or which allocated a huge amount of securitised assets

to the trading book.

With the new rules institutions that use their own risk models have to hold additional

capital to cover a stressed Value at Risk (VaR) (Deutsche Bundesbank, 2011a). The

stressed value at risk is calculated for a crisis scenario based on a one-year crisis period

of significant losses. It is assumed to reduce the observed pro-cyclicality of market risk

measures (European Banking Authority, 2012). Additionally, the new rules introduce an

incremental default and migration risk charge (IRC). This is relevant for institutions that

use their own risk models to determine capital requirements for the specific interest risk

of trading book assets. During the crisis banks accumulated losses that were not covered

by the calculated 99%-10 days VaR. Those were largely related to credit migrations75

combined with widening of credit spreads and a loss of liquidity. The new IRC is supposed

to cover both migration and default risk (European Banking Authority, 2012a).

Due to the crisis it was doubted whether institutes’ risk models were able to adequately

asses the risk of securitised assets. For this reason according to the CRD III and the

implementation law the specific risk of those positions in the trading book has to be

calculated according to a standard method similar to the one already in use for positions

73 For further discussion of capital requirements and the problems related to the use of internal risk modelssee Detzer (2014).

74 Zweite Verordnung zur weiteren Umsetzung der geänderten Bankenrichtlinie und der geändertenKapitaladäquanzrichtlinie; 26.10.2011

75 Migration means the up- or down-grading of a counterparty’s creditworthiness.

54


of the banking book. According to this method, they have to hold capital for the sum of the

short and long positions. An exception applies for certain standardised securitised

positions, which are based on liquid underlyings (so-called correlation trading portfolios,

CTP). For CTPs a modified standard method applies, which allows them to only hold

capital based on the maximum of the sum of the short and the sum of the long positions. If

institutions meet certain strict minimum requirements, they are allowed to use their own

models (so-called comprehensive risk measure, CRM). For institutions that do not use

their own risk models for the trading book positions the new rules only change in regard

to share holdings in the trading book. For those a uniform eight per cent capital charge

applies instead of the former 4 per cent and the 2 per cent for highly liquid stocks with low

credit risk. Additionally, for re-securitised assets increased risk weights apply in the

standard as well as in the internal rating-based approach.

Additionally, a range of new disclosure requirements applies. The necessary information

disclosed about market risk was extended regarding the results and calculation methods

of the newly introduced IRC, stressed VaR and CRM. For securitised assets there has to be

additional information provided on securitised assets in the trading book, sponsored SPV,

internal rating approaches, liquidity facilities, re-securitisations and assets that shall be

securitised (Deutsche Bundesbank, 2011a).

The most important changes in the capital requirements, however, came with Basel III. On

the EU-level the contents of Basel III were implemented by the CRD IV76 and the CRR77 that

were published in June 2013 and started taking effect at the beginning of 2014. A novelty in

the legislative approach was that a large part of the new regulations was passed in the

76 Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to theactivity of credit institutions and the prudential supervision of credit institutions and investment firms,amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC Text with EEArelevance

77 Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudentialrequirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012

55


form of an EU-Regulation, which has direct legal effects. Before that most of the time

directives were used that had to be implemented by national legislative measures. This

new approach aims at an even stronger harmonisation of banking supervision in the EU

and the achievement of a level playing field in a narrower sense. Therefore, for the whole

package the term ‘single rule book’ was adopted. While the previous directives have aimed

at establishing minimum standards, the new approach also tries to prevent the

establishment of individual national higher levels of regulation, so-called ‘gold plating’

(Luz et al., 2013).

While the CRR did not have to be implemented, there were still steps necessary to

implement the CRD IV. Also, conflicting superfluous national rules needed to be removed

or adapted. In Germany the necessary adaptions and implementation measures were

largely taken by the CRD IV – Implementation Act78 and a range of changes in the relevant

ordinances.

Large parts of the former national regulations regarding capital adequacy were

transferred into the CRR. One of the most relevant changes was the improved quality of

regulatory equity. This reverses the trend of gradual softening of the eligibility criteria for

capital that was started in Germany with Basel I.79 The new rules put a focus on capital’s

actual risk absorption capacity. This is a reaction to the widely observable phenomenon

that many equity instruments volatilised when the crisis broke out (Luz et al., 2013). Under

the new regulation there will be only 3 forms of capital: common equity tier-1 capital

(CET1), additional tier-1 capital (AT1) and tier-2 capital (T2). Tier-3 capital, which was

eligible for covering market risks, was abandoned completely. CET1 capital is composed

of paid-in capital and disclosed reserves, which both have to be available for unrestricted

and immediate use to cover risk and losses. Also, a principle-based approach of

78 Gesetz zur Umsetzung der Richtlinie 2013/36/EU über den Zugang zur Tätigkeit von Kreditinstituten unddie Beaufsichtigung von Kreditinstituten und Wertpapierfirmen und zur Anpassung des Aufsichtsrechts andie Verordnung (EU) Nr. 575/2013 über Aufsichtsanforderungen an Kreditinstitute und Wertpapierfirmen(CRD IV-Umsetzungsgesetz); 28.08.2013

79 See for an overview of those trends (Detzer, 2014).

56


‘substance over form’ is followed here. This is meant to do justice to the heterogeneity of

the European banking market and indicated that any instrument, which meets 13

conditions laid down in the CRR, and which display the characteristics of the common

equity of a public limited company and is contained in the catalogue compiled in the CRR,

can be counted as tier-1 capital. For cooperative and savings banks in Article 29 of the

CRR some exceptions are contained, which take into account their legal restrictions. AT1

capital needs to be continuously available for loss absorption purposes and thereby

enables the bank to continue its business on a going concern basis. Some of the defining

criteria of additional capital are such that they need to be subordinated and perpetual; the

distribution has to be discretionary and there are no incentives to redeem the instruments

permitted. Also, it has to be possible to convert them into CET1 capital or to depreciate

them in case the CET1-capital ratio falls below 5.125 per cent. The significance of T2

capital has been reduced and its remaining function is credit protection in case of

bankruptcy. T2 capital instruments need to have, at the minimum, a maturity of 5 years

and need to be subordinated with respect to repayment in case of bankruptcy. Incentives

to redeem are prohibited and repayment is only possible with the consent of the

supervisors. The only exception is the redemption of maturing T2 capital. At the same time

the rules for deductions were amended and now ensure that a deduction is taken from the

instrument which was originally increased by it. An overview of the new deduction rules

compared to the old ones is given in Figure 6.6. Additionally, the minority interests in

subsidiaries may no longer be recognised as capital at the group level. Also, capital issued

by special purpose vehicles can only be recognised as AT1 or as T2 capital (Deutsche

Bundesbank, 2013a).

In addition to the increased focus on the quality of capital, the total quantity of capital that

banks need to hold was also increased. An overview of the changes is given in Figure 6.7.

The ratio of CET1 capital will increase from 2 per cent to 4.5 per cent of risk-weighted

57


assets. In addition, a bank will have to hold 1.5 per cent of AT1 capital. T2 capital will be of

less importance. It will only be able to contribute 2 per cent (before 4 per cent) to the total

capital requirement of 8 per cent. The new rules will not be applicable immediately but

phased in gradually, while the eligibility of old capital instruments will be phased out over

time. Capital instruments issued before 2012 will be grandfathered. The total volume of

old instruments existing at the 31st of December 2012 will be gradually phased out until

the end of 2021. Also, the deductions as displayed in Figure 6.6 will be phased in until

2018. Capital support of government to certain institutions will be completely eligible until

the end of 2017. (for an overview see Figure 6.9 at the end of this section)

Figure 6.6: Deductions from capital – Banking Act and CRR compared

Position Treatment under German Banking Act Treatment under the CRR

Intangible assetsDeducted from tier 1 capital

Deducted from common equity tier 1capital

GoodwillDeducted from tier 1 capital (IFRSbanks), capitalised aggregationdifference (banks applying the GermanCommercial Code)


Non-consolidated holdings inthe financial sector

Deducted in equal parts from tier oneand tier 2 capital if certain thresholdsare exceeded

Deducted from the same capital classin which the investment was made ifcertain thresholds are exceeded*

Deferred tax assetsNo deduction/no limit

Generally deducted in full fromcommon equity tier 1 capital*

Losses in the current financialyear

Option of imposing an adjustment itemon liable capital


Value adjustment shortfalls(IRBA) banks

Deducted in equal parts from tier 1 andtier 2 capital


Surpluses from defined benefitpension plans No deduction


*Significant investments in the form of components of common equity tier 1 capital and certain deferred tax assetscaused by valuation differences between the balance sheet prepared in accordance with the German CommercialCode and the tax accounts can be exempted from deduction up to 10% of common equity tier 1 capital for each itemyet cumulatively only up to 15% of common equity tier 1 capital. A risk weight of 250% is applied to the non-deducteditems.Source: Deutsche Bundesbank, 2013a

58


In addition, the CRR introduces some changes for the coverage of counterparty credit risk

in derivative trades. The crisis revealed that many of the incurred losses were not caused

by the default of the counterparty, but by mark-to-market losses due to the loss of credit-

worthiness by the counterparty. Therefore, a new capital requirement was introduced and

a so-called credit value adjustment applied to all derivative transactions that are not

settled via central counterparties. The CRR defines, however, a range of exceptions, for

example for non-financial counterparties, certain intragroup transactions and derivative

business with pension funds, central banks, sovereigns and certain public bodies. In

addition, the CRR introduces a small capital charge for centrally cleared derivatives

through central counterparties (Deutsche Bundesbank, 2013a).

Figure 6.7: Definition of regulatory capital according to the CRR


Components of capital which qualify as regulatory capital

Common equitytier 1 capital

Tier 2 capital

Additional tier 1capital

“Subscribed” capital andreserves

Hybrid tier 1 capital***

Innovative hybrid T1

1st class tier 2 capital

2nd class tier 2 capital

Tier 3 capital

≤15% ofT1

≤50% ofT1

≥50% ofT1

≥100%of T1

Tie

r1

cap

ital

(T1

)T

ier

2ca

pit

al

Loss absorptionon going-

concern basis

Loss absorptionon gone-

concern basis

Present* Future**At least 8% of total exposure

amount

* See section 10 (2) to (2d) of the Banking Act. ** See Articles 50, 61 and 71 of the Capital RequirementsRegulation (CRR). *** Common equity tier 1 capital components which combine equity and debtcharacteristics

59


As a lesson from the crisis macroprudential oversight has become more important and

institutions have been established to take over supervision in this area. In addition, there

are tools needed to address macroprudential risks. Therefore, the so-called ‘flexibility

package’ was introduced. On the national level member states are able to impose stricter

regulatory measures in the area of own funds, large exposures, disclosure, etc. to address

systemic risks. If a member state wants to impose such measures, it has to inform the

European Parliament, the European Commission, the Council, the ESRB, and the EBA and

submit a justification for the measure (Deutsche Bundesbank, 2013a). The Commission

can propose to prohibit a national measure under certain conditions, in particular if it

identifies a potential distortion of the internal market (European Commission, 2013). It

then can be rejected by the Council by a qualified majority vote. However, there are

measures that can always be applied by the member states: an increase in the risk

weights for residential and commercial real estate loans and for intra-financial sector

exposure by up to 25 percentage points or a reduction of the large exposure limit by 15

percentage points. Besides those measures the flexibility package allows for a systemic

capital risk buffer which will be discussed below. If a systemic risk is EU-wide, the

European Commission can impose stricter prudential regulations in the area of own

funds, large exposures and disclosure for up to one year (Deutsche Bundesbank, 2013a).

To attenuate negative effects on credit availability or credit cost for small- and medium-

sized enterprises (SME) a so-called ‘SME-factor’ was introduced. Capital requirement for

exposures to SMEs will be multiplied by a factor of 0.7619 (Luz et al., 2013). This factor

neutralises the higher requirements of the capital conservation buffer of 2.5 per cent for

SMEs (see below). It can be applied to SMEs which have an annual turnover below 50

million euro and where an institution’s total exposure to the SME is below 1.5 million euro


The CRR imposed a stricter definition of capital and increased the overall amount of hard

core capital to be held within the 8 per cent capital requirement. Additionally, with the CRD

60


IV a range of capital buffers to increase overall capital requirements and address pro-

cyclicality and systemic risk were introduced. All the buffers have to be held as CET1

capital. An overview is given in Figure 6.8.

Figure 6.8: Capital buffers in the CRD IV and the CRR


Capital buffers in Capital Requirements Directive IV

Combined buffer requirement

Capital con-servation

buffer(Art. 129)

Counter-cyclicalcapital

buffer (Art.130 and 135

to 140)

Systemicrisk buffer(Art. 133and 134)

Systemically important institution buffers

Othersystemically

importantinstitutions (O-

SIIs)

Globalsystemically

importantinstitutions (G-

SIIs)

2.5%¹² 1% to 3,5%¹min. of 1%⁴0% to 2,5%¹³ max. 2%¹

Where an institution is subject to more than one of these buffers, onlythe highest of these buffers shall be applied. However, if the systemic

risk buffer is only applied to risk exposures located in the member statethat sets the buffer, this requirement shall be additive to any capital

buffer that may be applicable to G-SIIs or O-SIIs. ⁵

¹ As a percentage of the total exposure amount. ² National authorities can increase this rate to Art 458 CRR asappropriate. ³ May be higher; cross-border reciprocity is generally mandatory up to a buffer rate of 2.5%. ⁴ As apercentage of the risk-weighted exposure values of those risk exposures in respect of which the systemic risk buffer isimposed. The procedures for imposing the buffer vary depending on the amount and location of the risk exposures towhich the buffer is applicable. ⁵ If an O-SII is the subsidiary either of a G-SII or an O-SII domiciled abroad this issubject to an O-SII capital buffer on a consolidated basis, the capital buffer for O-SIIs may not exceed 1% on aconsolidated basis for these subsidiaries.Deutsche Bundesbank

61


A so-called ‘capital conservation buffer’ is introduced. It is set at 2.5 per cent of risk-

weighted assets. It is added to the 4.5 per cent CET1 capital requirement according to the

CRR. That means a bank actually needs to hold 7 per cent of CET1 capital. However, it is

allowed to fall below these 7 per cent. In this case some conservation measures kick in,

which aim at restoring capital again.

Additionally, a countercyclical buffer is introduced. It tries to counteract the effects of the

economic cycle on banks’ lending. It is calculated on an institute-specific base and

depends on the institute’s weighted average of risk exposures in different jurisdictions.

Each member state determines the countercyclical buffer for its jurisdiction based on

different measures, for example, credit growth, and fixes it between 0 and 2.5 per cent. In

special cases the buffer can be even higher. For Germany the BaFin fixes the level and is

supposed to consider the deviation of the credit to GDP ratio from its long-term trend.

Additionally, it has to consider the recommendations of the Financial Stability Committee

(see Banking Act from 2014 §10d). Domestic institutions have to apply the buffer rate

determined by the BaFin to their domestic exposure and buffer rates for foreign exposures

as determined by the foreign authorities. Within the EU the buffer rates between 0 and 2.5

per cent set by other member states have to be applied mandatorily by domestic

institutions. If the buffer rate set by another member state is above 2.5 per cent, the BaFin

can acknowledge the higher rate. For third countries the same applies. If a third country

has not set a rate, the BaFin can determine one that has to be applied by institutions under

its supervision. For a third country the BaFin can also apply a higher rate than the one set

by the respective country if it considers it appropriate to shield domestic institutions

(Deutsche Bundesbank, 2013a). The buffer can be abandoned when the economic cycle

turns and by this “releases” capital, so that banks do not need to stop lending due to

equity constraints in the downturn (European Commission, 2013). The capital conservation

62


buffer and the countercyclical buffer are phased in starting in 2016 in four steps (see

Figure 6.9) and will both be fully applicable in 2019 (Deutsche Bundesbank, 2013a).

As mentioned above, there will also be a ‘systemic risk buffer’. It is supposed to give

member states a tool to address, at the national level, long-term, non-cyclical systemic or

macro-prudential risks, which have the potential to adversely affect the financial and

economic system of a member state. The buffer should not have disproportionally big

effects on the financial system of other member states or the EU as a whole and should

not create obstacles to the internal market. It amounts to at least 1 per cent and can be

used flexibly. It can be employed to one or more subsets of institutions, to the financial

system as a whole and to exposures located in the domestic market, in other member

states, or in third countries. Different requirements can be set for different subsets. For

the buffer to come into effect certain procedures have to be followed. The relevant

authority is supposed to inform and justify the measure to the European Commission, the

EBA, the ESRB and the foreign authorities affected. For buffer rates below 3 per cent this

notification is sufficient (Deutsche Bundesbank, 2013a). Until 2015 the Commission will

need to approve all rates exceeding 3 per cent. After 2015 the member state has to notify

the Commission, the EBA, and the ESRB for rates between 3 and 5 per cent. The

Commission will then outline its assessment on the measure. If it is negative, the member

states will have to “comply or explain”. For rates above 5 per cent authorisation by the

commission will be necessary (European Commission, 2013). As with the countercyclical

buffers national authorities can recognise systemic risk buffers set in other member

states, which would then also have to be applied by domestic institutions for the relevant

exposure in those countries (Deutsche Bundesbank, 2013a).

There are additional institution-specific capital requirements introduced, which aim at

systemically important institutions. They are supposed to reduce the moral hazard

associated with implicit support and bail-outs by governments for those institutions and

63


apply from 2016 on. There is the ‘global systemically important institutions (G-SIIs) risk

buffer’. Those institutions identified as G-SIIs are required to hold, on a consolidated basis,

additional capital of 1 to 3.5 per cent depending on the systemic importance of the group in

question. The identification of G-SIIs takes place yearly and is based on an internationally

agreed procedure, which considers the following indicators: size, interconnectedness with

the financial system, substitutability, complexity, and cross-border activities.

In addition, national supervisory institutions can impose a buffer of 2 per cent on ‘other

systemically important institutions’ (O-SIIs). The criteria to identify O-SIIs are similar to

the ones for G-SIIs, but national authorities have more leeway in their interpretation. To

prevent adverse effect on the internal market a notification and justification procedure

applies (European Commission, 2013).

The G-SII and the O-SII surcharge are not supposed to be additive, because they are

supposed to cover the same risk. Therefore, only the higher one of the two applies. Also,

the systemic risk buffer is not additive to the G-SII or O-SII buffer, unless the systemic risk

buffer only applies to exposures located in the member state setting the buffer. In this

case, it can be assumed that they are supposed to cover different risks and therefore they

both apply (Deutsche Bundesbank, 2013a).

The combination of all the mentioned buffers is called ‘combined buffer requirement’. If an

institution fails or is in danger of failing to comply with the requirement, different

sanctions apply, which aim at re-establishing the buffers. It has to calculate the maximum

amount available for distribution. The further the capital of an institution is below the

capital requirement, the lower will be the amount available for distribution. Additionally,

within 5 days the institution has to submit a capital conservation plan in which it details

how it will restore its capital. Until the plan is approved by the BaFin, a pay-out block

applies (Luz et al., 2013).

64


Figure 6.9: Transitional provisions for capital ratios and capital buffers, deductions and components ofcapital according to the CRD IV and the CRR


0

12

8

4

Rising capital ratiosas a percentage of total exposure amount

Systemic risk buffer and/orcapital buffer for G-SIIs/O-SIIs*

Countercyclical capital buffer

Capital conservation buffer

Additional tier 1 capital

Tier 2 capital

Common equity tier 1 capital

out of commonequity tier 1capital

Transition to the new deduction rules**

20%

60%

40%

80% 100% 100%

2013 2014 2015 2016 20182017 2019

Phasing-out of grandfathered capital components***

80%

100%

70%

60%

50%

40%

30%

2012 2013 2016 201720152014 2018 2019

*G-SIIs – global systemically important institutions; O-SIIs – other systemically important institutions. Where an institution is subject to more than one of these buffers, onlythe highest of these buffers shall be applied. However, if the systemic risk buffer is applied only to risk exposures located in the member state that sets the buffer, thisrequirement shall be additive to any capital buffer that may be applicable to G-SIIs or O-SIIs. **Example: in 2016, 60% of a deductible exposure must be deducted fromcapital. The remaining 40% is treated in accordance with the deduction rules currently in force. ***Grandfathered eligible components of capital as a percentage of thecomponents of capital that are eligible exclusively under the old rules. Valid for instruments issued prior to 31 December 2011 and/or existing components of capital. Does notinclude government aid if such aid was provided as part of approved support measures and prior to the entry into force of the CRR. These components of capital are fullyeligible up to 31 December 2017 but no longer eligible from 1 January 2018 onwards.

65


In addition to those capital requirements which are based on risk-weighted assets, it is

considered to introduce a leverage ratio. This is supposed to set a limit for the on- and off-

balance sheet indebtedness of an institution. In Article 429 of CRR the approach for the

calculation of the leverage ratio is laid out. In Article 430 the disclosure and reporting

requirements are fixed.

The leverage ratio is calculated as Tier 1 capital divided by total exposure value. Total

exposure is the sum of on-balance sheet assets, off-balance sheet positions, derivatives

and securities financing transaction.

Currently, there is no binding minimum for the leverage ratio. The originally planned 3 per

cent minimum leverage ratio was, for the time being, suspended. The final definition and

calibration of the leverage ratio will only take place in 2017. Until then institutions have to

report their leverage ratios on a quarterly basis to the national authorities, which forward

them to the EBA starting in 2014. Beginning in 2015 institutions will have to disclose their

leverage ratios. By the end of 2016 the EBA will provide a report, which is supposed to

contain the effects of the leverage ratio on financial markets, business models and

balance sheet structures, the interaction between leverage ratio and capital requirements,

and the effect of different accounting standards on the comparability of the leverage ratio

(Luz et al., 2013).

66


7 Supervision on a consolidated basis

In the 1970s the Eurodollar markets grew rapidly and an increasing number of banks did

business through subsidiaries in the Eurodollar-market centres in Brussels, Luxembourg,

and London. With the growth of the business pursued by those subsidiaries, the potential

risks for the stability of the financial system also grew. National supervisory authorities,

however, only had informational and regulatory powers over the nationally based parent

banks. The risks accumulated in the Eurodollar market subsidiaries were not transparent

to the national regulators, but since the parent organizations may have to stand in for their

international subsidiaries, problems at those could easily spread to the national parent

bank (Herlt, 1979). Additionally, with the help of their international subsidiaries, banks

were able to circumvent national equity requirements by the so-called double gearing of

their equity (Deutsche Bundesbank, 1981).

Both problems were recognised and discussed nationally and internationally. On an

international level, the Cook Commission proposed in a report from 1975, among other

things, the consolidated accounting of parent banks with their subsidiary banks

independent of their domicile. In Germany, the Commission on Principle Questions of the

Banking Industry80 pointed to the same problems in their report of 1979. While some other

countries were able to implement consolidation rules quiet fast (Switzerland 1978, Japan

1978, Canada 1981) or already had some in place (USA, UK, Denmark),Germany only

amended its Banking Act in 1985 to enforce consolidation (Deutsche Bundesbank, 1981).

However, the Federal Banking Supervisory Office, the Bundesbank, and the banks

introduced voluntary measures in the form of gentleman’s agreements until the legislator

acted. In the first of those agreements which was introduced at the beginning of 1979 the

banks agreed on voluntarily reporting some general information about the risks at their

Luxembourgian subsidiaries. This took the form of submitting the auditor’s reports on the

80 Grundsatzfragen der Kreditwirtschaft

67


annual accounts of the subsidiaries to the BAKred and the Bundesbank (Herlt, 1979). Later

in 1981 the banking industry and the supervisory authorities agreed on the quarterly

submission of consolidated figures for banking groups. The threshold for consolidation

was a 100 or close to 100 per cent capital stake in a banking institution (Deutsche

Bundesbank, 1981).

Before the German legislator took action on a European level the directive 83/350/EEC81,

which introduced common minimum consolidation rules, was passed. When the Banking

Act was amended with the Third Act Amending the Banking Act82 in 1985, the new

consolidation rules were largely based on this directive. With the amended Banking Act,

Principle I (equity regulations) had then to be fulfilled by each single bank in the group but

also by a banking group as a whole. The basis for consolidation included domestic and

foreign banking daughters, mortgage banks, and also leasing and factoring companies.

Consolidation became necessary if the parent bank held directly or indirectly more than 40

per cent of capital of the respective firm or if it could directly or indirectly exert a

dominating influence. Here, the German legislators were slightly stricter. The directive did

put the consolidation threshold at 50 per cent.83

Not only the equity rules had to be met on a consolidated base, but also the large exposure

guidelines (see section 9) for the group as a whole. Also, the monthly balance sheet

reports had to be conducted by the individual institutions and additionally on a

consolidated basis for the group. However, the threshold for consolidation was set at 50

per cent of capital here (Deutsche Bundesbank, 1985). Due to the fact that before the

enactment of this law the German banks had extensively used foreign daughter banks to

81 Council Directive 83/350/EEC of 13 June 1983 on the supervision of credit institutions on a consolidatedbasis

82 Drittes Gesetz zur Änderung des Gesetzes über das Kreditwesen, 20.12.1984

83 The method that had to be used was the pro rate consolidation method. “Under this procedure the riskcarrying assets and the liable capital are to be consolidated with the actual percentage of the subsidiaries’capital held by the parent bank. A graduated calculation is used to determine the consolidated capital: thebook value of participation in the subsidiary is to be deducted from the parent bank’s liable capital; the prorata liable capital of the subsidiary is to be added” (Deutsche Bundesbank, 1985, p. 37).

68


extend their balance sheets without increasing their capital, an immediate implementation

of the new rules would have led to large capital needs, in particular for the big banks (Die

Zeit, 1984). Therefore, according to the law the groups only needed to fulfil the capital

requirements by 1991. Also for meeting the large exposure guideline on a consolidated

basis a transition period of 5 years was granted (Deutsche Bundesbank, 1985).

The next changes in this area were again due to an EU initiative. The Second Consolidation

Directive84 was implemented in 1994 with the Act Amending the Banking Act and other

Banking Regulations85, which included the Fifth Amendment of the Banking Act. Here the

German legislator decided to stick with the slightly stricter consolidation rules in Germany

(40 per cent consolidation rule for equity requirement), and only to extend them by the new

provisions of the directive. While the old law applied mainly to banks and some other

specified institutions, the new law encompassed a much wider range of financial

institution, which are not defined as banks in the German Banking Act (e.g. money broker),

and companies, which perform ancillary banking services. Additionally, the spreading of

financial holding groups86 made an amendment necessary to make also such groups

providing consolidated figures to the supervisory authorities. The duty to provide the

consolidated figures to the supervisors does fall on the largest or “oldest” subsidiary

bank.

Furthermore, the method of consolidation was amended. Full-consolidation87 had to be

applied to all majority owned subsidiary holdings. Pro rata consolidation could only be

applied to minority holdings (Deutsche Bundesbank, 1994a).

84 Council Directive 92/30/EEC of 6 April 1992 on the supervision of credit institutions on a consolidated basis


86 A financial holding group is a group which has a financial institution as a parent company and whose

subsidiary undertakings are exclusively or mainly banks or other financial institutions.

87 “All assets and liabilities of the parent and subsidiary undertakings including the capital shares owned byother undertakings are consolidated, but the book values of the participating interest in subsidiaryundertakings are deducted.” (Deutsche Bundesbank, 1994a, p. 62)

69


With the implementation of the Investment Services Directive88 from 1993 (and

implemented in 1997) a new type of institution – the financial service institution - was

defined in the Banking Act (see section 5). This also made changes in the consolidation

rules necessary. From then on also those financial service institutions can be the parent

organization of a group. Additionally, for a financial holding groups it is no longer

constitutive that a deposit taking credit institution is part of the group, but it is sufficient

that a securities trading house belongs to it. Last but not least, with the sixth amendment

of the Banking Act the German stricter consolidation rules for calculating the equity

requirements for the group were relaxed. The threshold of a 40 per cent capital stake for

consolidation was abandoned. From then on, consolidation was only necessary if the

parent company had a majority stake (or dominant influence) in the subordinated

undertaking. Therefore, consolidation rules applying for large exposure, monthly reports

and equity requirements were mostly unified, which reduced bureaucracy in the banking

groups (Deutsche Bundesbank, 1998).

With the Act Modernising Accounting Law89 from 2009 the general accounting

consolidation principles were changed. Since the supervisory consolidation principles (for

example for the holding of own funds) are taking the rules of the Commercial Code as a

starting point, the renewed stricter consolidation rules (see section 13) apply also in this

area of regulation. Hence, particularly special purpose vehicles have since to be

consolidated for supervisory purposes as well.

88 Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field.

89 Gesetz zur Modernisierung des Bilanzrechts (Bilanzrechtsmodernisierungsgesetz); 25.05.2009

70


8 Supervision of financial groups and conglomerates

Financial conglomerates are groups of connected companies, whose main activities are

financial services, such as bank, security or insurance services. In the group there has to

be at least one company active in the insurance and another one active in the banking /

investment services business.

The discussion on the supervision of this kind of financial groups started already in the

early 1990s on an international level. Nationally, the Bundesbank reported on it as early as

1994.

Due to the universal banking principle commercial and investment banking activities could

always be conducted within one bank, so that financial conglomerates did not play an

important role in Germany in this area. However, in other areas the report recognizes a

growing importance of financial conglomerates in Germany. The Bundesbank stated in

1994 that the strict separation of different fields of financial business in Germany is a thing

of the past. By then, most mortgage banks had long been subsidiaries of commercial

banks, and insurance companies had been owned some of the building and loan

associations for a while. Also, most investment funds belonged to insurance companies or

commercial banks. Additionally, banks and insurance companies are connected so that

they can offer all financial products one-stop.

The connection of insurance and banking business was recognised by the German

legislation. The normally binding investment restrictions for banks exclude capital

holdings of insurance companies explicitly. Contrarily, the supervision in Germany was

performed from separate federal agencies and split into banking, insurance, and

securities market supervision (Deutsche Bundesbank, 1994). Only in 2002 the three

different agencies were merged into one single agency – the German Federal Financial

Supervisory Agency (BaFin). Despite the fact that the three areas of supervision were still

organizationally separated there were cross-departments, which should improve

71


coordination, communication and co-operation. One department was particularly assigned

to the coordination regarding financial conglomerates.

However, until 2005 groups that included credit institutions, investment firms and

insurance undertakings have not been subject to a consolidated group wide supervision.

The first legislative action in Germany that particularly dealt with financial conglomerates

was taken as a reaction to the Directive 2002/87/EC90. The directive was implemented with

the Act Implementing the Financial Conglomerates Directive,91 which became effective in

January 2005.

The newly implemented law established regulations for financial conglomerates in mainly

four areas: equity requirements, risk concentration, intra-group transactions, and internal

risk management.

Financial conglomerates need to have sufficient equity as a whole. The BaFin and the

Bundesbank were empowered to enact the detailed regulations. This happened then in

September 2005 with the enactment of the Financial Conglomerates Solvency

Regulation92. According to this regulation own funds pursuant to the Banking Act or the

Act on the Supervision of Insurance Undertakings93 may be included in the conglomerates’

capital base. The conglomerates in Germany were allowed to calculate their capital

requirements by only two of the three methods proposed in the Directive 2002/87/EC94.

90 Directive 2002/87/EC of the European Parliament and of the Council of 16 December 2002 on thesupplementary supervision of credit institutions, insurance undertakings and investment firms in a financialconglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EECand 93/22/EEC, and Directives 98/78/EC and 2000/12/EC of the European Parliament and of the Council

91 Gesetz zur Umsetzung der Richtlinie 2002/87/EG des Europäischen Parlaments und des Rates (Finanz-konglomeraterichtlinie-Umsetzungsgesetz); 16.12.2002

92 Finanzkonglomerate-Solvabilitäts-Verordnung

93 Versicherungsaufsichtsgesetz

94 Calculation on basis of the consolidated accounts or deduction and aggregation method were allowed. Thebook value/requirement deduction method was not implemented, because the equity method, which it isbased on, is quiet uncommon in Germany.

72


Regarding the reporting of risk concentrations and intra-group transactions, the law

empowered the Ministry of Finance and the Bundesbank to enact detailed regulations.

Until such a regulation is enacted the law prescribes some preliminary rules. Those

demand that risks according to the Banking Act or the Act on the Supervision of Insurance

Undertakings, which individually or in sum reach 10 per cent of the conglomerates equity

requirements, have to be reported to the BaFin and the Bundesbank. The BaFin can

require the conglomerate then to back those risks by capital. For the intra-group

transactions the following preliminary rule was envisaged: all single transactions above 5

per cent of the conglomerate’s capital requirement have to be reported. Those preliminary

rules are still in place today (2014), since no regulation was enacted.

The Directive envisages also that the conglomerates have to establish an appropriate

conglomerate wide risk management and have adequate internal control methods in

place, including a proper business organisation and proper accounting procedures.

Additionally, there were some changes necessary in regards to the supervisory

coordination in case of internationally active conglomerates (Deutsche Bundesbank, 2005).

The Directive 2007/44/EC95 was introduced into German law with the Act Implementing the

Qualifying Holdings Directiv96 in 2009. In December 2008 the Committee of European

Banking Supervisors published guidelines for the prudential assessment of mergers and

acquisitions in the financial sector. Those substantiated the Directive further. Those were

introduced in Germany with the Regulation Regarding the Further Implementation of the

Directive on the Supervisory Assessment of Acquisitions in the Financial Sector97 also in

95 Directive 2007/44/EC of the European Parliament and of the Council of 5 September 2007 amendingCouncil Directive 92/49/EEC and Directives 2002/83/EC, 2004/39/EC, 2005/68/EC and 2006/48/EC as regardsprocedural rules and evaluation criteria for the prudential assessment of acquisitions and increase ofholdings in the financial sector

96 Gesetz zur Umsetzung der Beteiligungsrichtlinie; 17.03.2009

97 Verordnung zur weiteren Umsetzung der Beteiligungsrichtlinie; 20.03.2009

73


2009. With this the Ownership Control Regulation98 and the Reporting Regulation99 were

also adapted in the same year in regards to substantial investments.

The Directive had the aim of reducing obstacles to mergers and acquisitions in the

financial sector. The German Banking Act already contained rules, based on European

law, concerned with the reporting and the control of qualified owners in the banking

sector. The implementation of the Directive formalised the control process so that there

are now clear rules in form and content for the authorisation procedure. Also for the

BaFin there are binding time limits in which it has to finish the authorisation procedure.

Also, the catalogue for not granting permission was extended by the following reasons:

future directors are not reliable or qualified, the report is incomplete or incorrect or does not comply with the requirements of

the Ownership Control Regulation, a relation to financing of terrorism or money laundering exists, the reporting persons do not have adequate financial solidity.

Additionally, in cases, where the acquirer is located within the EU the responsible

authorities have to coordinate their activities and cooperate.

The Ownership Control Regulation prescribes bindingly which documents and statements

have to be submitted when making the notification regarding an acquisition or an increase

of a qualified participating interest. This shall contribute to a fast and predictable process

with a higher degree of legal certainty (BaFin, 2009).

98 Inhaberkontrollverordnung

99 Anzeigenverordnung

74


9 Large exposures

Already during the banking crisis in 1931 large exposures to single debtors led to banks’

defaults in Germany. Therefore, guidelines regarding large loans were already introduced

in 1934. Also, when the Banking Act was enacted in 1962 it had special rules for large

loans. The act defined a large loan as the indebtedness of one debtor that is above 15 per

cent of a bank’s equity according to §10 of the Banking Act. Based on this definition the

following rules were derived. One single large loan should not exceed 100 per cent of the

bank’s equity. Contingent liabilities only had to be included with 50 per cent of their value.

There was a de minimis limit of 20,000 DM. All large loans combined could not exceed 50

per cent of the total loans of a bank. Exceeding those limits was possible with the prior

agreement of the BAKred. If a limit was exceeded, there was an immediate notification

requirement to the BAKRED. Additionally, all large loans had to be registered at the

Bundesbank. Besides those rules, banks had to follow certain procedures for granting

large loans, which aimed at guaranteeing that the bank’s decision was well-founded (Bitz

and Matzke, 2011).

A first tightening of those rules was enacted with the second amendment of the Banking

Act in 1976. Contingent liabilities had now to be fully included and a single large loan was

not allowed to exceed 75 per cent of equity. Additionally, the regulation was changed from

being a directory provision100 to become an obligatory provision101. While before this in the

first instance breaking of the rules only led to a dialogue with the supervisory authorities;

according to the new rules it led directly to supervisory consequences. The de minimis

limit was increased to 50,000 DM. The limit for all large loans together was changed to

not exceed 800 per cent of a bank’s equity. Additionally, the five largest large loans were

not to exceed 300 per cent of equity (Deutsche Bundesbank, 1976).

100 Sollvorschrift

101 Mussvorschrift

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The Third Amendment of the Banking Act in 1984 tightened the rules again. The limit for a

single large loan was reduced to 50 per cent of the bank’s equity, while the limit for the

five largest loans was abandoned. Another important change that also affected large loan

regulations was the introduction of new consolidation rules. Until then, parent institutions

were able to circumvent large loan rules by granting loans through their subsidiaries.

From then on, this was prevented. A parent organisation had to control whether a group

as a whole had granted a large loan to a debtor. Based on this, it had to make the

necessary reporting to the Bundesbank and ensure that the limits for large loans were

not exceeded (Deutsche Bundesbank, 1985).

The new equity definitions (introduction of additional capital) of the Own Funds Directive

89/299/EEC102, which were introduced with the Fourth Amendment to the Banking Act in

1992, would have strongly broadened the basis for the calculation of the limits fixed in the

large exposure rules. The German legislator therefore decided to stick to the old definition

of equity for the definition of the limits until the intended EU regulations in the area of

large exposures were in place (Deutsche Bundesbank, 1993).

This happened with the directive 92/121/EEC103 in 1992, which made the amendment of the

large exposure guidelines necessary. The Act Amending the Banking Act and other

Banking Regulations104, including the Fifth Amendment of the Banking Act, implemented

the new rules and was introduced in January 1996. The new equity definition of the fourth

amendment did, from then on, also apply to the large exposure rules. In line with the

directive, a large loan was since defined as a loan that exceeds 10 per cent of a bank’s

equity. Additionally, the maximum of large loans to one entity was not allowed to exceed

25 per cent of a bank’s equity. German legislators, however, fully used the possible

102 Council Directive 89/299/EEC of 17 April 1989 on the own funds of credit institutions

103 Council Directive 92/121/EEC of 21 December 1992 on the monitoring and control of large exposures ofcredit institutions


76


transition period allowed in the directive, so that the 15 per cent limit for the definition as

a large loan and a 40 per cent limit for the maximum of exposure to one entity were valid

until 1998. The maximum amount of the sum of all large loans together stayed at 800 per

cent of equity.

However, the definition of what had to be included to calculate the exposure to one entity

was also widened. Until then, loans had been defined in a narrow sense and included

mainly money loans and guarantees. The amended law used the wider definition of the

Solvency Directive (see section 6). Therefore, all assets (e.g. also shares, bonds, options,

etc.) that can be assigned to a debtor and that bear a risk had to be included. However,

there were certain exemptions, for example, for debtors with excellent credit standing

(e.g. government) or where certain collateral was provided.

Additionally, with the new law more detailed regulations regarding notification rules, the

calculation of credit equivalent amounts for derivatives and also the weighting of the

different assets (e.g. interbank loans are weighted lower depending on their maturity with

0, 20 or 100 per cent) were introduced. The amended act also had a wider definition of a

borrower unit. Another important change was that it was in general possible to exceed the

limits for single entities as well as for all large loans. If that happened, a bank could

instead put aside equity for the exceeding amount, which could then not be used for the

coverage of other risks (Deutsche Bundesbank, 1994a).

The Sixth Amendment of the Banking Act from 1997 introduced the differentiation

between the banking and trading book. For the large exposure guidelines there were

some amendments for trading book institutions, so that their limits for overall business

(trading and banking book together) was now based on own funds instead of liable capital

(see Figure 6.3). The limits for the banking book were still calculated on the basis of liable

capital. Besides this, the reporting rules were changed so that there were now only

quarterly summary reports necessary instead of ad-hoc reports (Deutsche Bundesbank,

1998).

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The next changes in the large exposure regulation were triggered again internationally in

2006. The Basel II rules were put into the directives 2006/48/EC and 2006/49/EC and this

also made changes in the large exposure guidelines necessary.

Therefore, the Regulation Governing Large Exposures and Million Loans105 was amended

in December 2006. The regulation was changed, so that the definition of risk is based on

the solvency regulation. However, the risk weighting as it is done for the determination of

regulatory capital requirement does in general not apply to the large exposure

regulations. There are only few exceptions, so that normally the book value of a

transaction has to be taken as the basis for calculation. However, risk reduction

techniques can be applied similar to the rules that apply for the determination of the

regulatory capital requirements. The large exposure guidelines were adapted

accordingly. Additionally, for the calculation of credit equivalent amounts for derivatives

institutions were also allowed to use the Standardised Method (SM) and the Internal

Model Method (IMM) (see section 6 for more information) (Deutsche Bundesbank, 2006).

The change in accounting standards in 2009 (see section 13) led to amend the commercial

consolidation rules, so that consolidation applied to a wider range of companies, even in

cases where there is no formal control over the daughter institution. This now includes

special purpose vehicles in particular. These new rules affect the creation of credit units

as well. Companies, which need to be consolidated with the parent company, now, form a

credit unit (Deutsche Bundesbank, 2010a).

While the changes in the large exposure regulation due to the directives 2006/48/EC and

2006/49/EC were only in selective areas, they prescribed that the European Commission

had to prepare a report for the Parliament and the Council until the 31st of December

105 Groß- und Millionenkreditverordnung

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2007, which analyses the functioning of the large exposure regulation and puts forward

possible amendments for their improvement.

After several calls for advice addressed to the Committee of European Banking

Supervisors (CEBS) this committee published a report in March 2008, which became the

basis for large exposure rules in the Directive 2009/111/EC (CRD II)106. This Directive was

transposed into German law with the Act Implementing the Amended Banking Directive

and the Amended Capital Adequacy Directive107 and the Regulation Further Implementing

the Amended Banking Directive and the Amended Capital Adequacy Directive all in

2010.108

The most relevant change was that since then all claims against other credit institutions

and financial service institutions, independent of their maturity, have to be accounted for

in the 25 per cent large exposure limit of equity. In return a general allowance of 150

million euros was introduced (however, large exposures cannot exceed the total equity of

an institution). Claims against other institutions within one group still could be excluded

as long as they have certain characteristics. The exception for claims related to payment

transactions and security processing was newly introduced. Overnight loans related to

those transactions and loans related to correspondent banking until the end of the

business day were excluded from the large exposure regulation (Göddecke and Fuchs,

2010).

The large exposure limits have also been simplified. There was the 25 per cent limit for

loans to a single entity, the 20 per cent limit for loans to affiliated enterprises and the 800

per cent limit for all large exposures. The new regulation only accepted the 25 per cent

106 Directive 2009/111/EC of the European Parliament and of the Council of 16 September 2009 amendingDirectives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certainown funds items, large exposures, supervisory arrangements, and crisis management

107 Gesetz zur Umsetzung der geänderten Bankenrichtlinie und der geänderten Kapitaladäquanzrichtlinie;19.11.2010

108 Verordnung zur weiteren Umsetzung der geänderten Bankenrichtlinie und der geändertenKapitaladäquanzrichtlinie; 05.10.2010

79


limit. It was concluded that the aims of the other two limits could be better served by

other regulations or supervisory tools (Deutsche Bundesbank, 2009).

Another important change was related to the formation of borrower entities. Until then,

the formation of a borrower entity depended on mutual dependency109 in Germany.

According to the new regulation unilateral dependency is sufficient. It was also clarified

that for the formation of borrower units also the refinancing risk should be included.

Hence, entities, which depend on one source for refinancing such as many of the

purchasing companies of various asset backed commercial paper programs do, should be

included in a credit unit (Deutsche Bundesbank, 2009). In addition to this, claims against

certain investment structures (e.g. mutual funds) should not only consider the investment

structure as a borrower, but also consider the assets held by the investment unit. Until

then there was a choice for shares in investment funds where the bank could choose

under certain conditions to either regard the investment fund (basic approach) or regard

the underlying assets (alternative approach) as borrower. For other investment

structures with underlying assets the underlying assets did not have to be considered.

This has changed and now credit institutions have to consider both the investment

structure and the underlying assets. Exceptions are only possible, if the investment

structures are sufficiently diversified so that exceeding the large exposure limit is almost

impossible (Göddecke and Fuchs, 2010).

Also, a new approach, the so-called ‘substitution’ approach, regarding deduction of

collateral from the borrower’s total credit amount has been introduced. Credit

institutions can now choose to deduct the amount of a security from the limit of the

original borrower and add it to the limit of the issuer of the pledged security / of the

guarantor (Göddecke and Fuchs, 2010). This new method is possible in addition to the

already existing comprehensive method110 and the possibility to calculate the effect of the

109 Wechselseitige Abhängigkeit

110 Umfassender Sicherheitenansatz

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collateral on the Loss-Given-Default of the entity, if the advanced Internal Rating Based

Approach is used (Deutsche Bundesbank, 2009).

The new Capital Requirements Regulation 575/2013 (CRR) which was enacted in 2013 also

includes large exposure rules. Different from a directive, the regulation does not need to

be implemented but is directly applicable. However, conflicting or contradicting national

regulations have to be removed. This made far-reaching changes in the German Banking

Act and other German regulations necessary. Also, the EU-regulation leaves some

options to the discretion of national states. Those have to be exercised. Both were done in

2013 with the CRD IV-Implementation Act111 and an ordinance complementing the EU

large exposure regulations.112 Many of the rules in the new CRR are still similar to the

former national rules, which were already determined by EU-directives to a large extent.

The large exposure limits remained unchanged with 10 per cent of a bank’s equity as

defining criterion for a large loan and 25 per cent as the upper limit for a large loan to a

single entity. The CRR gives the national supervisors an option to take structured

measures and demand the reduction of the exposure to certain borrowers or groups of

borrowers. The new large exposure guidelines are based on the ‘eligible capital’, which

consists of tier 1 capital and tier 2 capital, up to a maximum of one third of tier 1 capital.

Hitherto, tier 2 capital could be 50 per cent of the total capital. A transition period with

gradually declining allowances for tier 2 capital until 2017 was granted. In Article 390 of

the CRR the calculation of the exposure value, which is the relevant amount on which it is

evaluated whether the large loan regulation applies, is detailed. In principle all assets and

111 Gesetz zur Umsetzung der Richtlinie 2013/36/EU über den Zugang zur Tätigkeit von Kreditinstituten unddie Beaufsichtigung von Kreditinstituten und Wertpapierfirmen und zur Anpassung des Aufsichtsrechts andie Verordnung (EU) Nr. 575/2013 über Aufsichtsanforderungen an Kreditinstitute und Wertpapierfirmen(CRD IV-Umsetzungsgesetz); 28.08.2013

112 Verordnung zur Ergänzung der Großkreditvorschriften nach der Verordnung (EU) Nr. 575/2013 desEuropäischen Parlaments und des Rates vom 26. Juni 2013 über Aufsichtsanforderungen an Kreditinstituteund Wertpapierfirmen und zur Änderung der Verordnung (EU) Nr. 646/2012 und zur Ergänzung derMillionenkreditvorschriften nach dem Kreditwesengesetz (Großkredit- und Millionenkreditverordnung -GroMiKV)

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off-balance sheet positions, as defined in the standardised approach for the

determination of capital requirements, have to be included. In Article 400 the CRR lists

exceptions and national choices for certain positions (Luz et al., 2013). The German

authorities have decided to make use of the following exceptions:

covered bonds loans to regional governments and local authorities (80 per cent of the assessment

base) overnight loans to institutes, which are not denominated in an important trade

currency minimum reserve requirements exposures to central governments (minimum Rating 3) to meet liquidity

requirements certain types of documentary letter of credit/approved credits with a low to medium

default risk. risks from trade financing within a group guarantees for loans refinanced with Pfandbriefen before a land charge

(Grundschuld) is registered exposures against recognised exchanges development loans

A major issue was the exception of intra-group claims, in particular within the savings-

and the cooperative banking groups. These claims do not fall under the regulation, if they

fulfil the requirements of Article 400 (1f). If those relatively strict requirements cannot be

fulfilled, the German authorities exercised some of the national option provided by the

regulation so that a partial exception can still apply for certain intra-group transactions of

up to 93.75 per cent in the most extreme case. Participations in institutions of the same

group are excepted, if the participation is below 25 per cent of eligible capital. Above that

threshold they have to be fully included (Thelen-Pischke, 2013).

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10 Investment services

Before the Investment Service Directive113 from 1993 there was no special supervision or

regulation of investment services. Some investment services were included in the Banking

Act and firms conducting those fell under banking supervision. Other investment services

fell under the general regulations to the Trade, Commerce and Industry Regulation Act114.

The directive was implemented with the Second Financial Markets Promotion Act115 in

1994 and the Act for the Implementation of EC Directives Regarding the Harmonisation of

Bank- and Security Related Regulations116 in 1997.

The German supervisory law now distinguishes between banks and financial service

business. Compared to the Investment Service Directive the German definition of banks is

wider and includes some activities regarded as investment services. Additionally, in the

German law the definition of a financial service business includes some activities that are

not mentioned in the directive at all. Therefore, the German implementation is slightly

stricter (for details, see section 5).

The Investment Service Directive mainly aimed at creating a level playing field for banks

and investment firms. Therefore, authorisation procedures and prudential rules for

investment firms were adapted to those of banks. There were minimum initial capital

requirements established and the Capital Adequacy Directive harmonised the capital

requirements for financial services business conducted by financial service firms and

banks. Financial service institutions were put under the supervision of the Federal

Banking Supervisory Office (BAKred) and the Federal Securities Supervisory Office

(BAWe). The former was mainly responsible for the licensing and solvency of the


114 Gewerbeordnung

115 Gesetz über den Wertpapierhandel und zur Änderung der börsenrechtlichen und wertpapierrechtlichenVorschriften (Zweites Finanzmarktförderungsgesetz); 26.07.1994

116 Gesetz zur Umsetzung von EG-Richtlinien zur Harmonisierung bank- und wertpapieraufsichtsrechtlicherVorschriften; 22.10.1997

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institutions, while the latter was largely responsible for the market supervision, i.e.

compliance with insider trading rules. In turn, as with banks, financial service institutions

were since then allowed to provide their services in the whole EU by either establishing a

subsidiary or by offering their services from a distance (European Passport), with only

little additional supervision and regulation by the host country supervisors (home country

control applies) (Deutscher Bundestag, 1997).

The Market Abuse Directive117 (MAD) from 2003 was implemented in 2004 with the Investor

Protection Improvement Act118. It introduced a range of changes in different areas related

to market abuse. Those issues were largely regulated in the Securities Market Trading

Act, where most of the changes happened. In the area of insider trading the range of

financial instruments covered was extended, so that, for example, also trade in derivatives

was considered. Additionally, for secondary insiders it became punishable as an

administrative offence to forward insider information or buy- and sell-recommendations

based on insider information to third parties. Until now, secondary insiders were only

forbidden to buy or sell themselves. Additionally, the sole attempt to buy or sell on insider

information is already punishable (Deutscher Bundestag, 2004). Issuers of securities are

now obliged to keep a register listing all persons that have access to insider information.

This has a preventive character, since the issuer has to make sure these persons were

informed about their duties regarding these information and the legal consequences of

infringement (BaFin, 2005).

Also, the regulations regarding ad-hoc publicity were amended. The separation of the ad-

hoc publicity rules and the insider trading rules were abandoned. Any information that

would be regarded as insider information and that directly concerns the issuer has to be

made available to the public. Under certain circumstances the issuer is allowed to

117 Directive 2003/6/EC of the European Parliament and of the Council of 28 January 2003 on insider dealingand market manipulation (market abuse)

118 Gesetz zur Verbesserung des Anlegerschutzes (Anlegerschutzverbesserungsgesetz); 29.10.2004

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withhold information. It is now left to the discretion of the issuer to decide upon

postponing the announcement. Before, this was only possible after an approval by the

BaFin. Regarding directors’ dealing the persons subject to reporting have been extended

and include now any legal or natural person. Additionally, the de minimis limit was

lowered. Before that there was no announcement of the transaction necessary if the

transactions of one person did not exceed 25,000 euro within 30 days. This was lowered to

5,000 euro (BaFin, 2005).

Also, important changes regarding market price manipulations were made. The already

existing prohibitions introduced with the Fourth Financial Market Promotion Act were

extended by the actions defined in the EC-directive from 2003. In particular, the category

‘other acts of deception’ laid down in the act were concretised. It is now explicitly

forbidden to send deceptive signals regarding demand and supply or to cause an

artificially high or low price level. One of the most relevant changes was that the intention

to manipulate market prices as a defining feature was abandoned. Hence, it is sufficient

that the offender regards it as possible and accepts that his behaviour may send deceptive

trading signals, even though he does not intentionally want to manipulate the market

(BaFin, 2005).

In the area of financial analyses existing regulations introduced with the Fourth Financial

Market Promotion Act were extended to include all types of financial analyses which were

produced or forwarded in a professional context. This only applied to investment trading

firms before and now includes all financial analysts, also for example, free analysts or the

issuer of securities (Deutscher Bundestag, 1997).

There are some exceptions to these rules that are derived from the EC-regulation 2273

from 2003. According to it, certain share price stabilisation connected to an initial public

offering or a capital increase are exempt. In addition, share buyback programs are

allowed, if they are performed for a capital reduction or if they are for the fulfilment of

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liabilities out of share purchase plans for employees. These rules are slightly more

restrictive than the former German regulations (BaFin, 2005).

The BaFin’s inspection and supervision rights have been extended to allow it to fulfil its

duties in line with the directive. In addition, a rule regarding the cooperation among

European supervisory authorities in cross-border prosecution of insider trading and

market manipulation was established (Deutscher Bundestag, 1997).

The Markets in Financial Instruments Directive (MiFID)119 from 2004 was implemented in

Germany by the Act Implementing the Markets in Financial Instruments Directive and

Implementing Directive of the Commission120 (FRUG) in 2007. The Directive aimed at

further harmonisation and specification of the EU-wide prevailing rules for licensing and

of activities of financial services institutions and trading platforms. It aimed at making

financial markets as a whole, as well as financial services for each single investor more

transparent and efficient.

The FRUG extended the list of financial services, which needed approval according to the

Banking Act. The list was extended with investment advisory services, operation of

multilateral trading facilities and services related to commodities derivatives.121 This

means that firms offering those services are supervised by the BaFin now, but also that

they can benefit from the European Passport (Bundesministerium der Finanzen, 2007).

To make securities trading more transparent the FRUG established a range of new

disclosure rules for multilateral trading platforms, for the regulated market122 and

119 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets infinancial instruments

120 Gesetz zur Umsetzung der Richtlinie über Märkte für Finanzinstrumente und der Durchführungsrichtlinieder Kommission (Finanzmarktrichtlinie-Umsetzungsgesetz, FRUG); 19.07.2007

121 There are some exceptions such as investment advisory services only regarding mutual fund shares ortrading platforms set up by exchange operators in the unofficial regulated market (Freiverkehr).

122 The official market (amtlicher Markt) and the regulated market (geregelter Markt) were both replaced bythe regulated market (regulierter Markt) by the FRUG.

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systematic internaliser123. Most relevant are the establishment of uniform rules regarding

pre-trade (bid and ask prices and the tradable volume have to be disclosed continuously)

and post-trade transparency (prices and revenues of transactions have to be disclosed).

Those rules are only binding for trade in shares and certificates representing shares

accepted for trade in the regulated market. In addition, financial services institutions have

to disclose information on deals in shares and certificates representing shares outside of

multilateral trading platforms and regulated markets (BaFin, 2009).

The FRUG also led to extensive changes in the requirements of credit and financial

services institutions in respect to the furnishing of information, conduct, record-keeping

and organisation as stipulated in sections 31 ff. of the Securities Trading Act. It further

specifies and differentiates information and reporting requirements regarding obtained

customer information and the best execution of customer orders. From now on, it has to

be differentiated by the type of the customer. For private customers there are stricter

rules than for professional clients. Also, for complex products, such as derivatives, there

are higher information requirements than for less complex products, such as shares.

Regarding the rules of conduct, the general guideline that financial services have to be

provided with the necessary skill, care and diligence in the interest of the client stayed

unchanged. However, it was extended by the explicit prohibition to accept financial or

other inducements from third parties or to offer those. An exception to these rules applies,

if inducements are disclosed to the customer and improve the quality of the service to the

customer124 (BaFin, 2008).

Another novelty was the duty introduced by the FRUG for the best execution of an order for

the customer. According to this rule, institutions when executing an order for a customer

or forwarding it to third parties have to take all adequate measures to ensure the most

123 Systematic internalisers are big banks or brokerage houses, which on a regular basis fulfil customers‘orders against their own book.

124 For more information on the changes in these areas see the sections on conflict of interest and customersuitability requirements.

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advantageous result for the customer as a rule. Until then, there was a legal priority for

organised exchanges, while from then on also alternative ways, such as execution via a

multilateral trading platform or against the own book, have to be included as well. For

best execution the following criteria should be included: costs, speed, and probability of

execution. Institutions have to formulate principles regarding best execution, which they

have to disclose to their customers (BaFin, 2007).

In addition to the FRUG a couple of ordinances were introduced and amended to

implement the Directive 2006/73/EC125 and the Regulation 1287/2006126 in 2007. Those

were the Regulation Specifying Rules of Conduct and Organisation Requirements for

Investment Services Enterprises127 and the First Regulation Amending the Financial

Analysis Ordinance128. They specified provisions, which were amended and integrated by

the FRUG relating to the rules of conduct for credit- and financial services institutions and

for financial analyses. They included detailed regulations on requirements concerning the

furnishing of information and reports by investment services enterprises to their clients,

on gathering of customer data for the assessment of suitability and appropriateness of

dealings in financial instruments, and on the best execution requirement of institutions for

client orders. It also included organisational requirements for supervising compliance

with statutory requirements themselves, dealing with conflicts of interest and providing

reports on investment services. Additionally, procedures for classifying clients as private

125 Commission Directive 2006/73/EC of 10 August 2006 implementing Directive 2004/39/EC of the EuropeanParliament and of the Council as regards organisational requirements and operating conditions forinvestment firms and defined terms for the purposes of that Directive

126 Commission Regulation (EC) No 1287/2006 of 10 August 2006 implementing Directive 2004/39/EC of theEuropean Parliament and of the Council as regards record-keeping obligations for investment firms,transaction reporting, market transparency, admission of financial instruments to trading, and definedterms for the purposes of that Directive

127 Verordnung zur Konkretisierung der Verhaltensregeln und Organisationsanforderungen fürWertpapierdienstleistungsunternehmen (Wertpapierdienstleistungs- Verhaltens- undOrganisationsverordnung); 23.07.2007

128 Erste Verordnung zur Änderung der Finanzanalyseverordnung; 23.07.2007

88


customers, professionals or eligible third parties are transposed from the MiFID itself

(BaFin, 2007).

Additional changes were necessary in a couple of ordinances. In 2007 The Ordinance on

the Examination of Investment Services Enterprises129 was adapted to the requirements of

the FRUG and far-reaching revisions were made. In the same year the Ordinance on the

Analysis of Financial Instruments130 was adapted to the new requirements. Additional

organisational requirements were introduced to make conflicts of interest controllable or

prevent them in the first place. The concrete requirements for the conflict of interest

management of an institution depend on its size, field of business, and risk potential of its

analyses. Essential novelties are the codification of the organisational duties of financial

services institutions when preparing and distributing financial analyses. It particularly

regulates: control of information, remuneration, prevention of improper influence on

analysts, special monitoring of employees and the prohibition of inducements, and the ban

of certain employee transactions. Additionally, the record-keeping requirements were

extended. The MiFID requires the EU-wide exchange of information on securities

transactions. To enable this, in 2007 the Securities Trading Reporting Ordinance131 was

amended regarding the new provisions for reporting. Most affected by the change is the

technical format of the reports. According to the MiFID a transaction is, independent of the

place of the transaction, first reported to the home country supervisor of an institution.

The respective supervisor then forwards the information to other supervisors, especially

those that have the most liquid markets for the concerned financial instrument. Lastly,

also in 2007 the Market Access Information Ordinance132 was amended. It contains the

regulations for foreign regulated markets and their operators when they attempt to grant

direct access to their trading platforms for domestic market participants. It was amended

129 Wertpapierdienstleistungs-Prüfungsverordnung

130 Finanzanalyseverordnung

131 Wertpapierhandel-Meldeverordnung

132 Marktzugangsverordnung

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to make the cross-border access to regulated markets easier. For regulated markets

within the EU the notification obligations were abandoned (BaFin, 2007).

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11 Deposit guarantee

The system of deposit and investor protection in Germany is rather complex. Today’s

system is divided by type of institutions (deposit taking or not), ownership type

(cooperative, private, public), type of insurance (deposit insurance, institutional insurance),

and whether the schemes are voluntary or statutory (see Figure 9.1 for an overview).

The complexity of today’s system stems from the fact that it developed historically. Until

1931 there was no system of deposit insurance. With the crisis of 1931 the government

directly saved banks through direct and indirect guarantees. After the crisis a banking law

was enacted. However, this law did not contain provisions for deposit insurance. At the

same time, the cooperative banks possibly due to their members’ call liability in case of

bankruptcy took action themselves and established support or guarantee funds on a

regional level in the 1930s. In 1937 they established a guarantee fund on the federal level.

In 1941 the association of Raiffeisen banks (local rural credit cooperatives) followed and

established a support fund (both were merged in 1977 when the association of Raiffeisen

banks and the association of cooperative banks were merged into one institution) (Nolte

and Schöning, 2004). First initiatives of the private banks followed in 1959 when the

Bavarian banking fund was established. The first version of the Banking Act in Germany

passed in 1961 did not contain any statutory initiatives regarding deposit insurance.

However, the parliament recognised this weakness and requested the government to

investigate the creation of a deposit protection scheme. Before the government could take

position on this issue, a couple of insolvencies of private banks led to the establishment of

a first nation-wide joint fund of the private banks at the Federal Association of German

banks in 1966. In 1968 the government presented the report on deposit protection

schemes. The main results were that a general deposit protection was necessary and that

existing schemes were not sufficient. In particular, the lack of a legal claim of depositors

and the low capacity of the funds were criticised. All over, it recommended the

introduction of a general statutory scheme, if the existing schemes were not restructured

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in a way that made them more effective and also neutral regarding competition.

Threatened by statutory regulation the private banks reacted promptly with an

improvement of their existing fund (Zimmer, 1993). Also, as a reaction to the report the

German Savings Bank and Giro Association established twelve regional savings banks

guarantee funds in 1969. Those regional funds were connected due to joint-liability

agreements133. Until then deposits in savings banks were protected indirectly and to the

full amount due to the public guarantee obligation134 and institutional liability135 local and

regional governments provided for those institutions. However, the report demanded the

establishment of funds to reduce the competitive advantage, which saving banks had due

to their public guarantees (Krätzner, 2002). Despite the fact that central demands (like

establishing a legal claim for depositors) of the report were not met, the proposed law for

a statutory scheme was withdrawn (Zimmer, 1993).

One of the main differences between the schemes was that savings and cooperative

banking groups’ schemes both aimed at guaranteeing the survival of member institutions

from the beginning. Therefore, all kinds of deposits were indirectly insured without

limitation. In contrast to this, the fund operated by the private banks explicitly did not have

the aim of protecting institutions, but only protected certain deposits up to a certain

amount. The early version of the fund only protected savings as well as wage, salary and

pensioners’ accounts with balances of up to DM 10,000. This was later extended to all sight

and time-deposits and was raised to balances of DM 20,000.

A further impetus for the development of the schemes came from the default of the

Herstatt Bank in 1974 and subsequent problems at other banks. Existing schemes were

unable to cope with the situation. As a result three major changes that were directly

relevant for deposit insurance came into place.

133 Haftungsverbund

134 Gewährträgerhaftung

135 Anstaltslast

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Firstly, the Liquiditäts-Konsortialbank was founded by the Bundesbank and all of the

banking associations. It was enabled to fulfil the role of a microeconomic lender of last

resort for in principle healthy banks with liquidity problems (Zimmer, 1993). This was

necessary because until then the Bundesbank was not allowed to fulfil this role. Since the

foundation of the Liquiditäts-Konsortialbank it could do so indirectly (Deutsche

Bundesbank, 1992a).

Secondly, the Second Amendment of the Banking Act in 1976 led to extend the intervention

rights of the banking supervisory authority. In particular, the possibility of imposing a

moratorium on a bank and the sole right to file a petition in bankruptcy are important

here, because those gave the banks and the supervisory authority time to overcome and

solve problems at an institution.

Thirdly, the government under the lead of the social democratic finance minister Hans

Apel were again threatening the banks with a statutory scheme, if they were not able to

establish sufficient voluntary schemes (Zimmer, 1993).

This threat as well as an active trend among depositors to transfer deposit to savings

banks, which were guaranteed by the state, made the private banks react promptly. In May

1976 a guarantee fund at the German Association of Private Banks was established

(Krätzner, 2002). The coverage was more encompassing (all sight-, time- and saving

deposits) and much higher (30 per cent of the bank’s equity per depositor) than in the

previous fund (Deutsche Bundesbank, 1992). In the same period of time the Landesbanken

and central clearing organisations of the savings banks were also forced to establish an

own insurance scheme. They established the Guarantee Fund of the Central Savings

Banks and Central Giro Institutions, which also aimed at the viability of all members and

joined the existing joint liability agreements of the savings banks. The plan for a statutory

regime was abandoned. The schemes proved successful during the management of some

problem banks and were regarded with high confidence from the general public thereafter

(Krätzner, 2002). In the following years only minor changes occurred. Following a

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recommendation of the European Commission from 1986 with the Fourth Amendment of

the Banking Act in 1992 banks that were not members of any deposit protection scheme

had the duty to inform their customers about this (transparency requirement) (Deutsche

Bundesbank, 1993).

With those three protection schemes in place only few banks were not covered, for

example some state-owned banks. Public banks, which did not belong to the savings

banks sector (for example certain development banks), only introduced a scheme in 1994.

It was a deposit insurance scheme designed similar to that of the private banks and did not

prevent institutions from failing. The reason for this was mainly the newly enacted

transparency requirement, but also the discussion of an upcoming EC-Directive aiming at

harmonising deposit protection.

At the same time in 1994 the Deposit Guarantee Schemes Directive 94/19/EC136 was

passed against the vote of Germany. Despite some amendments that made the directive

more compatible with existing deposit insurance schemes in Germany (like exemption of

banks that belong to an institutional insurance scheme and deletion of a limit to deposit

insurance in the directive), Germany decided to file a suit at the European Court of Justice

against the directive. The reasons were mainly the incompatibility of some elements of the

directive with existing German provisions. First, the directive envisaged an encompassing

compulsory membership, while the German system was based on voluntary membership.

Additionally, Germany was worried about the so-called “topping up”. Thus, the subsidiary

of a foreign bank had to be enabled to join domestic deposit insurance schemes to

increase its protection to the level of the host country. German politicians were concerned

about the fact that a foreign subsidiary could join the German scheme but would be

supervised by a foreign authority. Additionally, Germany did not agree to the “export-ban”,

which limited the cover that German banks’ subsidiaries could offer to the level prevailing

136 Directive 94/19/EC of the European Parliament and of the Council of 30 May 1994 on deposit-guaranteeschemes

94


in the host country. However, the law suit was rejected by the European Court of Justice in

1997.

In the meantime in 1997 at the EU level the Directive 97/9/EC137 on investor-compensation

schemes was passed. Since Germany had to introduce the directive 94/19/EC after the

rejection of the European Court of Justice, the introduction of both directives in one law

suggested itself. It was implemented with the Deposit Guarantee and Investor

Compensation Act138 from 1998. For the first time a statutory system of deposit insurance

was introduced in Germany. Since the German authorities were confident about the

existing private scheme, the passed law introduced a scheme which fulfilled the minimum

requirements of the directives, while it kept the private schemes largely unchanged. A

change of the existing schemes compliant with the directive was not possible without

changing fundamental characteristics, in particular, voluntary membership and possible

exclusion of members. Therefore, three different statutory schemes were introduced. One

for private deposit taking institutions, one for public deposit taking institutions and one for

non-deposit taking institutions (securities trading banks, financial services institutions,

investment companies). The law allowed delegating the operation of the schemes to

private entities. In case of the public and private deposit-taking banks this possibility was

used. Each, the federal association of private and of public banks, established daughter

companies. Both were initially funded by transferring the minimum capital of 1 million

euro from the private funds to the newly established daughters.

Comparable institutions for security trading firms did not exist. Therefore, a compensation

scheme (Entschädigungseinrichtung der Wertpapierhandelsunternehmen) at the German

Reconstruction Loan Corporation was established. Its capital was financed through an

initial one-time contribution of all assigned members.

137 Directive 97/9/EC of the European Parliament and of the Council of 3 March 1997 on investor-compensation schemes

138 Gesetz zur Umsetzung der EG-Einlagensicherungs-richtlinie und der EG-Anlegerentschädigungs-richtlinie (Einlagensicherungs- und Anlegerentschädigungsgesetz); 16.07.1998

95


In regards to covered claims from investment business and in regards to the amount of

protection, the statutory systems were mainly oriented at the absolute minimum

requirements of the directive. The protection was limited to 20,000 euro per depositor and

a retention of 10 per cent was introduced. Also, the covered depositors were limited. Not

covered were most financial institutions, public bodies, medium-sized and large

incorporated enterprises, insurance enterprises, as well as creditors in certain group

relationships.

However, existing private insurance schemes were amended so that they worked

subsidiary to the statutory schemes. Therefore, the protection level did not change, at

least for deposit-taking institutions.

Due to the absolute minimum in the statutory scheme, concerns regarding the “topping

up”-rule and the “export ban” were circumvented. The latter one was abandoned in 1999

by the European Commission anyways (Deutsche Bundesbank, 2000).

During the Financial Crisis, which started in 2007, limits for deposit insurance were

increased. The EU passed the Directive 2009/14/EC which raised the statutory deposit

guarantee level to 50,000 euro from the 30th of June 2009 and harmonised the level at

100,000 euro from the 31th of December 2011 (Schich, 2009). The changes were

implemented by the Act for the Amendment of the Deposit Guarantee and Investor

Compensation Act and of other Acts139 in 2009. Therefore, since July 2009 the amount

covered increased to 50,000 euro and the 10 per cent retention was abandoned. Since 2011

the covered amount was increased to 100,000 euro.140 Some other important changes were

introduced with the law. It increased the focus on early identification of imminent

compensation cases. This was achieved by an obligation of the funds to regularly conduct

audits at their member institutions. Intensity and frequency of the audits depended on the

riskiness of the respective institution’s business. Additionally, the BaFin had to inform

139 Gesetz zur Änderung des Einlagensicherungs- und Anlegerentschädigungs-gesetzes und andererGesetze; 25.06.2009

140 Additionally the payment delay was limited to a maximum of 30 days.

96


affected compensation schemes, if it obtained information suggesting that a compensation

case could occur at an institution. Additionally, the contributions to the funds by the

institutions were amended. The law demanded that the risk of an institution triggering a

compensation case is reflected in the contribution to the insurance scheme. Additionally,

the rules on special contributions were amended (BaFin, 2010).

In 2008, when the Bundesbank informed the government about increasing cash

withdrawals, Chancellor Angela Merkel and finance minister Peer Steinbrück guaranteed

all saving deposits in a public declaration. The guarantee was renewed when the loss

participation of depositors in Cyprus was discussed (Die Zeit, 2013).

In 2011 private sector banks decided to reduce the maximum amount covered by their

private scheme. It will be reduced from 30 per cent of liable capital to 8.75 per cent (that

means a minimum of 437,500 euro per depositor). Starting in 2015 this will gradually be

reduced until 2025 (Handelsblatt, 2011).

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Figure 9.1: Overview of deposit and investor protection schemes in Germany in 2013

Organization Institutional protection or statutorydepositor/investor protection

Voluntary deposit protection

Deposit taking institutionsUnder private law

Credit cooperatives andregional institutions of creditcooperatives

Institutional protection (operated by theFederal Association of German People'sBanks and Raiffeisen Banks, regionalcooperative associations)1

Other deposit-takinginstitutions (private commercial banks)

Statutory cover of a deposit 2 (maximum100,000) andup to 90 % of a claim arising frominvestment business3 (maximum20,000) (operated by theEntschädigungseinrichtung deutscherBanken GmbH) 1

Supplementary cover for deposits notcovered by depositor/investorprotection4 per depositor up to 30 % ofthe liable capital5 of the institutionconcerned (operated by the DepositGuarantee Fund of the FederalAssociation of German Banks)1

Under public law

Savings banks, Landesbanks,public building and loanassociations

Institutional protection (operated by theGerman Savings Bank and GiroAssociation, regional savings bankassociations)1

Other deposit-takinginstitutions

As in the case of other deposit-takingcredit institutions under private law(operated by theEntschädigungseinrichtung desBundesverbandes öffentlicher BankenDeutschlands GmbH)1

Voluntary supplementary cover of adeposit6 up to the full amount (operatedby the Federal Association of PublicBanks)1

Other institutions

Credit institutions withprincipal brokingunderwriting

Statutory cover up to 90 % of a claimarising from investment business3

(maximum 20,000) (operated by thecompensation scheme of securitiestrading firms(Entschädigungseinrichtung derWertpapierhandelsunternehmen) at theReconstruction Loan Corporation) 1, 7

Credit institutions andfinancial services institutionswith

investment brokingcontract brokingportfolio managementown-account trading

Investment companies withasset management for others

1 Administration of a fund's assets for the settlement of claims, compulsory contributions by the cooperating/assigned institutions.2 Protected deposits mainly account balances and registered debt securities denominated in euro or an EEA currency. Issued bearer bonds, inparticular, are among the items which are not protected. The protected group of depositors/investors consists mainly of individuals; financialinstitutions, public bodies, medium-sized and large incorporated enterprises, in particular, are not protected.3 Protected claims arising from investment business are mainly claims to ownership or possession of funds (denominated in euro or an EEAcurrency) or financial instruments. Protected group of investors, see footnote 2.4 Protected deposits are mainly sight, time and savings deposits as well as registered debt securities, irrespective of the currency in which theyare denominated (amounts owed to customers). Issued bearer bonds, in particular, are not protected. The protected group of depositors includesall non-banks (especially individuals), business enterprises and public bodies.5 Sum of core capital and prudential supplementary capital, with the latter being included only up to 25 % of the core capital.6 See footnote 4; certain public bodies (Federal Government, Länder, their special funds) do not belong to the protected group of legal persons.7 Unless an institution is assigned to another scheme in specific cases.


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12 Crisis management schemes

Like most EU-countries, Germany did not have a special insolvency scheme for banks until

recently. Instead, the general bankruptcy law applied to banks (Marinc and Vlahu, 2012).

However, there were certain exceptions to this law and some crisis management tools

were laid down in §45 and §46 of the Banking Act so that supervisors were able to deal

with potential crises. Paragraph 45 has provision allowing supervisors to take measures

that aim at preventing an insolvency, while § 46 deals directly with the case of an

insolvency.

Paragraph 45 allows the BaFin to put certain restrictions on banks that do not comply with

capital or liquidity requirements. In particular, it can prohibit pay-out of profits, granting of

new loans or investment in certain assets. Paragraph 46 goes further and gives the BaFin

a special role in case there is a risk that a bank may be unable to satisfy obligations to its

creditors, especially with respect to the safety of the assets entrusted to it. Most central to

this is that not the bank itself or creditors of the bank can file insolvency at the responsible

court, but only the BaFin is allowed to do so. This has been implemented to ensure that

external creditors do not aggravate the situation of an endangered bank by filing

insolvency prematurely. This shall allow a competent authority to be able to take

reorganisation measures. The BaFin also plays an important role since it is one of the few

official organisations that have the competence to identify problems in an institution

(Dombret, 2010). If the management would be forced by other laws to start an insolvency

procedure, a duty to notify the BaFin applies instead. According to §46, the BaFin can then

prohibit acceptance of deposits and granting of new loans. It can ban owners or managers

from doing business for the bank and order a commissioner instead. It has also the right

to enact a moratorium for certain banks or even a general moratorium.

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While in 2000 a special European insolvency regulation was established on the European

level, it explicitly did not target banks. Instead, in 2001 the directive 2001/24/EC141 was

passed. It was supposed to ensure that if a bank with subsidiaries in different member

states got troubled, only one insolvency proceeding was started (Dombret, 2010). The

directive was implemented in Germany in 2003 with the Act Implementing the Regulatory

Provisions for the Remediation and Liquidation of Insurance Companies and Credit

Institutions142. With the new law in place only the mother country is allowed to start an

insolvency procedure for a bank domiciled in the EU. Since then, Germany has to

recognise proceedings that started in other member states irrespectively of the

exceptions put forth in section 343 (1) of the insolvency code. Accordingly, territorial

insolvency proceedings are no longer possible for banks (BaFin, 2004).

A range of information duties apply since the implementation of the directive as well. If

reorganisation measures are ordered, the BaFin is required to notify the competent

authorities of the other states of the European Economic Area prior to or at least directly

following this step. This shall ensure that other authorities are able to initiate

accompanying measures at other entities under supervision. The BaFin is also obliged to

publish any reorganisation measures in order to ensure that affected third parties can

lodge an appeal, if their rights are impaired. Far-reaching information rights for creditors

and informational obligation for courts and insolvency administrators are introduced to

ensure the enforcement of creditor rights. Additional informational obligations among

different EU supervisory authorities are introduced in case a subsidiary in the EEC

belonging to an institution domiciled outside the EEC is endangered (BaFin, 2004).

The law implementing the directive was used to implement some additional changes in the

German insolvency rules for banks. The insolvency cause “imminent illiquidity” was added

141 Directive 2001/24/EC of the European Parliament and of the Council of 4 April 2001 on the reorganisationand winding up of credit institutions

142 Gesetz zur Umsetzung aufsichtsrechtlicher Bestimmungen zur Sanierung und Liquidation vonVersicherungsunternehmen und Kreditinstituten; 16.12.2003

100


to the existing causes of illiquidity and insolvency. This was done in an attempt to align the

insolvency rules in the Banking Act with the general Insolvency Code. However, this cause

comes only into effect, if a affected debtor agrees with it. In addition, the BaFin is given a

more central position in insolvency proceedings. It has the right to be heard before an

insolvency administrator is appointed. The insolvency administrator has to supply

demanded information to the BaFin at all times (BaFin, 2004).

After the intensification of the financial crisis starting in October 2008 several new laws

were introduced to stabilise financial markets and institutions in Germany. The first one

was the Act Establishing a Package of Measures for the Stabilisation of the Financial

Market in 2008,143 which aimed at restoring trust in the financial system and re-

establishing orderly business among financial institutions (Bundesministerium der

Finanzen , 2008).

The first Article of the law was the Act Establishing the Financial Market Stabilisation

Fund144. Its main purpose was to establish the Special Fund for Financial Market

Stabilisation145 (SoFFin) and the Agency for Financial Market Stabilisation146 (FMSA). The

SoFFin became the most prominent instrument in containing the financial crisis in

Germany. The Fund is operated by the FMSA. It had three main instruments at its disposal:

guarantees, recapitalisation measures, and risk assumptions. The fund had a volume of

400 billion euros for guarantees and 80 billion euros for recapitalisation measures. In

general, any company considered as a part of the financial sector could apply for aid.

However, the fund could attach certain conditions to its aid. Those could include a cap for

management payments, restrictions on bonus payments and profit pay-outs. It could also

demand the reorientation of the overall business strategy for example, abandoning certain

143 Gesetz zur Umsetzung eines Maßnahmenpakets zur Stabilisierung des Finanzmarktes; 17.10.2008

144 Gesetz zur Errichtung eines Finanzmarktstabilisierungsfonds

145 Sonderfonds Finanzmarktstabilisierung

146 Bundesanstalt für Finanzmarktstabilisierung

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high-risk businesses and taking into account the financing needs of the real economy, in

particular of SMEs. Conditions were imposed on a case-by-case basis and depended on

the details of required aid and the type of an affected institution (Bundesministerium der

Finanzen, 2008). The fund was supposed to stop taking on any new measures after

December 2009 and to phase out the already incurred actions.

The second Article of the law was the Act on the Acceleration and Simplification of the

Acquisition of Shares and Risk Positions of Financial Sector Enterprises by the Fund147. It

was supposed to make action of the fund more effective and quick. The law simplified

acquisition of shares in a financial institution by the SoFFin. In particular, some hurdles

from German general corporate law were removed. For the injection of capital into a

company the Fund had three main instruments available. It could initiate a fast capital

increase by the creation of a legally authorized capital148, a regular capital increase by a

simple convocation of the general meeting149, or a simplified creation of jouissance right

capital and the acceptance of silent partnerships. Those measures could be applied to

institutions that were not organised as corporations accordingly. They were accompanied

by a range of exceptions to other laws, which would inhibit fast and effective action by the

fund. The act also included rules for the organised reduction of the fund’s participation

after stabilisation was achieved (Winterfeld, 2011).

In April 2009 the Act for Further Stabilisation of the Financial Market150 was enacted. It

aimed at increasing flexibility and effectiveness of the tools available to the SoFFin. It

included 3 Articles amending the laws enacted in 2008 and enacted the new Rescue

147 Gesetz zur Beschleunigung und Vereinfachung des Erwerbs von Anteilen an sowie Risikopositionen vonUnternehmen des Finanzsektors durch den Fonds "Finanzmarktstabilisierungsfonds - FMS"(Finanzmarktstabilisierungsbeschleunigungsgesetz)

148 The management of a listed financial company was authorised to increase the nominal capital by 50 percent through issue of new stock to the Fund. Only the authorisation by the supervisory board, not by thegeneral stockholders’ assembly was necessary. Right issues by stockholders were excluded.

149 The period of notice could be shortened to one day.

150 Gesetz zur weiteren Stabilisierung des Finanzmarktes; 19.04.2009

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Takeover Act151. The amendments included an extension of the maximum maturity of

guarantees by the SoFFin from 36 to 60 months. It also included changes in the area of

corporate and takeover law, in particular, regarding the participation of the SoFFin in a

financial corporation.152 Additionally, the purchase of assets or participation in financial

corporations was simplified and fastened. The Rescue Takeover Act allowed the SoFFin

the nationalisation and expropriation of financial institutions until the 30th of June 2009

(Deutsche Bundesbank, 2010a). It was aimed at nationalisation of the Hypo Real Estate but

was never used since the SoFFin managed to get the necessary majority without measures

enabled by the law (Winterfeld, 2011).

Later in 2009 the Act on the Further Development of Financial Market Stabilisation153 was

enacted. It was also called the “Bad-Bank” law. It provided the SoFFin with an instrument

that enabled banks to clean up their balance sheets from toxic assets. The main purpose

of allowing banks to establish “bad banks” was to make it possible for them to get

planning security regarding the losses of their toxic assets. Additionally, banks were

enabled to split off entire business fields, if they attempted to redirect their business

model. There were three bad-bank options enabled.

The Special Purpose Vehicle Model154 enables the bank to establish a domestic special

purpose vehicle (SPV). It can transfer its complex structured assets at book value (30th of

March 2009 or 30th of June 2008) with a discount (normally 10 per cent) to the SPV. The

SPV buys the assets and finances them by issuing bonds, which it sells to the bank. The

SoFFin guarantees those bonds. The bank has to pay a fee for the guarantee to the SoFFin.

Also, for a maximum of 20 years it has to pay a yearly compensation out of its profits155 to

151 Rettungsübernahmegesetz

152 For example, the duty to make a takeover bid does not apply in case of the SoFFin.

153 Gesetz zur Fortentwicklung der Finanzmarktstabilisierung; 16.07.2009

154 Zweckgesellschaftsmodell

155 Ausgleichsbetrag

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the SPV amounting to the difference between the book value and the fundamental value156

of the transferred assets. When the SPV is liquidated and a surplus is achieved, it will be

distributed to the owners. If there is a deficit, the bank will be subject to a dividend

payment constraint, so that dividends are paid to the government instead of the owners

until the deficit is reimbursed. The immediate effect on the bank is that it can exchange

illiquid assets against highly liquid and safe bonds. This means it does safe equity (due to

the government guarantee there is no capital requirement) and it can use the bonds to

refinance itself. Potential losses from the assets are stretched over a long period of 20

years. This gives the bank planning security. However, it still holds the risks of the

transferred assets. Banks that want to use this model have to undergo a stress test, which

shall help to identify needs for improvements in banking strategy or risk management.

The second option is the Consolidation model157, which includes the establishment of a

federal winding-up agency.158 While it has the aim to also clean up the balance sheet of the

concerned banks, it allows to transfer a wider range of assets, which can potentially

include all risk positions and non-strategic business fields to the established agency. The

winding-up institutions are established as legal parts of the FMSA but remain

organisational and economically independent. The banks can transfer assets to the

winding up-institutions. Those institutions do their accounting according to the German

commercial code159, so that constant revaluation of the assets in accordance with their

market value is avoided, and are not regarded as banks so that they do not fall under full

banking regulation. Refinancing of institutions has to be organised by the transferring

bank or its owners. For the refinancing of structured assets the SoFFin can provide a

guarantee. Losses from the sale of transferred assets have to be borne by the direct or

indirect owners of the transferring institution. There is a special rule for public banks

156 Value of an asset at maturity estimated by an expert.

157 Konsolidierungsmodell

158 Bundesrechtliche Abwicklungsanstalt

159 Handelsgesetzbuch

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established that details loss-bearing among the savings banks and the states (Länder) in

case a Landesbank uses this consolidation model. For private institutions like listed

banks, where the fall-back to the owners is impracticable a solution similar to the special

purpose-model is envisaged where the losses are covered by profits of the transferring

institution over time. As a third alternative, the law allows regional German states the

establishment of winding-up institutions under state-law for winding-up or reorganisation

of their Landesbanken (Bundesministerium der Finanzen, 2009).

In addition the “Bad Bank”-Law allowed the SoFFin to stay active until the end of 2010

(Bundesanstalt für Finanzmarktstabilisierung, 2014).The Restructuring Act160 of 2010 was

established to enable a mechanism that allows for reorganisation, restructuring or

winding-up of systemically important banks without causing systemic instability. It was

established on a national level but structured in a way that would conform to an expected

EU-legislation in this area. The omnibus law contains 3 main articles. Article 1 introduces

the Reorganisation Law for Credit Institutions161, which introduces tools for the

restructuring and reorganisation of credit institutions. Article 2 changes the Banking Act

and gives the BaFin different options to intervene in endangered credit institutions under

certain conditions. In particular, the transfer procedure is introduced as a regulatory

restructuring or winding-up tool. Article 3 introduces the Restructuring Fund Act162, which

establishes a fund to finance measures connected with the reorganisation and rescue of

credit institutions (Deutsche Bundesbank, 2011).

The Reorganisation Law for Credit Institutions provides a two-stage procedure for the

recovery and reorganisation of banks. It has to be initiated by the institution itself and is a

tool for internal crisis management. The recovery procedure is regarded as a tool to

160 Gesetz zur Restrukturierung und geordneten Abwicklung von Kreditinstituten, zur Errichtung einesRestrukturierungsfonds für Kreditinstitute und zur Verlängerung der Verjährungsfrist der aktienrechtlichenOrganhaftung (Restrukturierungsgesetz); 09.12.10

161 Kreditinstitute-Reorganisationsgesetz

162 Restrukturierungsfondsgesetz

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manage a crisis situation well before the stage of insolvency. The reorganisation

procedure is inspired by the ordinary insolvency plan procedure and allows for an

intervention in third-party rights (Deutsche Bundesbank, 2011).

The recovery procedure has to be initiated by a declaration of the concerned institution at

the BaFin. The declaration has to include a recovery plan. It can involve any measure that

is suitable for the recovery of the institution as long as no intervention into third-party

rights is necessary. It is, however, possible to give preferential treatment to recovery loans

(up to 10 per cent of the institutions equity). The institution also has the right to propose a

recovery adviser. While the right to initiate the procedure stays with the concerned

institution, the right to apply at the responsible higher regional court in Frankfurt am Main

for the recovery procedure to be conducted remains with the BaFin. When transmitting the

appeal to the court it also gives its expert opinion on the proposed recovery plan. The court

then appoints the proposed recovery advisor (unless he is obviously not suitable) and

starts the procedure. The advisor is responsible for the implementation of the recovery

plan and gains far-reaching information rights and powers, such as to instruct the

management. He, in turn, has to report to the court and the BaFin regularly (Deutsche

Bundesbank, 2011).

The reorganisation procedure can be initiated by a declaration to the BaFin. This can be

done by the recovery advisor with the approval of the concerned bank, if the prior recovery

procedure failed. Alternatively, it can be done by the institution directly, if a recovery

seems unpromising. A reorganisation plan has to be transmitted to the BaFin with the

declaration. While the recovery procedure is available to all domestic credit institutions,

the BaFin can only apply at the court for reorganisation procedure to be conducted, if the

survival of the concerned credit institution is threatened, and if this would pose a systemic

threat. After hearing the BaFin, the Bundesbank, and the concerned institution, the court

then has to decide whether these conditions are fulfilled and whether the procedure

should be initiated. The reorganisation plan and the reorganisation advisor are central in

106


the procedure. The reorganisation plan includes information about the basis and the

effects of the plan. Additionally, in a second part it details how the legal statuses of the

involved parties are affected. The affected parties are grouped depending on their legal

status. Each group has to agree with the plan. Within each group a majority has to be

reached according to the number of votes and according to the amount of claims against

the institution. After the acceptance by involved parties the court has to confirm the plan

before it comes into effect (Deutsche Bundesbank, 2011).

While the introduction of the recovery and the reorganisation procedures provides

voluntary procedures to solve problems at an institution, the second Article of the Law

amends the Banking Act to extend the sovereign tools available for crisis management. It

includes the extension of the available supervisory measures in special cases. According

to §45 of the Banking Act, the BaFin can order measures for the improvement of equity or

liquidity level of an institution, if the assumption is warranted that an institution will not be

able to sustainably fulfil the statutory requirements. This rule was amended so that an

earlier intervention by the BaFin is possible. The measures were extended to include

ordering of a restructuring plan by the bank, which details how and in what time frame the

bank should re-establish an adequate level of capital or liquidity. The BaFin can demand

regular reports. It has the right to ask for an amendment of the plan, if it regards it as not

suitable. Additionally, it can appoint a special representative, entrust him with specific

tasks and assign him the necessary powers within the institution (Deutsche Bundesbank,

2011).

The central change in the Banking Act is the introduction of the so-called transfer order163,

which can be used in case the stability of the financial system is threatened. The BaFin can

use it to transfer all or some of a credit institution’s assets and liabilities to a new legal

entity (transferee legal entity) through spin-off. It allows the resort to rescue measures for

the stabilisation of an institution without consent of the owners. It makes it possible to

163 Übertragungsanordnung

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spin-off the systemically relevant parts of an institution to a new entity and focus

stabilising measures on this new entity, while for the leftovers of the old institution an

insolvency procedure is possible. A transfer order can only be used if the survival of a

credit institution is endangered and if this threatens systemic stability and there is no

other measure available to prevent the threat to the system with the same effectiveness.

Whether those conditions apply has to be evaluated by the BaFin and the Bundesbank


If the sum of the transferred assets and liabilities is positive, the transferring bank has to

be compensated for it. Usually this happens in the form of ownership shares in the

receiving entity. However, compensation in cash is also possible in certain cases. If the

sum of the transferred assets and liabilities is negative, the transferring institution is

liable to compensate the receiving institution in cash. An important feature of the law is

that in the national context the transfer of assets due to a transfer order cannot be a

reason for calling or termination of debt relationships. This precludes the “event of

default” problem, that means that only due to the sovereign action lenders can withdraw

funds from the institution, which would aggravate the overall situation. (Deutsche

Bundesbank, 2011).

Lastly, the third article of the Act contains the Restructuring Fund Act. The Act established

a restructuring fund for credit institutions at the BaFin. Every credit institution according

to §1 of the Banking Act has to pay into the fund. Only development banks are exempt. The

Fund has a target volume of 70 billion euros and is filled by yearly bank contributions

(estimated at roughly 1 billion per year). The law states that contributions should be levied

according to the systemic risk of an institution and uses the liability side of the balance

sheet (with some exceptions like customer deposits and equity) and the nominal value of

derivatives as a proxy (Deutsche Bundesbank, 2011). The calculation details are enacted by

an ordinance – the Restructuring Fund Ordinance164. The most recent version established

164 Restrukturierungsfonds-Verordnung

108


progressive multipliers with a minimum of 0.02 per cent (below 10 billion euros) and a

maximum of 0.06 per cent (above 300 billion euros). There is an exemption amount of 300

million euros where no fee is levied. This means big and systemic relevant institutions

have to contribute more to the fund than smaller and less important institutions. For the

nominal value of derivatives, a uniform rate of 0.0003 per cent applies. Contributions in

2011 to 2013 were between 13 - 13.5 per cent due to derivative positions and 86.5 – 87 per

cent due to liabilities. Actual contributions in those years were between 520 and 693

million euros. There are certain caps that shall ensure that banks are not overburdened by

the levy. Due to those, a large part of the fees (between 1.2 and 1.3 billion euros) was not

levied. Theoretically, they could be called in during later years but actual payments on

those outstanding fees were very small. The largest part of the contributions is carried by

only a few banks. Between seven and eleven institutions paid 75 per cent of the

contributions for the years 2011 to 2013 (Deutscher Bundestag, 2014). The fund is

supposed to finance restructuring or winding up measures for systemically important

institutions. It can, in particular, make use of the following measures: establish a bridge

bank, acquire participations, grant guarantees, and carry out recapitalisation measures


Since the 31st of December 2010 the SoFFin was not allowed to provide new stabilisation

measures. It was, however, still responsible for the already extended measures. Due to

the stress test of the European Banking Authority for European Banks the fund was

reactivated with the Second Financial Market Stabilisation Act165 from 2012 until the end of

2012. The Third Financial Market Stabilisation Act166 from the same year allowed continued

activity until the end of 2014 (Bundesanstalt für Finanzmarktstabilisierung, 2014).

165 Zweites Gesetz zur Umsetzung eines Maßnahmenpakets zur Stabilisierung des Finanzmarktes (ZweitesFinanzmarktstabilisierungs-gesetz); 24.02.2012

166 Drittes Gesetz zur Umsetzung eines Maßnahmenpakets zur Stabilisierung des Finanzmarktes (DrittesFinanzmarktstabilisierungsgesetz); 20.12.2012

109


In June 2013 the Act on the Shielding of Risk and the Planning of Recovery and Resolution

of Credit Institutions and Financial Groups167 was passed. Again, it was an omnibus law

that included several new regulations. The law included regulations regarding planning of

the recovery and winding-up of credit institutions in the first article. The second article

was concerned with the separation of certain risky activities in a separate institution. The

third and fourth articles were concerned with the criminal liability of a bank’s

management.

According to the first article, potentially systemically important credit institutions have to

draw up a recovery plan. Those plans have to be updated at least yearly. This is supposed

to make credit institutions consider measures that they could take in the event of a crisis,

so that they are able to solve it quickly, effectively and without external support. Groups of

institutions have to draw up recovery plans for the entire group. Whether an institution

poses a potential systemic risk is determined by the BaFin and the Bundesbank based on

the size of the institution, its domestic and foreign business, its interconnectedness with

the rest of the financial system, and its irreplaceability (BaFin, 2013). The BaFin lays down

the necessary content of a recovery plan in its Minimum Requirements for the Design of

Recovery Plans168. It published a first consultative version in November 2012. The draft

requires institutions first to analyse and depict the corporate structure including its

systemically important activities and its connectedness. Potential options to restore

viability in case of a crisis are determined and then examined with the help of a stress test.

The BaFin has the option to reject a recovery plan, if it does not meet these requirements.

If that is the case and the bank cannot correct the plan within a certain timeframe, the

BaFin can demand certain measures from the bank to enable a recovery (Freshfields

Bruckhaus Derninger LLP, 2013). The BaFin can demand that recovery measures are

initiated and implemented (BaFin, 2013).

167 Gesetz zur Abschirmung von Risiken und zur Planung der Sanierung und Abwicklung von Kreditinstitutenund Finanzgruppen; 07.06.2013

168 Mindestanforderungen an die Ausgestaltung von Sanierungsplänen – MaSan

110


Additionally, the BaFin established a winding-up unit. This unit draws up winding-up plans

for national and global systemically important institutions. It does constantly evaluate the

possibility of winding-up for all banks and banking groups. The winding-up plans for

systemically important institutions are drawn up by the BaFin in cooperation with the

respective institutions. The primary aim of these plans is to prevent or remove systemic

threats. The winding-up procedure in the plan shall only make use of financial resources

that are available according to the Restructuring Fund Act. Basic principles for all plans

are that losses should be borne first by owners, that creditors should not bear higher

losses than in a regular insolvency procedure, and that the management is dismissed and

personally liable. If the BaFin identifies barriers to the effective winding-up of an

institution, which is a potential threat to systemic stability, it can demand the removal of

the barrier. If the credit institution does not take the necessary measure to remove the

barrier effectively, the BaFin can order different measures such as a limit to certain

positions or the cessation of certain activities (Freshfields Bruckhaus Derninger LLP,

2013).

The second article of the Act bans certain risky or speculative businesses for deposit-

taking credit institutions and groups and for financial conglomerates that include such an

institution. The concerned businesses are in particular own-account trading, high-

frequency trading and credit and guarantee business with hedge funds or highly leveraged

alternative investment funds. However, a range of businesses can still be conducted.

These are, among others, long-term equity participations, market making and own

account trading as a service for third parties. Additionally, the activities are only banned, if

they exceed the threshold of 100 billion euros or exceed 20 per cent of the balance sheet

of the concerned institution and the institution’s three-year average of the balance sheet

exceeds 90 billion euros. The BaFin can ban additional business fields at individual

institutions if they threaten the institution’s solvency. If a credit institution wants to

continue these operations, it has to transfer them to a separate financial trading

111


institution. The new institution may still be part of the group but needs to fulfil certain

conditions. In particular, it has to be economically and legally independent, has to organise

its refinancing independently and its organisational structure has to be separated in

certain fields (Freshfields Bruckhaus Derninger LLP, 2013).

The third and fourth article of the act set out criminal sanctions for managers of credit

institutions, if they intentionally or negligently infringed their risk management duties and

due to this the survival of the credit institution was threatened. However, the sanctions

only apply if the BaFin requested the removal of the shortcomings in risk management

and the management did not comply. The sanctions include prison sentence up to 5 years

or fines up to 10.8 million euros. Similar sanctions were introduced for the management of

insurance companies (Freshfields Bruckhaus Derninger LLP, 2013).

112


13 Accounting

The accounting rules for banks remained largely the same from 1968 until first changes

became necessary when the EC provisions on annual accounts and consolidated accounts

of enterprises had to be implemented. This happened through the Annual Accounts

Directive Act169 of 1985 (Deutsche Bundesbank, 1992). All changes in general commercial

accounting rules also affected banks’ accounting.

The specific rules for banks, however, remained valid until the Bank Accounts Directive

86/635/EEC170 in 1986 was enacted (Fandré, 1987). It had to be implemented until 1993.

German accounting rules for credit institutions hitherto were set out in the Banking Act, in

a forms ordinance171, in accounting guidelines issued by the BAKred and in various Federal

and Länder laws, special regulations and orders. The necessary adjustment to the EC-

directives was used to completely reorganise the existing rules. Now all relevant rules are

contained in the Third Book of the Commercial Code, which was extended with a fourth

paragraph concerned with the complementary regulations for credit institutions, and in

the Accounting Regulation172.

The implementation was pursued in Germany by the adoption of the Bank Accounts

Directive Act173 in 1990 and the Accounting Regulation for Credit Institutions174 in 1992,

which replaced the forms ordinance and the accounting guidelines issued by the BAKred .

Special accounting rules for institutions of a particular legal form (e.g. private banks) or

business orientation (mortgage banks) were abolished. For the first time most of the new

169 Bilanzrichtlinien-Gesetz

170 Council Directive 86/635/EEC of 8 December 1986 on the annual accounts and consolidated accounts ofbanks and other financial institutions

171 Formblattverordnung

172 Rechnungslegungsverordnung

173 Bankbilanzrichtlinie-Gesetz; 30.11.1990

174 Verordnung über die Rechnungslegung der Kreditinstitute

113


rules had to be applied for the financial year beginning after December 31, 1992 (Deutsche

Bundesbank, 1992). The most relevant changes shall be outlined in the following.

The new accounting law redefined a number of concepts. The most significant one is the

reformulation of the concept of securities. A main concern was the distinction between

assets and liabilities not evidenced by a certificate175 and securities. This was difficult

because banks had developed a range of quasi-papers, which could not be easily

categorised. The new concept of securities used the marketability as a major defining

feature of securities.

The securities according to the new law had to be divided into three categories: securities

included in trading portfolios, securities held as fixed financial assets, and securities held

as liquidity reserve. The categorisation has important consequences for the valuation, the

level of undisclosed reserves, and the accounting of profits and losses. The provision,

however, is only clear for the category of securities held as fixed financial assets. Those

are securities which are intended for the use on a continuous basis in the normal course

of an undertaking’s activities. Since there is no legal definition of the other two categories,

the banks are relatively free in their categorisation. However, the commercial law

demands that banks have clear internal guidelines for the grouping, which also prevent

discretionary regrouping.

Regarding the disclosure of sale and repurchase agreements banks have to distinguish

between genuine sale and repurchase transactions176 and sales with an option to

repurchase177. The special regulation governing what was known as repurchase

transactions and sales with an option to repurchase178 was abolished.

175 Buchforderungen/-verbindlichkeiten

176 Echte Pensionsgeschäfte

177 Unechte Pensionsgeschäfte

178 Unechte echte Pensionsgeschäfte

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Regarding the disclosure of trust funds administered by banks hitherto only “loans on a

trust basis” had to be shown on the balance sheet. Under the amended rules all assets

and debts that a credit institution administers in its own name but for the account of third

parties have to be included. This attempted to increase the transparency of business that

involves neither credit, nor liquidity risk for the banks.

Additionally, the bank’s balance sheet format was changed. Compared to the previous

form for incorporated banks the number of asset items was reduced from 22 to 17 and the

number of liability items from 15 to 12 (Deutsche Bundesbank, 1992). The main changes of

the balance sheet format are listed in Figure 13.1.

Figure 13.1: Changes to the balance sheet format for credit institutions before and after 1992*

I. New balance sheet items and off-balance-sheet memo items

Designation of item Explanatory note Hitherto included in

Money market paper (sub-item ofasset item “Debt securities includingfixed-income securities”)

Intangible assets

Assets and liabilities which a creditinstitution administers in its ownname but on behalf of third parties

Debts evidenced by certificates

Subordinated liabilities

Fund for general banking risks

Placing and underwritingcommitments

Irrevocable lending commitments

Transferable Euro-notes, certificates of deposit,commercial paper and other rights evidenced bycertificates

Including EDP software acquired for valuableconsideration and derivative goodwill

Assets and liabilities which a credit institutionadministers in its own name but on behalf of third parties

Debt securities and other debts for which negotiableunregistered certificates have been issued

Liabilities which in the event of winding up or ofbankruptcy of a credit institution are to be repaid onlyafter all the claims of all other creditors have been met

Disclosed taxed general value adjustments (prudentialreserves)

Guarantees under which a credit institution undertakesto underwrite financial instruments or grant a loan if thepaper cannot be placed in the market

Every irrevocable commitment which could give rise to arisk

Loans and advances tobanks/customers or securities

Other assets

Loans on a trust basis (hitherto othertrust business has not been requiredto be shown on the balance sheet)

Bonds, own acceptances andpromissory notes in circulation

Liabilities to banks/other creditors orbonds

-

Contingent liabilities arising fromguarantees and other warranties

-

115


II. Balance sheet items and off-balance-sheet memo items no longer be shown

Designation of item Explanatory note In future included in

Cheques, matured bonds, interest anddividend coupons, and items receivedfor collection

Bills

Holdings of more than one-tenth of theshares of a corporation (sub-item ofasset item “Securities not required to beincluded elsewhere”)

Loans on a trust basis

Bank premises, furniture and equipment

Shares in a controlling company or acompany holding a majority interests

Value adjustments

Amounts due from affiliates

Collection items now included in the item “Otherassets”

In the future, bills not eligible for refinancingwith central banks to be treated like loans notevidenced by certificates

Deleted without replacement

To be included in the broader item“Assets/liabilities which a credit institutionadministers in its own name but on behalf ofthird parties”

Included in tangible assets

In the future shares in an affiliated undertakinghave to be shown by banks and non-banks in thesame item

In the future set-off of value adjustments againstthe relevant assets mandatory for all items

Hitherto off-balance-sheet memo item

Other assets

Treasury bills and other bills eligible forrefinancing with central banks (eligiblebills) or loans and advances to creditinstitutions/customers (non-eligible bills)

Assets/liabilities which a credit institutionadministers in its own name but on behalfof third parties

Tangible assets

Shares in affiliated undertakings

Sub-items of the asset items in question ordetails to be provided in the notes on theaccounts

* Pursuant to the Order concerning the accounting of credit institutions (Verordnung über die Rechnungslegung der Kreditinstitute (RechKredV)) of February 10, 1992, applicable for the first time to the annual accounts for the financial year beginning after December 31, 1992.


One of the main issues under discussion in Germany was the treatment of undisclosed

reserves. Before the change in legislation banks were allowed to enter receivables and

securities held as current assets179 in their balance sheets at a lower value than

prescribed by the Commercial Code to the extent that this is required in accordance with

sound business judgement for the protection against the particular risk associated with

banking. Gains and losses from changes in valuation and the realisation of profits and

losses can silently be offset against each other. The difference between market and book

value of those assets need not to be disclosed. The limit to reserve creation was given by

the principle of “sound business judgement” (Schütz, 1987). On the EC level this rule was

179 Wertpapiere des Umlaufvermögens

116


disputed and seen as incompatible with fair value accounting which became popular in

Anglo-Saxon countries in the 1990s. However, after longer discussions the directive left

options to the member states to allow for undisclosed reserves to a certain degree

(Fandré, 1987). Despite the fact that the German legislator made full use of the available

options, some restrictions on the creation of undisclosed reserves were established. The

creation of undisclosed reserves was limited to receivables against banks and customers

and securities held as liquidity reserves. The difference between the lower value and the

value which would result from the use of general valuation rules is limited to 4 per cent.

However, the Bundesbank argues that this is a relatively high level, so that it should not be

a hindrance in practice. Also, the limit only counts for newly created undisclosed reserves

but not for already existing reserves. An important feature of undisclosed reserve is that

an external reader of the balance sheet cannot recognise their purpose – loss

compensation, profit smoothing or reserve creation. This means the creation and

liquidation of those reserves should not be recognisable from the profit and losses

account. For this reason, the so-called cross-compensation, i.e. the compensation across

business lines between expenses and receipts in the area of lending and securities, was

allowed. The new law restricts this cross-compensation. It can only take place for

securities of the liquidity reserves and partial compensation is also no longer permitted.

Additionally, prudential reserves can be built up in the form of a published and then

unlimited increase in the “fund for general banking risk”. This position counts for

supervisory purposes as core capital, while undisclosed reserves only count as

supplementary capital (Deutsche Bundesbank, 1992).

For the first time, German accounting laws contained a provision governing currency

translation. The regulation was based on the Bank Accounts Directive and applies to credit

institutions only. For positions in foreign currency held as fixed assets calculation is based

on historical rates, unless there is a special cover for those positions. For other positions

117


in foreign currency and forward contracts the current rate method applies. That means

they enter the balance sheet with the year-end exchange rate. For all positions the

imparity principle has to be applied. That means negative translation balances have to be

included in the profit and loss accounts, while positive differences must only be included

under certain circumstances (micro- or macro-hedges available).

Figure 13.2: Disclosure of trading and valuation results from securities in the profit and loss accountsof credit institutions after the changes in the Bank Accounts Directive Act and the AccountingRegulation for Credit Institutions

Securities category Type of valuation Item in the profit and loss account

Securities included inthe trading portfolio

Strict lower value principle Net profit on financial operations

Net loss on financial operations

Set-off mandatory (section 340 c (1) of the Commercial Code)

Securities held asfinancial fixed assets

Diluted lower value principle Value readjustments in respect of participating interests, shares in affiliatedundertakings and transferable securities held as financial fixed assets

Value adjustments in respect of participating interests, shares in affiliatedundertakings and transferable securities held as financial fixed assets

Set-off optional, partial set-off not permissible (section 340 c (2) of theCommercial Code)

Securities held as aliquidity reserve

Strict lower value principle

Formation of undisclosedreserves permissible (section340 f (1) of the CommercialCode)

Value readjustments in respect of loans and advances and specificsecurities and provisions for contingent liabilities and for commitments

Value adjustments in respect of loans and advances and specific securitiesand provisions for contingent liabilities and for commitments

Set-off optional, partial set-off not permissible (section 340 f (3) of theCommercial Code)


The new rules also led to changes in the profit and loss accounting. The most important

ones stem from the new categorisation of securities. Depending on their categorisation

trading and valuation profit and losses have to be put into different positions. Also the

valuation methods differ depending on the categorisation. An overview is given in Figure

13.2.

118


Furthermore, extraordinary profit and losses have to be shown separately, so that the

result from normal operations is visible and clear in the accounts (Deutsche Bundesbank,

1992).

It was also enacted that credit institutions need to add notes on the accounts180, which are

as important in status as the balance sheet and the profit and loss account. Also, many

exemptions from general commercial law disclosure rules were abolished in line with the

Bank Accounts Directive. Therefore, the notes on the accounts can become quite

substantial. Out of the large number of reporting requirements that were introduced the

Bundesbank identifies the following as the most important:

disclosure of the accounting and valuation methods disclosure and justification of deviations from the accounting and valuation

methods, and description of their impact on the assets and liabilities, financialposition and profit and loss

breakdown of the operating income by geographic markets disclosure of the range of principal services offered report on calls under placing and underwriting commitments disclosure of the basis of the translation of foreign exchange amounts disclosure of the total Deutsche Mark amount of the assets and liabilities

denominated in foreign currency list of the types of uncompleted forward transactions and disclosure of the extent to

which these contracts were concluded for purposes of hedging or speculation. Inthe light of the more liberal disclosure practices observed in many other countriesthe Deutsche Bundesbank and the BAKred had advocated – albeit unsuccessfully –a disclosure of also the volume of these transactions which is growing steadily.

Another change was the information about maturity of assets and liabilities in the annual

financial statements. Their breakdown by maturity was based on the remaining maturity

instead of the initial maturity. The maturity breakdown was also shifted from the balance

180 Bilanzanhang

119


sheet to the notes to the balance sheet. However, this rule only had to be applied starting

in 1998 (Deutsche Bundesbank, 1992).

A next change in the accounting rules came about with the implementation of the directive

93/22/EEC181 in 1993. With its implementation in 1997 the concept of financial service

institutions was introduced and the firms that fell under the definition now also fell under

banking regulation. That means they also had to apply the special accounting rules for

banks according to the commercial code and the special Accounting Regulation for Credit

Institutions. However, in some areas the rules were slightly relaxed for the financial

service institutions, e.g. the disclosure requirements of §340 of the commercial code

applied only to financial service institutions that are incorporated companies. Also smaller

financial service institutions had lower requirements for their annual audit. Additionally,

for some credit institutions that only have a license for certain banking services, some

relaxations were introduced (Deutsche Bundesbank, 1998c).

In 1998 the Law of the Facilitation of Capital Acquisition182 was passed. It allowed listed

companies to use IAS183 or US-GAAP184 when drawing up their consolidated accounts. This

had an exempting effect on the duty to prepare consolidated financial statements in

accordance with the Commercial Code. In anticipation of an EU-regulation this allowance

was only valid until the end of 2004 (Deutsche Bundesbank, 2002).


182 Kapitalaufnahmeerleichterungsgesetz

183 International Accounting Standards

184 United States Generally Accepted Accounting Principles

120


With the regulation 1606/2002185 it became obligatory to draw up consolidated accounts

according to International Accounting Standards (IAS) for capital market-oriented

enterprises starting in 2005 (and in some cases 2007). It was left to the discretion of the

member states to decide according to which standards the annual accounts of capital

market-oriented enterprises and annual and consolidated accounts of non-capital

market-oriented enterprises should be drawn up (Becker and Peppmeier, 2011).

In Germany the Act to Reform Accounting Law186 from 2004, among other things,

concretised the regulation 1606/2002 and implemented the Modernisation Directive

2003/51/EC187 from 2003, the Threshold Directive 2003/38/EC188 from the same year, and

the Fair Value Directive 2001/65/EC189 from 2001 into German law (D’Arcy, 2004).

Regarding the options in regulation 1606/2002 for the drawing up of the annual accounts

German legislators decided that the usage of IAS is not possible. The calculation of tax and

profit-distribution is still founded on the accounts based on the Commercial Code.

Therefore, an annual account based on IAS can be drawn up and also published but only

for informational purposes. The consolidated accounts leave a choice for non-capital

market-oriented enterprises to use the IAS. Also, if an enterprise applies for admission of

a security on a domestic organised market, it had to draw up its consolidated accounts

according to international accounting standards (D’Arcy, 2004). The Act to Reform

Accounting Law only implemented the obligatory parts of the respective directives. From

185 Regulation 1606/2002 on the application of international accounting standards for capital market orientedenterprises

186 Gesetz zur Einführung internationaler Rechnungslegungsstandards und zur Sicherung der Qualität derAbschlussprüfung (Bilanzrechtsreformgesetz), 04.12.2004)

187 Directive 2003/51/EC on the annual and consolidated accounts of certain types of companies, banks andother financial institutions and insurance undertakings

188 Directive 2003/38/EC amending Directive 78/660/EEC on the annual accounts of certain types ofcompanies as regards amounts expressed in euro

189 Directive 2001/65/EC amending Directives 78/660/EEC, 83/349/EEC and 86/635/EEC as regards thevaluation rules for the annual and consolidated accounts of certain types of companies as well as of banksand other financial institutions

121


the Modernisation Directive the regulations regarding management reporting, audit

certificate, and transparency requirements for incorporated enterprises were

implemented. The most important change was the extension of the management report’s

content, so that it included information about opportunities and risks of the company and

aims and strategies of the management. Additionally, a comparison of actual versus target

performance should be enabled and the most relevant non-financial indicators should be

included.

According to the Commercial Code sub-groups of a group which are listed at a regulated

market within the EU, now have to draw up their own consolidated accounts. An exemption

because of the existence of consolidated accounts on a higher level within the group is no

longer possible.

Also, the consolidation prohibition according the §295 of the Commercial Code was

abolished. Until then, it was forbidden to include daughter organisation with dissimilar

activities in the consolidation group.

From the Fair Value Directive only the mandatory parts were implemented. The

corresponding changes therefore mainly concern necessary information in the notes to

the balance sheet and in the management report of incorporated enterprises. In the notes

to the balance sheet the Commercial Code now demands information regarding derivative

financial instruments. In particular, the fair value190 of financial assets and instruments

has to be published. In the management report information about the use of financial

instruments by the enterprise have to be included.

The conservative implementation of only mandatory parts of the directives into German

law was largely justified by a planned and more comprehensive reform of the German

accounting law.

The implementation of the Threshold Directive led to an increase in the thresholds in §267

of the Commercial Code. This paragraph defines the quantitative thresholds for the

190 Beizulegender Zeitwert

122


definition of small and medium-sized companies. The thresholds were increased by

roughly one sixth, so that more companies were regarded as small or medium-sized and

therefore could profit from lower reporting requirements (D’Arcy, 2004).

Parallel to the introduction of the new accounting standards in the EU the discussion

about enforcement of accounting standards was triggered by the Enron-affair. The

Committee of European Securities Regulators published a paper for the enforcement of

accounting standards in October 2002. In Germany the basis for the implementation of its

proposals was put in place by the Accounting Control Act191 in 2004. In principle it was

planned to establish a private organisation that would be responsible for the control of the

accounts of capital market oriented enterprises. A control is triggered if there is a

suspicion of accounting errors. This suspicion can be triggered by hints of investors or

creditors of an enterprise as well as by media reports. Random controls or controls upon

request by the German Federal Financial Supervisory Agency are also possible. The

cooperation of the controlled firms is voluntary; however they are obligated to provide true

and complete information by law. If there is no cooperation, the BaFin can enforce the

control by public law. Mistakes have to be published. In case of evidence for a criminal act

the BaFin activates the authorities responsible (D’Arcy, 2004).

In 2009 the Act Modernising Accounting Law192 was passed. It modified the accounting

rules of the Commercial Code and moderately harmonised them with the International

Financial Reporting Standards (IFRS). Additionally, the law aimed at simplifying and

scaling back some accounting rules for SMEs. While this was a reform not aimed at banks

in particular, there were many changes that were highly relevant for them.

191 Gesetz zur Kontrolle von Unternehmensabschlüssen (Bilanzkontrollgesetz); 15.12.2004

192 Gesetz zur Modernisierung des Bilanzrechts (Bilanzrechtsmodernisierungsgesetz); 25.05.2009

123


In the future credit institutions’ trading portfolios will be valued at their fair value. For

some time already a number of big banks have interpreted the principles of orderly

accounting193, in a way so that financial instruments assigned to the trading portfolios are

stated at their fair value. This is now formally allowed by the new law, even though the

legislator introduced some safeguards so that not the actual market value is entering the

balance sheet, but a haircut has to be made and a dividend block applies. While it was

originally planned to introduce fair-value accounting for all companies, its role in the

financial crisis raised much scepticism against it, so that it was only introduced for credit

institutions. The new subsection 3 of section 340e of the German Commercial Code

stipulates for those institutions that financial instruments assigned to the trading portfolio

are to be valued at fair value minus a risk haircut. The trading portfolio is oriented

alongside the definition of the trading book in the Banking Act. Hence, derivatives also

have to enter the balance sheet with their respective net-worth. However, the definition in

the Banking Act is broader and includes commodities as well. According to the new

accounting law, it means that besides fixed assets, current assets, and liquidity reserves

the trading portfolio now appears as a new category (see Figure 13.3). All financial assets

that are not held as fixed assets, liquidity reserve or current assets belong to the trading

portfolio. To prevent regulatory arbitrage a reallocation is only possible under very

restrictive conditions, such as a serious disturbance of the tradability of the asset. The

assets have to be valuated according to their fair value, but along the prudence principle, a

deduction for risk has to be made (Deutsche Bundesbank, 2010a).

193 Grundsätze ordnungsgemäßer Buchführung

124


Figure 13.3: Categorisation of financial instruments in accordance with the German Commercial Code(before and after the Act Modernising Accounting Law) and the German Banking Act

CommercialCode (old)

Assets treated ascurrent assets

CommercialCode (new)

Financialinstruments

assigned to thetrading portfolio

Trading book

Banking Act

- of which financialinsytruments

assigned to thetrading portfolio

Assets treated ascurrent assets

Banking book- of which claims

and securitiesassigned to the

'liquidity reserve'(section340f of theCommercial Code)

- of which claimsand securitiesassigned to the

'liquidity reserve'(section 340f of theCommercial Code)

Assets treated asfixed assets

Assets treated asfixed assets


The act itself contains no legal definition of the fair value. However, following international

definitions, it ‘may be understood to mean the amount for which an asset could be

exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length

transaction’ (Deutsche Bundesbank 2009, p. 56). For the determination of the fair value a

hierarchy of market prices is established (see Figure 13.4). This was inspired by the

problems during the financial crisis, where formerly active markets became illiquid for

many assets. Generally speaking, the fair value is equal to the market price of the asset in

an active market. If there is no active market, the fair value can be determined by

generally accepted valuation models. As a fall back the act allows to use the amortised

cost measurement. In this context the fair value determined last is regarded as the

amortised costs (Deutsche Bundesbank, 2010a).

125


Figure 13.4: Valuation hierarchy pursuant to section 255 (4) of the German Commercial Code after theAct Modernising Accounting Law


active market

generally accepted valuation model

amortised cost measurement

market price

model value

fair value last determined is deemed to beamortised cost

fair value

no

no

yes

yes

Valuation hierarchy pursuant to section 255 (4) of the German Commercial Code

126


Figure 13.5: Valuation of the trading portfolio / Accounting of hedge units after the Act ModernisingAccounting Law


To tackle the risk of counting unrealised valuation gains as income, the law does not allow

the actual market value to fully enter the balance sheet (see Figure 13.5). Instead a haircut

has to be applied. This haircut should account for the probability of default of the

unrealised gains. The act itself does not determine how this haircut should be calculated.

However, it refers to the internal risk management according to regulatory requirements.

This suggests the Value at Risk for the determination of the haircut. As a second measure

to preserve the principle of prudence, the act requires the accumulation of a risk reserve.

It is required that 10 per cent of the net income from the trading portfolio has to be

Balance sheet value of trading assets and trading liabilities

For values of the financial instruments assigned to the tradingportfolio – risk haircut or + risk premium

Allocation to the reserveitem in the special item

pursuant to section 340g ofthe Commercial Code

Possible dissolution of thereserve item in the specialitem pursuant to section340g of the Commercial

Code

10% of net trading portfolioincome

Up to 50% of the average of thenet trading portfolio income of the

last 5 years

Trading income Trading loss

Valuation and balance sheet reporting of the trading portfolio in accordance withsection 340e (3) and (4) of the German Commercial Code

Hedge relationship(valuation unit)

Hedged item

Individual financialinstrument or

group/portfolio offinancial instruments

Hedging instrument

Derivative of non-derivative financial

instruments

-hedgeable risks-offsetting changes in value or cash flows-effectiveness testing

Balance sheet reporting

“Freezing” methodValue adjustment

dispensed with as far asa hedge is effective

“Booking through”method

Value adjustment withregard to the hedged

risk in the hedged itemand the hedging

instrument

Hedge accounting pursuant to section 254 of the German CommercialCode

127


allocated to the special item for general banking risks. These allocations have to continue

until the fund covers 50 per cent of the average net annual income of the trading portfolio

of the last 5 years (only years with a gain are included). Since this is a compulsory

allocation, it effectively blocks dividend pay-outs based on these gains. The reserve can be

dissolved in case a loss occurred and so a countercyclical element is introduced (Deutsche

Bundesbank, 2010a).

The reform of the law introduced valuation units (see Figure 13.5). Their purpose is to

report hedging relationships in the balance sheet. The use of valuation units is not new to

German accounting but it was based on a practice-oriented interpretation of the principles

of orderly accounting194 only. The creation of valuation units is not codified in the new

accounting rules. The valuation units are used to account for hedging relationships. The

problem here is that according to German accounting rules a loss would lead to

depreciation, while the gains through the corresponding hedge cannot be booked as

income. A valuation unit whose purpose is to hedge against a change in the fair value is a

fair value hedge. A cash flow hedge, on the other hand, hedges the exposure to the

variability of the cash flow. There is a broad definition of hedgeable items, so that debt as

well as firm commitments and highly probably transactions are eligible. The law

recognises financial instruments as hedges. Hence, traditional financial instruments as

well as derivatives can be used. To build a valuation out of hedged items and hedging

instruments, they have to be exposed to the same risk but react to it in opposite ways.

Proof for this has to be provided and a hedging relation has to be recorded. The

effectiveness of a hedge has to be proven. If a hedge does not fully compensate for the

changes due to a risk, it is regarded incomplete. In this case a hedge has to be separated

in an effective part and an ineffective part. For the ineffective part regular accounting rules

including amortised cost and imparity principles apply. The recording of the valuation unit

194 Grundsätze ordnungsgemäßer Buchführung

128


in the balance sheet entails two different methods: freezing method195 or the booking

through method196. If the hedge is effective, the freezing method makes changes in

valuation and explicit recognition of the hedging relationship in the balance sheet

unnecessary. The booking through method records all valuation changes. In the profit and

loss account with an effective hedge those should compensate each other. The valuation

unit and the corresponding risk compensation become fully visible in the balance sheet.

Until now the freezing method was used in practice and the effectiveness of the hedge was

taken as given, after it has been proven once (Deutsche Bundesbank, 2010a).

The Act also changes the consolidation rules. During the financial crisis in 2008 it became

obvious that the existing German rules were relatively easy to circumvent. Until then the

consolidation rules in the Commercial Code were based on two concepts for determining

whether a potential subsidiary had to be included in the consolidated accounts of a parent

company. The so-called ‘single-management’ concept was not very specific and could

easily be refuted. The control concept was based on the control actually exerted over a

subsidiary. However, it largely recognised formal corporate ties and could be

circumvented with relative ease. The law has been changed now, in particular to include

special purpose vehicles. To do this, an overall renewal of the existing rules was

necessary. According to the new rules a potential daughter organisation has to be

included in the consolidated accounts if control is merely possible (see Figure 13.6). The

defining criteria for control are listed in subsection 2. Those include the already existing

indicators of control. It was complemented by special definition of control, aiming in

particular at companies set up to achieve a closely and clearly defined objective of the

parent company. They are regarded as being under control of the parent company, if the

parent company bears the majority of risks and opportunities from an economic point of

195 Einfrierungsmethode

196 Durchbuchungsmethode

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view. The Act explicitly refers to the rules of the SIC12 of the International Financial

Reporting Standards.

Figure 13.6: Consolidation requirements according to the German Commercial Code after the ActModernising Accounting Law


The information that has to be included in the required notes to the accounts has also

been extended. Most importantly the following three areas have been affected: off-

balance-sheet transactions, (derivative) financial instruments, and valuation units. For off-

balance sheet transactions there has to be information on the type, reason, risks, and

advantages of off-balance sheet transactions. Derivatives not recorded in the balance

Subsection 1 Subsection 2

Controlling influence

Majority of voting rights

Right to appoint majority of the membersof the executive bodies

Controlling agreement or provision in thearticles of association

Special purpose entity-economic perspective-majority of opportunities/risks-narrowly defined objective-broad definition of whatconstitutes a company

Parent company is a corporation*

Domiciled in Germany

Possibility of controlling influence

+

*Pursuant to sections 340i and 341i of the Commercial Code, credit institutions and insurers are required to draw upconsolidated accounts irrespective of their legal form

Consolidation requirement pursuant to section 290 of the German Commercial Code

130


sheet at their fair value require additional information. For financial instruments of the

trading portfolio information on determination of the fair value has to be provided. A range

of new information about the created valuation units has to be given. This includes the

types of valuation units, types of hedged risk, the effectiveness of the hedge, etc.


131


14 Corporate governance

Especially since the financial crisis in 2008 the corporate governance structure of financial

institutions have been criticised sharply because many studies argued that remuneration

schemes encouraged managers to take on greater risk in their management strategies,

which makes the financial sector much more unstable (Deutsche Bundesbank, 2009,

2009b, 2010). To address these problems the German government and its central bank

implemented various initiatives to enhance the corporate governance structure in

Germany during the last years. However, first regulatory attempts to influence the design

of corporate governance in banks were taken already in 2005. Generally, the main focus

was on the design of remuneration systems.

In 2005, the BaFin issued a circular letter, which addressed the problems of excessive risk

taking in financial institutions. These Minimum Requirements for Risk Management197

(MaRisk) defined some clear guidelines to assess risk more competently within the firm.198

Although the circular clearly explained that managers are overall responsible to impose

adequate monitoring and control mechanisms that adequately determines the level of risk

in its business operation so that the level of risk is always overseen on a regular and

ongoing basis, it does not go into detail about the role of remuneration schemes and its

effects on managers’ incentives to take on extra risk. Instead, it only briefly stated that

remuneration and incentives schemes should not contradict the aims set forth in the

strategy of the financial institution (Deutsche Bundesbank, 2005a).

After the financial crisis in 2008, it has widely been recognised that remuneration schemes

that link managers compensation to the performance of the company’s stock can incline

managers to take on a much higher level of risk because first, riskier investment

strategies are associated with higher returns when they are successful and second,

managers do not bear the full cost of unsuccessful investments. Since 2008, it has been

197 Mindestanforderungen an das Risikomanagement

198 The guidelines laid down in those circulars are binding for the concerned institutions.

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accepted that excessive risk taking by top managers can contribute to a financial crisis or

increase its severity to a great extent. Thus, the German supervisors took these aspects

more closely into account and included the assessment of remuneration schemes in the

new Minimum Risk Management Requirements in 2009.

This revision included more detailed guidelines for adequate remuneration schemes. It

determined that managers’ incentives and especially incentives given through

remuneration schemes should be aligned to the strategies and goals of the credit

institute. Further, remuneration and incentive schemes should now be structured in a way

that precludes any possibility for manipulation and avoids negative incentives. Additionally,

this circular letter also suggested the implementation of a supervisory board for

remuneration schemes. This remuneration board should oversee all schemes

implemented but especially of those managers and top executives in risk-relevant

positions. The remuneration committee should consist of staff members that are familiar

with the risk assessment procedures in the firm and its business strategies so that the

board consists of members with sufficient expertise to fulfil their task (Deutsche

Bundesbank, 2010). Remuneration schemes should take into account the individual’s

success of managers but also of its team members and of the company as a whole.

Furthermore, it suggests that negative developments should also be reflected in the

remuneration schemes paid. Additionally, remuneration schemes should be arranged with

a long term perspectives so that the performance of the staff can be closely monitored and

the incentives of them are better aligned to the companies’ strategies avoiding negative

incentives. (Deutsche Bundesbank, 2010).

Short after the renewal of the MaRisk, in September 2009 the Financial Stability Board

(FSB), an international organisation for the coordination of the work of supervisory

authorities and for common standard setting at the Bank for International Settlement in

Basle, released implementation standards for the FSB Principles for Sound Compensation

Practices. Those led the supervisors in Germany to replace the rules laid out in the

133


MaRisk with a separate circular. Additionally, in December 2009, the three largest

insurance companies and an additional eight big banks voluntarily committed themselves

to direct their remuneration schemes to a sustainable business operation, and to adopt

the standards of sustainable remuneration schemes determined by the G20 and to

implement the principles derived from it, which are stated in the Principles for Sound

Remuneration Practises introduced in September 2009 by the FSB (Deutsche Bundesbank,

2010).

The circular letter of the BaFin regarding the requirements for remuneration supervision

included all requirements set in the earlier circular but additionally presented much

greater details about what should be taken into account when remuneration schemes are

set. The circular was split into general and specific requirements, where the former apply

to all financial institutions and employees while the latter should only apply to managers

and employees engaged in high risk-related positions. The general section clarifies that

the management board is responsible to set adequate remuneration schemes for other

employees but their own, which is set by the supervisory board. Additionally, it explains

how remuneration schemes can lead to negative incentives through various channels. For

example, it clearly states that a high dependency on variable compensation can lead to

encourage excessive risk taking. Also, managers should not be guaranteed indemnity.

Instead, remuneration payments should take into account the success of the strategy

implemented by the manager and the organisational unit and also reflect negative results.

And last, interest conflicts can also lead to negative incentives. Thus, the difference

between the compensation schemes of control units and its corresponding controlled

department should be reasonable to avoid conflicts of interests. Additional requirements

refer to the transparency of the remuneration schemes and suggest that all schemes

should be acknowledged not only to the supervisory board but also to all managers and

employees. Additionally, the financial institution should include their practices of

remuneration standards in its code of conduct accessible to the general public. Again,

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remuneration schemes should be reviewed on a regular basis so that they remain

adequate in the light of the changing economy over time (Deutsche Bundesbank, 2009b).

The special requirements of this circular include additional details about the variable

compensation. Whether an institution has to apply those specific rules is determined by

the introspection of the financial institutions. The relevant criteria are the scope and the

complexity of its business operation, and the degree of international involvement. Fixed

and variable compensation should be proportionate so that neither a dependence on the

variable income occurs nor positive incentives are discouraged. Further, it argues that

guaranteed bonus payments are unreasonable and should only be paid, when for example

a new working contract is implemented. Further, the variable compensation should not

only represent the financial success as described above but also should consider non-

financial indicators such as customer’s satisfaction and contributions to the internal

working processes. Additionally, the financial institution should assess the level of risk it

has taken on including the cost of liquidity and interest payment expenses. The risk

orientation of the remuneration should not be safeguarded by hedge- or other counter

measures. The circular also included instructions for the payment procedures for variable

compensation. For example, a minimum of 40 per cent of the variable compensation can

only be paid out after three years so that managers are inclined to take focus on long term

business strategies to make their business operations more sustainable in the long term

and allow repayments to reflect negative developments over time (Deutsche Bundesbank,

2009b).

The circular also aimed to make remuneration schemes more transparent. It suggests the

regular publication of implemented remuneration schemes clarifying the proportion of

variable compensation, the amount of fixed compensation, and the number of employees

receiving them. Additionally, the institution should publically be able to demonstrate how

their remuneration schemes are aligned to the business operations and risk standards. To

enhance this, the supervisory board should also release annual reports to other officials.

135


This increases the pressure of financial institutions to justify their compensations paid and

thus, decreases their ability to increase managers’ compensations disproportionately in

relation to other staff members. These publications also allow better long term studies in

which different remuneration schemes and the resulting business success can be

evaluated more closely leaving scope for possible improvements in the long run (Deutsche

Bundesbank, 2009b).

In 2010 on the EU-level the CRD III package199 was passed, which also included detailed

requirements regarding the remuneration practices of financial institutions. In Germany

the Act on the Supervisory Requirements for Institutions’ and Insurance Companies’

Remuneration Systems200 from 2010 implemented the Directive and made the necessary

changes in the Banking Act.

The new rules tightened the general requirements and added a few details for those

managers and employees in the category for special requirements. A new §25 is

introduced in the Banking Act, which emphasizes that all remunerations should be paid in

a suitable fashion that aim to fulfil the sustainability of the development of the company

and should remain transparent to outsiders. To make variable compensation stricter, it

also includes an article stating that a company must not pay out its variable compensation

when the financial institution experiences equity or liquidity problems.

Additionally, a mandate for the Ministry of Finance is included to implement, in accordance

with the Bundesbank, a Regulation Governing Remuneration at Institutes, which defines

and substantiates the required standards. This was done in October 2010. The new

regulation replaced the circular from December 2009. It is in many regards similar to the

circular, but also includes some new paragraphs. It again has a general and a specific

199 Directive 2010/76/EU

200 Gesetz über die aufsichtsrechtlichen Anforderungen an die Vergütungssysteme von Instituten undVersicherungsunternehmen; 21.07.2010

136


part. The former applies to all institutions, while the latter only to relevant institutions. A

relevant institute is assumed if the balance sheet exceeds 40 billion euro or if the institute

has a balance sheet size above 10 billion euro and its internal risk assessment suggests

that it is a relevant institution. Within relevant institutions the specific rules only apply to

certain employees. Those are always the members of the management board and so

called risk-takers, which need to be identified by the internal assessment of the

institution.

The general part includes general norms for the appropriate design of remuneration

schemes for all institutions. Those include in particular the following requirements and

areas:

Alignment with aims and strategies of the institute Requirements for the compensation of the management board Suitability of the compensation schemes Avoidance of incentives to incur unreasonable risks Relation of fixed and variable compensation Compensation of control units Ban of guaranteed variable compensations Ban of safeguards contradicting the intended risk oriented compensation

structure Disclosure Information policies towards administrative or supervisory bodies Total variable compensation is not allowed to limit the ability of an institute to

regain or preserve equity

In relevant institutions for members of the management and for identified risk takers,

additional requirements apply. In particular the variable remuneration is going to be

regulated stricter. This concerns the pay-out of variable compensation, which cannot be

paid out completely, immediately, and in cash. At least 40 per cent of the variable part of

the compensation has to be paid out over a period of 3 to 5 years. For the top management

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and the level below top management the rules are even stricter and at least 60 per cent of

the variable payment has to be retained.

A minimum of 50 per cent of the variable payment has to depend on a sustainable

development and has to be retained for an adequate period of time. This part of the

payment can be made in shares or should depend on some economic indicators. It is now

clearly demanded that negative business developments should lead to cuts in the variable

compensation paid to the managers. Additionally, relevant institutions need to establish a

committee, which supervises the appropriateness of the remuneration schemes

(Bundesverband Öffentlicher Banken Deutschlands, 2011).

The CRDIV and the CRR made additional changes necessary. They were implemented in

2013 by the CRDIV Implementation Act201, which changed the Banking Act and updated the

Regulation Governing Remuneration at Institutes202 (19.12.2013), which was introduced in

January 2014.

The changes included for example, explicit restrictions on variable remuneration of all

employees and managers, which do prohibit variable compensation to exceed 100 per cent

of the fixed compensation paid. This limitation might be raised to 200 per cent of fixed

compensation by a vote of the owners.

The details of the requirements for remuneration schemes are laid out in the Regulation

Governing Remuneration at Institutes (Deutsche Bundesbank, 2013a). It is again split in a

general part, which is relevant for all institutions and a specific part only applied for a

subset of relevant institutions. An essential novelty is the determination of relevant

institutions. Institutions that are supervised by the ECB, which are categorised as

potentially systemically important and financial trading institutes203 automatically are

201 Gesetz zur Umsetzung der Richtlinie 2013/36/EU über den Zugang zur Tätigkeit von Kreditinstituten unddie Beaufsichtigung von Kreditinstituten und Wertpapierfirmen und zur Anpassung des Aufsichtsrechts andie Verordnung (EU) Nr. 575/2013 über Aufsichtsanforderungen an Kreditinstitute und Wertpapierfirmen(CRD IV-Umsetzungsgesetz)

202 Institutsvergütungsverordnung

203 Finanzhandelsinstitute

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regarded as relevant. Also, institutions with an average balance sheet size above 15 billion

euro unless they can prove with an internal risk analysis that they are not relevant. Those

institutions now have to appoint a representative for remuneration supervising the

adequateness of remuneration schemes (Bundesverband Öffentlicher Banken

Deutschlands, 2011).

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15 National regulations

Antitrust enforcement and competition policy15.1

In general, there is no freedom of trade in the banking sector. The Banking Act in §32 has

a provision, so that only after licensing by the supervisory authority banking business can

be taken up. However, this provision does not aim at restricting competition, but is

supposed to ensure the reliability and stability of the licensed institution. If the stated

requirements are fulfilled, the supervisory authorities have only limited and clearly

defined criteria to refuse licensing.

This was different until July 1958. Banking supervisors could refuse the approval to

establish a new bank or a new branch office based on the local or nationwide needs. The

supervisors used this instrument actively to curtail the expansion of banking networks

after the introduction of the Deutsche Mark in 1948. However, the Federal Administrative

Court declared this regulation to be not in conformity with the German Constitution and

therefore it had to be abandoned. Thereafter the branch networks of the banks grew

rapidly and the Bundesbank was concerned that an increased competition would lead to

instability in the banking sector (Deutsche Bundesbank, 1959).

However, historically there were other measures that restricted competition among

banks. Since the second half of the 19th century competition was limited by private

arrangements. Most importantly, there were local interest rate cartels.204 A decisive

trigger for additional measures limiting competition was given by the Reichsbank in 1907,

which wanted to curtail private banks’ recourse to its gold and foreign exchange reserves

by increasing their profitability. Following the initiative by the Reichsbank, the General

Agreement of the Association of Banks and Bankers205 of 1913 was established. It aimed at

increasing profitability of the banks by restricting competition in different areas, in

204 They were formed after the example of the Berlin ‘Stempelvereinigung’ of 1894.

205 Allgemeine Abmachung der Vereinigung von Banken und Bankiers.

140


particular interest rates, but also other terms and conditions. This was extended in scope

and geographically in the following years. Those agreements, however, were only among

private banks, while cooperative and savings banks had not joined. Only in 1928 the

different associations of the banking groups established a common agreement on

competition which largely regulated some aspects of banks’ advertisement (Büschen,

1998).

Statutory limits on competition in the banking sector were established in 1931 and were a

direct consequence of the banking crisis in the same year. By emergency decree the

government under German Chancellor Heinrich Brüning appointed a board of trustees and

an imperial commissioner for the banking industry. The commissioner was empowered

with far-reaching information and control rights. At the same time he gained influence on

banks’ terms and conditions. He initiated an agreement with the umbrella organisations of

the banks which included arrangements on interest rates and competition. After the

Banking Act of 1934, the agreement was updated and, in 1935 the arrangement was

declared generally binding. In principle it existed until 1965 when it was replaced by an

ordinance on interest rates. This ordinance was based on a provision in the new Banking

Act of 1961. It allowed the supervisors to release directives for the banks about their

conditions for loans and deposits. The directives aimed at supporting the credit policy of

the Bundesbank, preserving the functioning of the banking system, ensuring sufficient

credit supply for the macroeconomic development and support saving activity. However,

under the liberal thinking of the time, the ordinance was abandoned in 1967. The provision

in the Banking Act that allowed for such ordinances was completely eliminated in 1984

(Büschen, 1998).

While there were these specific norms for banks, there was also a general anti-trust law

in Germany. The anti-trust law206 of 1957 had a provision which excluded some sectors

206 Gesetz gegen Wettbewerbsbeschränkungen.

141


from falling under its full reach. This included the banks. It was justified with the fact that

banking, as a very trust-sensitive business which, in the case of a crisis, might also affect

other sectors of the economy, should be enabled to ensure its stability in some restricted

cases even by forming price cartels. This meant that certain regulations in the anti-trust

law that apply to most regular companies did not apply to the banking sector but were

instead regulated in the Banking Act. Contracts, decisions and recommendations of

individual banks or bank organisations are not subject to the anti-trust law. However, they

only come into force if they are related to a law, an approval or the supervision by the

supervisory authority, and if they are suitable to increase individual or sector-wide

performance of the banks for the benefit of the economy as a whole. However, for

contracts, decisions or recommendations within the meaning of the anti-trust law, a

report including a justification for the action has to be delivered to the anti-trust

authorities which can then prohibit certain actions. In 1974 the authorities made clear that

banks still fall under §25 of the anti-trust law which prohibits acting in collusion

(Büschgen, 1998).

Asset restrictions15.2

According to §12 of the Banking Act established in 1961, credit institutions were not

allowed to permanently hold real estate, ships and participations in companies that

exceeded an institution’s liable capital (Deutsche Bundesbank, 1961). This restriction

aimed at ensuring the liquidity of credit institutions (Deutsche Bundesbank, 1993). With

the third amendment to the Banking Act in 1985 §12 was modified. The concept of

permanence was dropped. Additionally, the term ‘participations’ was replaced by ‘shares

in capital’. All holdings of shares in the capital of other banks irrespectively of the amount

and all holdings in other enterprises exceeding 10 per cent were counted to the §12 limit.

Due to their similarity with participations holdings, jouissance rights capital207 also had to

207 Genußrechtskapital.

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be included in the limit of §12. With an increasing use of technology in banking business

the importance and value of furniture and equipment208 had increased and now needed to

be included as well (Deutsche Bundesbank, 1985). Regulations of §12 were largely aiming

to ensure the liquidity of credit institutions. With the fourth amendment of the Banking Act

in 1993 a new rule was introduced to limit the infection risk by affiliated undertakings.

According to it, credit institutions were not allowed to hold qualifying participating

interests exceeding 15 per cent of the institution’s equity in non-financial companies. The

sum of all such qualifying participating interests was not allowed to exceed 60 per cent of

equity. If one of the limits was breached, the exceeding amount needed to be covered fully

by equity which is then unavailable for fulfilling other regulatory requirements. A long

transition period until 2002 was granted (Deutsche Bundesbank, 1993).

With the Fourth Financial Market Promotion Act from 2002, so-called E-money institutions

were introduced in the Banking Act. To ensure their liquidity, asset restrictions were

established. They were only allowed to invest into assets with high liquidity and low risk.

Also, §12 of Banking Act was amended and restricted E-money institutions’ holdings of

participations, unless they were involved in the operations of the institute (Deutsche

Bundesbank, 2002a).

Conflict of interest rules15.3

Regarding conflict of interest rules there was an early regulation based on §6 of the

European Code of Conduct Relating to Transactions in Transferable Securities from 1977

(Cristea, 2001). Additionally, in Germany there were so-called Rules for Trader and

Consultants209 which stated some principles regarding the conduct of securities services.

Credit institutions, brokers and investment consultants voluntarily complied with those

rules. The rules were monitored by examination boards of stock exchanges. In 1980 the

208 Betriebs- und Geschäftsausstattung.

209 Händler und Beraterregeln.

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BAKred communicated that it regards separation of trading, execution and control as

essential. However, those early rules were largely based on voluntary compliance or self-

regulation. As part of the Second Financial Market Promotion Act210 from 1994 the

Securities Trading Act was passed, which included rules of conduct in section 5. The act

also served for the partial implementation of the EEC-Directive Regarding Investment

Services211 from 1993 which was almost adopted identically in wording. In §§31 – 33 the act

includes rules on conflict of interest. Those paragraphs contained general and specific

rules of conduct and organisational duties. In the general part in §31 of the act it is stated

that a financial service provider has to endeavour to avoid conflict of interest and if it is

unavoidable, the customer’s interests need to be safeguarded. From this general provision

certain prohibitions are derived. It is explicitly prohibited to give investment advices which

are not in the interest of the customer or are primarily in the interest of the financial

service provider. Also, there is an explicit ban on so-called front-running, which means

own deals executed with the knowledge about the customer’s order whereas the

institutions deal would be disadvantageous for the customer. According to §33 a financial

services firm has to organise its business in such a way that ensures its compliance with

the rules of conduct. In particular, it is stated that it should be organised in a way that

prevents conflict of interest between itself and its customers and among its customers. As

the BAKred did before the BAWe announced that it saw separation of trading, execution

and control as essential to prevent conflicts of interest (BAWe, 1996). In May 1997 the

BAWe released the Guideline for the Concretisation of the Commission-, Fixed-Price- and

Intermediary Business of Credit Institutions which details what measures the BAWe

regards as essential to comply with the rules of conduct (BAWe, 1998). In December 1998

an additional guideline regarding the organisational duties of credit institutions was

released. Among other things it recommends the establishment of Chinese walls, watch

210 Gesetz über den Wertpapierhandel und zur Änderung der börsenrechtlichen und wertpapierrechtlichenVorschriften (Zweites Finanzmarktförderungsgesetz, 26.07.1994.


144


and black lists to ensure the proper handling of sensible information. In addition, a

compliance department responsible to the management only should be established

(BAWe, 1999). In November 1999 the BAWe replaced those guidelines relevant for credit

institutions by similar ones, but now also applying to financial service firms. However, it is

explicitly stated that for small firms a ‘basic compliance’ is sufficient. The concrete

requirements for compliance depend on the size, business and structure of the relevant

institution (BAWe, 2000). In July 2000 the Guideline for the Concretisation of the

Commission-, Fixed-Price- and Intermediary Business of Credit Institutions was replaced

by a guideline with an extended scope which also included financial service firms (BAWe,

2000). With this and a further update in September 2001 it was also amended to new types

of services provided (BAWe, 2002). Following the introduction of the Act Implementing the

Markets in Financial Instruments Directive and Implementing Directive of the

Commission212 in 2007 the guidelines were abolished. However, the BaFin suggested that

they can still be seen as ‘best practice’ to comply with §31 – 33 of the Securities Trading

Act (BaFin 2007). The rules were largely transferred into the new Regulation Specifying

Rules of Conduct and Organisation Requirements for Investment Services Enterprises213

from 2007. It did implement detailed regulation of the Directive 2006/73/EG. The new

regulation concretised the new legal requirements for financial services. Here in §13 rules

regarding conflict of interest are detailed. There is a three-step procedure envisaged.

Financial service providers first have to identify possible conflicts of interest that might

lead to disadvantageous outcomes for the customer. Then measures have to be

implemented to avoid or overcome those conflicts. If despite the measures a disadvantage

for the customer cannot be precluded, it has to be disclosed to the customer

(Bundesministerium der Finanzen, 2007a).

212 Gesetz zur Umsetzung der Richtlinie über Märkte für Finanzinstrumente und der Durchführungsrichtlinieder Kommission (Finanzmarktrichtlinie-Umsetzungsgesetz); 19.07.2007.

213 Verordnung zur Konkretisierung der Verhaltensregeln und Organisationsanforderungen für Wertpapier-dienstleistungsunternehmen (Wertpapierdienstleistungs- Verhaltens- und Organisationsverordnung);23.07.2007.

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Customer suitability requirements15.4

With the Second Financial Market Promotion Act214 from 1994 for partial implementation of

the EEC-Directive Regarding Investment Services215 rules of conduct were introduced in

section 5 of the Securities Trading Act. Those included customer suitability requirements.

§31 – 33 contained general rules and derived specific rules of conduct and organisational

duties. As general rules they demanded that financial services were conducted with an

appropriate expertise, prudence and diligence and in the interest of the customer. In

addition, they demanded financial service providers to query their customers about their

experience and knowledge of transactions to be conducted, their aims and financial

background. A financial service institution was obliged to provide all the necessary

information about a transaction to the customer. This meant that information provided had

to be specific and appropriate for the investor and his investment. Necessary information

depended on the riskiness of the investment and experience of the investor and had to

enable the investor to make an investment decision in his best interest. This included

information about liquidity, repayment, fees and charges, but in particular about the risks

and returns of a financial product. For financial service providers this included the duty to

enable their staff to assess the customer’s situation, which may require special training

(BAWe, 1996).

In May 1997 the BAWe released the Guideline for the Concretisation of the Commission-,

Fixed-Price- and Intermediary Business of Credit Institutions which detailed how the

BAWe assessed whether a financial service providers complied with the rules of conduct.

In particular, it detailed the information that had to be provided based on the customer

assessment. It also clarified the firm’s duties for order executions and investment

214 Gesetz über den Wertpapierhandel und zur Änderung der börsenrechtlichen und wertpapierrechtlichenVorschriften (Zweites Finanzmarktförderungsgesetz, 26.07.1994.


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consulting. It gave information about requirements for so-called ‘execution only’ services

where the information duties are limited (BAWe, 1998). In July 2000 the Guideline for the

Concretisation of the Commission-, Fixed-Price- and Intermediary Business of Credit

Institutions was replaced by a guideline that also included financial service firms. In

addition, there were special information duties for transactions that involve third party

intermediaries. Moreover, the list of financial products and services that fall under the

regulation was extended (BAWe, 2001). The spreading of Day Trading was addressed with

an update of the guideline. Information duties of firms offering day trading services were

extended. In addition, in an accompanying note the BAWe formulated recommendations,

such as establishment of daily limits for Day Trading, separate disclosure of costs and

losses, etc. (BAWe, 2002).

The Act Implementing the Markets in Financial Instruments Directive and the

Implementing Directive of the Commission216 from 2007 also affected the §§31 – 33 of the

Securities Trading Act. Duties to obtain customer information and to inform the customer

appropriately were specified and more differentiated. In particular, it differentiated among

different customer groups so that now there were stricter requirements for private

customers than for professional customers. Also, there were stricter requirements

established for more complex products (BaFin, 2008).

Following the introduction of the Act in 2007 the guideline mentioned above was abolished.

However, the BaFin suggested that it could still be seen as ‘best practice’ to comply with

the §31 – 33 of the Securities Trading Act (BaFin, 2007). The rules were largely transferred

into the new Regulation Specifying Rules of Conduct and Organisation Requirements for

Investment Services Enterprises217. It implemented detailed regulation of the Directive

2006/73/EG. It laid out the details for categorisation of customers as professional, private

216 Gesetz zur Umsetzung der Richtlinie über Märkte für Finanzinstrumente und der Durchführungsrichtlinieder Kommission (Finanzmarktrichtlinie-Umsetzungsgesetz); 19.07.2007.

217 Verordnung zur Konkretisierung der Verhaltensregeln und Organisationsanforderungen für Wertpapier-dienstleistungsunternehmen (Wertpapierdienstleistungs- Verhaltens- und Organisationsverordnung);23.07.2007.

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or eligible third parties. It also included detailed regulation about the furnishing of

information and reports for clients, on the gathering of customer data for the assessment

of suitability and on the types of information that had to be provided. It also provided

information about when an assessment could be foregone or had to be less detailed (for

example, for non-complex instruments (Bundesministerium der Finanzen (2007a)).

Interest rate regulations15.5

Interest rate regulations were established in Germany in 1931 (Börsenzeitung, 2009). The

new Banking Act of 1961 allowed the Ministry of Economics in accordance with the

Bundesbank to establish interest rate regulations for the loan and deposit business of

banks. It could delegate this function to the banking supervisory office, which it did in

January 1962. During a period of consultation, the responsible federal department and

academia argued for an abolishment of the existing regulation, while the banking

associations and the Bundesbank voted for the maintenance of regulations. Eventually, the

enacted regulation fixed maximum deposit interest rates in absolute terms and left

changes at the discretion of the Ministry of Economics and the Bundesbank, while the

maximum for most debit interest rates were established relative to the Bundesbank’s

discount rate. The regulation was less encompassing, than before, so that it can be seen

as a partial deregulation (Deutsche Bundesbank, 1965). Further steps of deregulation

came into force in July, 1966, when regulation for large deposits was abolished.

Eventually, interest rates were fully liberalised in April 1967 (Deutsche Bundesbank, 1969).

Liquidity requirements15.6

Germany had liquidity requirements relatively early. There was a provision in the Banking

Act of 1934 that allowed for the enactment of binding liquidity requirements. However, it

was never used in practice. In 1951 the Bank of the German States218 regarded it as

218 Bank Deutsche Länder, predecessor of the Bundesbank.

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appropriate to establish norms for banks’ minimum liquidity. Those were no legal norms

but rather seen as guidelines that banks should fulfil if they wanted to use the Bank’s

refinancing support. However, they were relatively fast regarded as general accepted

norms, even by banks not dependent on the central bank (Deutsche Bundesbank, 1962).

When the Banking Act of 1961 was enacted it included a provision that required the banks

to hold adequate liquidity (§11). The details of this general requirement had to be

established by the banking supervisor in consultation with the Bundesbank in the form of

an ordinance. As a basis for this the Bank’s norms were taken as a guideline. This

arrangement to only establish general guidelines in the law and to provide the details in

an ordinance allowed for flexibility, practicality, quick responses to new experiences and

special situations. After far-reaching consultations with the banks and simulation studies,

the so-called Principles219 were established. While Principle I was concerned with capital

adequacy, Principle II and III were concerned with liquidity (Deutsche Bundesbank, 1962).

Principle II stated the so-called golden rule of banking that long-term assets should be

financed by long-term liabilities. The following types of assets were regarded as long-

term: long-term lending, syndicate holdings, participations, securities not quoted on a

stock exchange and land and buildings. As long-term liabilities own capital, own bonds220

in circulation, bonds sold in advance, long-term loans taken, 60 per cent of saving

deposits, 10 per cent of demand and time deposits of non-banks were acknowledged.

Additionally, central institutions of the savings and cooperative banking groups could add

20 – 50 per cent of time deposits of banks within their own groups (Deutsche Bundesbank,

1962).

Principle III limited the use of external funds for financing of short- to medium-term

assets which cannot be liquidated easily. It stated that credit institution’s debtors, its bills

drawn on debtors, its dividend bearing stock-exchange listed securities and its other

219 Grundsätze.

220 Schuldverschreibungen.

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assets were not allowed to exceed the total of the following funds: 60 per cent of sight and

time deposits of non-banks, 35 per cent of sight and time deposits of credit institutions, 20

per cent of savings deposits, 35 per cent of borrowed funds with a maturity or notice

period above one month and below four years, 80 per cent of customers’ availments of

credits opened at credit institutions abroad, 80 per cent of circulating own acceptances,

promissory notes, and own drawings credited to the borrowers, plus the financing

surplus/minus the financing deficit from Principle II. Stocks of goods could be excluded

from the assets. Long-term liabilities not used in Principle II could be included for the

financing of assets in Principle III (Deutsche Bundesbank, 1962).

If a credit institution failed to fulfil these requirements repeatedly or to a large degree, it

would have given ground to the assumption that the respective institution is not

adequately liquid. However, the supervisors could take into account special circumstances

and justify higher or lower requirements at certain institutions (Deutsche Bundesbank,

1962).

In 1969 an adjustment of the Principle I – III became necessary after new accounting

principles for banks were released. For Principle II and III that meant that there was an

adjustment of the items that had to be included on the asset and liability side and an

adjustment of the rates at which they entered. The general working of the Principles

however stayed the same (Deutsche Bundesbank, 1969a). Later on, in April 1973 Principle

III was amended again. This became necessary since the changes in 1969 led to a situation

where liabilities to banks with a maturity of 4 years or below could be included as funds in

Principle III at a rate of 35 per cent, while corresponding claims against banks were

excluded from the asset side. This was changed so that short term liabilities against banks

could be included at 10 per cent and medium term liabilities at 50 per cent. On the asset

side medium term claims against banks had to be included with a rate of 20 per cent. All

over, this increased liquidity requirements for banks to about the level of 1969. However,

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with the different rates on bank’s liabilities and assets there was still room left for

regulatory arbitrage (Deutsche Bundesbank, 1973).

The introduction of the European Passport, while leaving the liquidity Principles in general

unaffected, needed some amendment. While equity could be fully included as long-term

liability in Principle II, net liabilities with a parent company were only recognised at 50 per

cent in Principle III. After the introduction of the European Passport and the fourth

amendment of the Banking Act it was not necessary for subsidiaries of banks from EC

member countries to hold allotted capital as equity anymore. If the company now would

have decided to replace the equity by long-term liabilities, its liquidity position would have

deteriorated. The new Principles II and III were adapted and demanded that gross claims

and liabilities vis-à-vis a foreign parent company now enter according to their maturity

into Principles II and III instead (Deutsche Bundesbank, 1993a).

In 1998 Principles II and III were replaced by a new Principle II. The old principles aimed at

the balance sheet structure and tried to limit the refinancing risk. This means the risk

occurring from maturity transformation when a follow-on financing is not available at all

or at bad terms only. Differently, the new Principle II aimed at the so-called ‘call-risk’.

This could manifest in an unexpected use of credit lines, a sudden withdrawal of deposits

or a belated inflow of loan payments. Changes were necessary for different reasons. The

former Principles were based on original maturities. New accounting rules demanded

banks to categorise assets and liabilities according to their residual maturity. An

additional reason was that the liquidity principles also had to be applied now for financial

services institutions, while they were originally envisaged for universal banks. According

to the BAKred the existing rules did not take account of the specific characteristics of

those institutions (BAKred, 1999).

The new Principle II therefore demanded banks to display the call risk by listing liquid

assets and liquidity inflows and potential and actual outflows of funds in the next twelve

months according to their residual maturity or the assumed call probability in one of four

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maturity bands. The liquidity position of an institution had to be captured by the so-called

liquidity coefficient (one-month coefficient) which divided liquid assets by liquidity outflows

within the next month. It had to be reported monthly to the supervisors. A coefficient above

one showed, as a rule, that the institution was sufficiently endowed with liquidity.

Additionally, for monitoring purposes also the liquidity coefficient for the next eleven

months had to be calculated and reported. Focusing on the one-month coefficient

stemmed from the assumption that a solvent institution in the medium or long run should

not have problems to obtain liquidity. Differently, it was assumed that in the short term

unexpected events and market situations could stress the liquidity position even of solvent

institutions. Additional monitoring of the twelve-month horizon should have helped the

supervisors to identify early liquidity or structural refinancing problems (BAKred, 1998).

Principle II was replaced with the Liquidity Regulation221 at the beginning of 2007.

According to the Liquidity Regulation, banks can chose between two options to measure

their liquidity. There is a standard approach which in principle adopted the rules of

Principle II, so that for many banks there was no substantial change. The actual innovation

was the introduction of an escape clause which allows banks to use their own liquidity

measures and management techniques. For the use of own models222 the prior approval by

the BaFin is necessary. While there are some qualitative criteria that the liquidity models

have to fulfil, the regulation was not including any specifications regarding the methods to

be used. The requirements are formulated broadly, so that there is a high degree of

freedom for the institutions. According to the Bundesbank, this allows institutions to

achieve a convergence between calculations for supervisory and for internal purposes and

so reduces the overall administrative burden (Deutsche Bundesbank, 1998).

221 Liquiditätsverordnung.

222 Model in this context does not necessarily mean stochastic model, but implies the entirety of liquidity riskmeasure- and management and its embededness in the overall risk management of an institution.

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During the financial crisis it became clear that not only solvency but also liquidity is a

crucial factor for the survival of financial institutions. Consequently, one of the key

innovations of Basel III was the creation and introduction of comparable liquidity indicators

and monitoring tools. The EU adopted the Basel proposals in principle in the Articles 411 –

428 of the CRR where for the first time unified and binding rules for the monitoring of

liquidity were laid down. There are two key elements envisaged: a liquidity coverage

requirement (LCR) and a Net Stable Funding Ratio (NSFR) (Luz et al., 2013). Additionally, a

range of monitoring metrics is also intended to give the supervisors a more

comprehensive overview about institutions’ liquidity situation. The Basel committee only

published its revised framework on the LCR in January 2013 and the process of revising

and reviewing the framework for the NSFR may continue until 2016. This was also taken

into account when the CRR was prepared. The LCR will be defined in more detail by the

commission through delegated legislation until the 30th of June 2014 and will only

gradually become binding between 2015 and 2018. For the NSFR the commission will

decide by the end of 2016 if and how it may be implemented (Deutsche Bundesbank,

2013a).

The LCR requires institutions to hold a buffer of highly liquid assets to be able to

compensate for net liquidity outflows for 30 days under stressed conditions. Depending on

the type of liquid asset a haircut may need to be applied reflecting its duration, credit risk,

liquidity risk and typical haircuts for repos in periods of market stress. The stress scenario

includes market wide events as well as events specific to the respective institution, such

as the withdrawal of a portion of the clients’ deposits or the loss of access to certain

short-term refinancing sources. The LCR is calculated as liquid assets divided by net-

liquidity outflows under the stress scenario within the next 30 days. However, the LCR will

be implemented only gradually, so that the ratio that has to be reached is 60 per cent in

2015 and increases yearly to reach 100 per cent by 2018 (Luz et al., 2013).

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Additionally, Article 413 of the CRR requires the institutions to ensure that long-term

obligations are adequately met with a diversity of stable funding instruments under both

normal and stressed conditions. However, at the moment only a reporting requirement is

established which later should, if found appropriate, become a binding rule. With the

NSFR, the CRR introduces a reporting requirement for long-term liquidity indicators. The

institutions to which the CRR applies have to report the balance sheet positions that

provide stable funding and those that require stable funding. The NSFR is calculated as

the positions that need stable funding divided by the positions that require stable funding.

The positions will have to be reported according to their remaining maturity within 5

maturity bands, with the lowest category being within three months, and the highest above

twelve months. However, it is only an informative indicator and there is currently no

minimum ratio established. The commission will, based on the collected information,

prepare a legislative proposal on how to ensure that institutions use stable sources of

funding. Until then the member states can maintain or introduce national rules (Luz et al.,

2013).

Restrictions on geographic reach15.7

In Germany there are no legal restrictions on the geographical reach of banks. However,

for the savings and cooperative banks a so-called regional principle applies by their

respective statutes. That means that in Germany around 75 per cent223 of the institutions in

the banking sector in Germany follow a regional principle.

For the savings banks the regional principle is anchored in the model statutes, different

state laws for the savings banks and in North Rhine Westphalia in the Savings Banks

Regulation. The regional principle states that generally the savings banks should only be

active in the area of their respective guarantor224 which is often a city, municipality or the

223 However, their share in assets is smaller.

224 Gewährträger.

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administrative district. However, there is some flexibility in the respective rules. It is

strongest regarding the granting of loans where the public mission is most clearly

expressed and it is stated that the savings banks funds should primarily be used to

support the local economy and population. Regarding the deposit business, there is higher

flexibility and it is in principle allowed to take in funds from other regions. However, this is

limited in practice since the savings banks are not allowed to open branches outside their

territory and are encouraged to not actively acquire business outside their region. This

regional anchoring prevents banks from concentrating on fast growing areas only.

Therefore, it prevents that some German regions are neglected and have no access to

financial services and loans. Therefore, the regional principle is often seen as a

contribution to an even development of all German regions (Gärtner, 2003)

For the primary institutions of the cooperative banks comparable rules exist that anchor

them in their respective regions (Büschgen, 1998). However, there is no legal basis for this

local focus but it has historical roots. The cooperative banks have been founded as local

institutions to support their local members. From this local focus they have spread their

business area paralleling the growing focus of their customers. This means there are also

overlaps in the business area of different cooperative banks. In these areas they compete

not only with banks from the other banking groups, but also among themselves.225

225 Information retrieved from the central organization of the cooperative banking group (Bundesverband derDeutschen Volksbanken und Raiffeisenbanken)).

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16 The Banking Union – a German perspective

The current state of the Banking Union16.1

In the aftermath of the financial crisis, the establishment of the Banking Union is

fundamentally changing the framework of financial supervision and regulation in the Euro

Area. The Union contains a Single Supervisory Mechanism (SSM) and a Single Resolution

Mechanism (SRM), closely related to the Banking Recovery and Resolution Directive

(BRRD). Though, a common deposit guarantee scheme was once envisaged, it is no longer

considered in current political discussions. Instead, a further harmonisation of national

deposit guarantee schemes is being pursued.

The first political discussions concerning a Banking Union began in mid-2012 and since

then the initial ideas have taken on a more concrete shape. The legal basis for a single

supervisor under the auspice of the ECB was established at the end of 2013 by the

European Parliament and the European Council. After a 12 month preparation period, the

ECB will assume responsibility for the supervision of banks in all Euro-Area and EU

member states willing to join the SSM. The ECB will directly supervise the systemically

important banks. Whether a bank is classified as important depends on its balance sheet

size (absolute and in relation to home country GDP) and its cross border activities.

Additionally, the three largest institutions of a member state will automatically be deemed

systematically important. According to those criteria, the ECB will have direct supervision

over 128 of the 6,000 banks found within the Eurozone, accounting for 80 per cent of

European banks’ balance sheets. For less important banks, national supervisors will still

pursue the day-to-day supervision, according to the regulations and instructions of the

ECB. Before the ECB takes over supervision, a comprehensive assessment of the

concerned banks will be pursued, so that a high degree of transparency regarding the

risks is achieved. This assessment contains three parts: 1) A newly established Risk

Assessment System will be used to get an extensive overview about the existing risk

factors; 2) An Asset Quality Review will assess the proper valuation of the banks’ assets;

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and 3) Finally, a stress test by the ECB and the European Banking Authority shall asses

the robustness of the large European banks against adverse macroeconomic

developments. Any recapitalisation needs discovered during this assessment will be

regarded as having developed under national responsibility, and will therefore primarily

be corrected at the national level (Deutsche Bundesbank, 2014).

The legislative framework for the second pillar of the banking union, a common European

restructuring and resolution regime, was just passed by the European Parliament in mid-

April 2014. It contains two main elements. The Bank Recovery and Resolution Directive

(BRRD) establishes instruments for the recovery and the winding-up of banks. A

centralised European decision making mechanism is established by the SRM-regulation.

The BRRD applies to all institutions within the EU. However, the use of the established

recovery and resolution powers is left to the discretion of the member states. Besides the

duty for all members to establish national resolution agencies, it establishes rules and

instruments in three areas: prevention, early intervention and resolution. In the area of

prevention, it demands that banks and resolution agencies establish recovery and

resolution plans and remove potential obstacles to them. This is similar to the already

established crisis management scheme in Germany. In the area of early intervention, it

establishes more extensive intervention rights of the competent authorities. For the

resolution of banks, it lays out the basic principles, aims and conditions. It also establishes

the instruments for a resolution or restructuring process. An important part are the bail-

in rules, which try to ensure that the owners and creditors of the institution are the first to

bear losses, before drawing on external funds. Depositors are still insured. However, it is

planned to demand the contribution of the deposit insurance funds (Deutsche

Bundesbank, 2014).

With the SRM, an EU authority will be responsible for decisions regarding large Eurozone

banks that run into trouble. It will contain a Single Resolution Board (SRB), which makes

the resolution decisions. The SRB consists of a chairman, a vice chair, four permanent

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member and the relevant national authorities. Additionally, the European Commission and

the ECB will participate as observers (European Commission, 2014). A European

Resolution Fund (see below) may be used to cover the costs of a resolution process. The

SRB will be deciding on resolution plans and actual resolutions for all banks under the

direct supervision of the ECB. Additionally, it will decide upon cases where the European

Resolution Fund will be used and when member states have transferred competencies to

the SRB. Otherwise, resolution powers remain with the national authorities, which

however have to apply the common rules laid out in the BRRD (Deutsche Bundesbank,

2014). A resolution procedure is normally initiated by the ECB, as the supervisor. The SRB

will then prepare a resolution plan and submit it to the European Commission. The

Commission can reject the proposal under certain conditions directly. It also can propose

to the Council to reject or amend the proposal in certain regards. In particular, a

necessary condition for using the SRM is that there is a public interest. If a proposal is

objected on the grounds that there is no public interest, the institution will be orderly

wound up according to national law (European Commission, 2014). In substance the

resolution of bigger and nationally and internationally important banks depends on a

range of discretionary decisions including political bodies. Far reaching bail-out is still

possible.

The European Resolution Fund is intended to finance resolution processes when, after the

bail-in of owners and creditors, there are still financing needs. The fund will be financed

by a levy on banks, and has a target volume of 55 billion euros . Banks will start being

levied from 2015 on. It will be enabled to extend its means by levying special contributions

or by taking loans. The use of the fund is tied to the use of the bail-in instruments. Only if

the owners and creditors have borne losses to a certain minimum degree, can one resort

to the fund’s money. Additionally, the national deposit insurance systems shall contribute

the amount they would need to pay, in case of a regular insolvency procedure. This is to

prevent national costs from being shifted to the European level (SVR, 2013). The funds

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means will be accumulated over a period of eight years in national pots. Those national

pots will be gradually mutualised so that, in the first year, 40 per cent of the national

contributions will be pooled, in the second year, 60 per cent, etc. (European Parliament,

2014).

While it had been originally planned to create a European deposit insurance system, those

plans are no longer pursued on a European level. Instead, a further harmonisation of the

existing national schemes was agreed upon. The already prevailing coverage of 100,000

euro per depositor was kept. The financing base and the funding-level were further

harmonised and the pay-out delay was fixed at a maximum of seven working days

(European Parliament, 2013).

The debate in Germany16.2

The following will present an overview of the general stance in Germany on the issue of

the Banking Union and the further harmonisation and centralisation of regulatory

competencies at the EU level. The official concerns and positions of relevant actors in this

field, namely the Bundesbank, the Council of Economic Experts, the Ministry of Finance,

and the different Banking groups, will be outlined and discussed.

One of the main concerns of most actors (Deutsche Bundesbank, 2013b; Die Deutsche

Kreditwirtschaft, 2013; SVR, 2013) is the introduction of the SSM on the basis of Article 127

of the Treaty on the Functioning of the European Union. This was necessary for a swift

introduction of the new supervisory framework without changing primary EU law.

However, some consider this legally problematic since Article 127 allows only for the

conferment of specific tasks upon the European Central Bank, while in the case of the

SSM the basic task of banking supervision is conferred (Die Deutsche Kreditwirtschaft,

2013).

Besides those concerns about the legal validity of the establishment of the SSM based on

Article 127, there are additional concerns that derive from the construction of the SSM

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within the ECB’s institutional framework. According to the existing primary law, the

ultimate responsibility for supervision has to remain with the Governing Council of the

ECB. Therefore, the same body that is responsible for the monetary policy in the Euro Area

will be responsible for supervisory tasks (Deutsche Bundesbank, 2013b). This is seen as

critical by many commentators. A potential conflict of interest could undermine the

effectiveness of monetary policy or banking supervision. In case of problems at an

institution, the ECB’s supervisory competence may be drawn into doubt. Therefore, it may

be inclined to use monetary policy, e.g. liquidity injections, to save a bank silently. On the

other hand, it may use its supervisory powers to ban the use of certain financial

instruments that potentially undermine monetary policy (Deutsche Bundesbank, 2014; Die

Deutsche Kreditwirtschaft, 2013; Hartmann-Wendels, 2013; Schäuble 2014; SVR, 2013).

Regarding the participation in the Banking Union of EU members that are not part of the

Euro Area, the fact that the ECB Council will have the ultimate decision making power is

also seen as problematic. While they will have the option of joining the SSM voluntarily,

non-Euro Area EU member states cannot be represented on the Governing Council of the

ECB. Therefore, their incentives to join are limited (Deutsche Bundesbank, 2013b; SVR,

2013). In the current framework the problems are addressed by establishing a supervisory

board, which adopts draft decisions. Those are submitted to the ECB Council. Drafts are

deemed as accepted if the Council does not reject them within 10 working days. If it rejects

a draft, the draft will be negotiated in a Mediation Panel.226 Additionally, the ECB Council is

supposed to hold separate meetings for monetary policy and supervisory issues. To

balance the missing participation rights in the Council for non-Euro Area member states,

they are granted far reaching safety nets, such as the option to leave the SSM and not to

be bound to supervisory decisions of the SSM (Buch et al., 2013).

226 Consisting of one member per participating EU Member State, chosen from among the members of the

Governing Council and the Supervisory Board.

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While it seems generally understood that the use of Article 127 as a basis was necessary

to establish the Banking Union relatively quickly, most experts and institutions wish to

ameliorate the above mentioned legal problems by giving the Banking Union a safer legal

basis on the ground of an amended primary law. Thereafter, it is advocated to revise the

institutional structure within the ECB to give ultimate decision making power and

responsibility to the Supervisory Board, or even to establish a separate institution outside

of the ECB (Buch et al., 2013; Deutsche Bundesbank, 2013b; Die Deutsche

Kreditwirtschaft, 2013). Given the institutional structure of supervision at the ECB, the

Council of Economic Experts has advised that the bifurcated banking supervision process,

overseen by two separate institutions, be reconsidered in order to minimise friction losses

(SVR, 2013).

One of the more controversial points in Germany is the question of which banks should be

supervised by the ECB and which by the national supervisors. In Germany, there are

different positions advocated. One asks for direct ECB-supervision for all financial

institutions in all member states. The other only wants systemically relevant institutions,

supervised by the ECB, while less relevant institutions stay under the supervision of the

national authorities (for the supporters of the two positions see below). For the first

position, the main argument is that a central supervisor would be most capable of pushing

for uniform supervisory standards. This would prevent regulatory arbitrage among the

member states and would bring about a level playing field. Advocates of the separation of

supervision among national supervisors and the ECB argue that national authorities have

better knowledge regarding the specifics of the national banking systems and are

therefore better suited for the supervision of local smaller banks. The system currently in

preparation is oriented along the lines of the latter position. However, there is a

compromise in so far that the ECB can assume responsibility for the supervision also of

smaller banks if that is necessary to secure uniformly high supervisory standards.

Additionally, the standard setting of the EBA will help to limit the threat of a two-class

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supervisory system (Hartmann-Wendels, 2013). The Bundesbank supports the currently

pursued solution, even though it considers the threshold of 30 billion euros as too low for

Germany. Additionally, the Ministry of Finance regards it as important that the supervision

of non-systemically important banks remains at the national level. German banks are

seemingly divided on this issue. The German savings banks, the cooperative banks and the

public banks regard the European supervision only as sensible for large, systemically

relevant and internationally active banks, but not for small, locally active and systemically

inconsequential banks. They also consider a higher threshold (50 – 70 billion euros) as

more suitable. They argue that the supervisory requirements for a large, systemically

relevant bank may be inappropriate for small, local banks and might overburden it, so that

an undifferentiated supervisory regime may endanger the heterogeneity and diversity of

the European banking systems (Bundesverband der Deutschen Volksbanken und

Raiffeisenbanken, Deutscher Sparkassen und Giroverband, Bundesverband Öffentlicher

Banken Deutschlands, 2012; , Bundesverband der Deutschen Volksbanken und

Raiffeisenbanken, Deutscher Sparkassen und Giroverband, 2014). Contrarily, the

association of private bank advocates that all banks should be supervised directly by the

ECB. The Association of foreign banks also supports a further Europeanization of

supervision and advocates gradually placing all banks under the supervision of the ECB

(Deutscher Bundestag, 2013a). The Council of Economic Experts also prefers a solution

where the ECB is entrusted with more competencies and can assume supervision of less

significant institutions and even has to do so if an institute falls below critical equity

values. Hoping to prevent a division of supervisory practices between national regimes and

ECB supervision, the Council sees this issue as particularly important since the both large

and the small banks within the savings and cooperative sector are connected via their

respective group structures and so a separation of supervision might lead to conflicts

between the national supervisors and the ECB (SVR, 2013).

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In the longer term, the Council of Economic Experts and the Bundesbank would welcome

the full participation of all EU member states in the Banking Union. The Council of

Economic Experts finds this to be critical, since many Euro Area banks have high market

shares in non-Euro Area countries, in particular in Eastern Europe. However, they do not

regard the current institutional set up as appropriate to achieve this (see above) (Deutsche

Bundesbank, 2013c; SVR, 2013).

Another important issue that is particularly stressed by the German banks is the

importance of a clear separation of tasks between different supervisory and regulatory

authorities at the national, Euro Area and EU level. The Bundesbank, the German banks

and the Ministry of Finance urge for a clear division of tasks between the EBA and the SSM

so that questions of supervision are only in the auspice of the ECB and regulatory

standards are only set by the EBA. Similarly, they demand that there is a clear division of

tasks between the national supervisors and the ECB, so that a double or triple burdening

of the banks is avoided. (Deutsche Bundesbank, 2013b; Die Deutsche Kreditwirtschaft,

2013)

As with the SSM, most actors involved share the concerns regarding the legal uncertainty

which occurs as a result of basing the SRM on existing primary law. The Ministry of

Finance regards the currently pursued legal structure as covered by the existing treaties.

However, it would not grant any more powers or higher independence to the SRM under

the current legal structure. In the longer term, the Ministry is in favour of changing the

treaties and making way for establishing a more powerful and independent centralised

resolution authority. Also the Bundesbank, the Council of Economic Exports and the

German banks regard the current legal basis for the SRM as an interim solution and

favour a change of the treaties to reduce the legal insecurity in the medium term

(Bundesverband deutscher Banken, 2013; Deutsche Bundesbank, 2014; Schäuble, 2013;

SVR, 2013).

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The legal construction of the SRM requires the involvement of certain European

institutions and cannot give the Single Resolution Board (SRB) regulatory powers which

reach too far. Therefore, if the resolution board makes a decision, the European

Commission has to be involved and the European Council has the final decision making

power. While there were relatively short time limits established to speed up the decision

making process, the Bundesbank doubts the practical feasibility of the complex processes

(Deutsche Bundesbank, 2014). Furthermore, the Council of Economic Experts is of the

opinion that the current decision making structures are too complex and do not allow for

quick decision making. It regards the voting rules in the SRB as useful to reduce the risk

of regulatory forbearance, but sees the double involvement of the Commission as

problematic. The Commission is involved already before resolution decisions are taken.

Therefore this may lead to forbearance, since early mistakes may be revealed in the

course of a resolution. Additionally, the Council of Economic Experts sees the risk of

regulatory capture since with the centralisation of decision making powers at few

institutions, lobbying can be more directed and focused and hence, becomes relatively

cheaper for the large banks. Therefore, it advocates giving more institutions the

competency to trigger the resolution mechanism (SVR, 2013).

An additional issue, which many German institutions are concerned about, is the problem

of legacy assets. Many banks may currently have recapitalisation needs, which are yet to

be discovered. The Bundesbank is strongly opposed to relying on monetary policy to

resolve this problem, and states that those needs have to be solved on a national level,

before the SRM and the SSM take over responsibility. Furthermore, the use of

supranational financing mechanisms, such as the ESM, should in the opinion of the

Bundesbank only be in the form of loans (Deutsche Bundesbank, 2014). This or similar

positions are expressed by other German actors. The Ministry of Finance also states that

all legacy assets that come to light now have to be tackled nationally and sees resorting to

the ESM as acceptable only in extreme circumstances, i.e. only after bail-in instruments

164


and national funds have been exhausted (Schäuble, 2013). A similar position is expressed

by the German private banks (Bundesverband Deutscher Banken, 2013).

To finance the winding-up of banks, a European resolution fund will be established. There

are differing positions on who should participate and on what basis the contribution should

be levied. Among the banks, there are differing positions on who should participate in the

SRM and pay into the resolution fund. The savings and cooperative banks are generally

against a European resolution fund. They argue that institutions that are only regionally

active will be forced to pay for the potential resolution of systemically important banks

(Bundesverband der Deutschen Volksbanken und Raiffeisenbanken, Deutscher

Sparkassen und Giroverband, 2014). Additionally, they advocate that their systems of

institutional insurance should be more explicitly recognised (Bundesverband der

Deutschen Volksbanken und Raiffeisenbanken, Deutscher Sparkassen und Giroverband,

Bundesverband Öffentlicher Banken Deutschlands, 2013). On the other hand, the private

banks argue that the savings and cooperative banks, due to their organisation in groups

and their similar business models, may also pose a systemic risk and therefore should not

be exempted from contributing to the fund. They argue further that the system of

institutional insurance is not designed for solving systemic crises (Bundesverband

deutscher Banken, 2013). A similar position is taken by the Council of Economic Experts,

which thinks that the groups of savings banks and cooperative banks should be levied

based on a consolidated balance sheet (SVR, 2013).

There are also a diversity of opinions regarding the calculation of the contributions.

Savings and cooperative banks stress the importance of calculating the contributions

based on the riskiness of an institution (Bundesverband der Deutschen Volksbanken und

Raiffeisenbanken, Deutscher Sparkassen und Giroverband, 2014). The Council of

Economic Experts regards this as too complicated and prefers a simple measure, such as

the size of the respective institution (SVR, 2013). Additionally, the private banks asked for a

cap on the contributions, similar to the one that is currently used for the collection of the

165


German bank levy (Bundesverband deutscher Banken, 2013). In the current discussion,

the Ministry of Finance advocates a proposal where the caps on the contributions are

removed. Additionally, banks with balance sheet sizes below 500 million euros would be

exempt from contributions (Handelsblatt, 2014)

Regarding the deposit guarantee system the savings and cooperative banks strongly

oppose a centralisation on the European level. The Ministry of Finance supports them in

their resistance and prefers a further harmonisation of the existing national schemes

instead. This is a point of particular importance for Germany, since the savings banks and

the cooperative banks in Germany do not have an ordinary deposit guarantee scheme but

rely on institutional insurance within their respective group. This would be difficult to

integrate into a European system. Therefore, in the negotiations the Ministry of Finance

was already strongly against a European scheme (Schäuble, 2014).

To sum up, the overall opinion of major stakeholders in Germany leans in favour of a

further harmonisation and centralisation of banking supervisory and regulatory powers at

the Euro Area level. Generally, most actors would support even spreading the established

system to all EU countries. The main concern shared by all actors is the shaky legal

foundations on which the new institutions are built. Here, an amendment of the treaties

would be strongly supported. Despite the support for a European system of supervision

and resolution, there are concerns that countries might try to transfer legacy assets to the

supranational level. Additionally, when it comes to future burden sharing, there is a

reluctance to stand in for other member countries. Further concerns have been expressed

by the savings and cooperative banks, mostly small and medium sized institutions, that

centralised supervision may be designed for large, systemically important banks while

smaller banks might be overburdened with inappropriate regulation and may have to pay

for the risk incurred by those big banks. Therefore, they advocate national supervision for

the non-systemic banks, which can take into consideration the specific structure of the

German financial system. They are supported in this regard by the Ministry of Finance and

166


the Bundesbank. Part of that opposition stems from the impression that European

regulation is geared largely towards capital market based finance and that this might

damage or substantially change the successful and robust German bank based system

(Bundesverband der Deutschen Volksbanken und Raiffeisenbanken, Deutscher

Sparkassen und Giroverband, 2014). Also the mutualisation of deposit guarantee is

opposed since that might not be compatible with the structure of the German system.

167


17 Conclusions

This study gave an overview about banking regulation in Germany. In the second section

some general trends were presented. Thereafter the most important areas of regulation

where EU legislation had a major impact were discussed. Thereafter, areas that remained

largely national were reviewed. Lastly, a short overview about the currently constructed

Banking Union was given and the main concerns and opinions of different German actors

were examined.

Looking at patterns of the influence of EU-legislation on the German regulatory

framework, there seem to be large differences in the different areas.

In some areas, the EU legislation had no impact at all, since Germany was already

conforming to the demanded regulations. This was true for the directive on freedom of

international capital movement where Germany had already removed the last official

capital control measures before the directive came. Similarly, when the first Banking

Directive on minimum licensing requirements was passed, Germany had already

conformed to it.

In the areas of consolidation, financial conglomerates, and crisis management schemes,

new developments in financial markets led to a need for new supervisory rules. In these

areas there were no developed national regulations in Germany. In these cases the

international regulation determined many of the later introduced national rules in

Germany. In the area of consolidation, legislative steps were only taken in Germany after

an EC-directive was enacted. Before that, there were only agreements between the

supervisors and the banks to voluntarily submit information. Also consolidation

requirements for financial conglomerates were only established in Germany after a

directive was passed on the EC-level. In the area of crisis management schemes the

picture is different. The need for instruments to deal with the financial crisis during and

after the Great Recession and to wind banks up if necessary created new demands for

financial market regulation. Steps on the EU-level were taken to prepare a directive

168


addressing this area. However, in this case Germany took measures before the directive

was passed. However, the national law was oriented along the internationally discussed

rules and the expected directive. This new approach to pass regulation discussed on an

international level before an international agreement is reached is according to the

Minister of Finance to speed up the international processes and to set standards to trigger

international regulations (Schäuble, 2013a).

The effect of international developments and especially on EU level on areas where there

was long standing national rules and regulations in Germany was quite different. In the

area of deposit insurance for example, Germany had a very specific scheme for different

groups of banks in place that was seen as effective. However, there was doubt whether the

EU-regulation would not negatively affect it and therefore Germany resisted the

implementation and filed a law suit against the directive. After it had lost and had to

implement the directive, a complex system of statutory schemes and private schemes was

established that circumvented many of the concerns Germany had. Therefore, while there

were legal adaptions to conform to the directive there were no substantial real changes

needed and implemented.

In the area of capital requirements there was also an established and well founded system

of regulation in Germany. Here the influence of directives was quite substantial. This can

be seen in particular while looking at the discussion regarding eligibility criteria for

capital. Despite pressure on the national level by some groups of the finance industry to

soften those criteria, the legislator was reluctant to do so, and also the Bundesbank was

strictly against it. Overall in Germany after World War II until the 1980s there was a

consensus that strict financial market regulation including substantial equity holding by

banks was desirable.

However, a major change took place with the implementation of the Solvency and the Own

Funds directives from 1992. Despite concerns of some national actors, a possible topping

up on the international rules was largely prevented due to concerns about international

169


competitiveness of German banks. The criteria for the quality of capital were further

softened with the introduction of Tier-3 capital due to the capital adequacy directive. While

for many countries those new rules were stricter than what prevailed originally, for

Germany harmonisation in this field meant a softening of the standards. That the trend to

soften equity criteria was misleading became clear, when during the financial crisis in

2008 and the following years the problematically low level of capital in many banks was a

major problem. With the new Capital Requirements Regulation it has been reversed and

only capital of higher quality can fulfil regulatory requirements. However, this lesson

came at high cost to the public purse.

To sum up, the effect of EU legislation on the German regulatory framework were quite

divers. Sometimes, there were no effects, sometimes the EU legislation added important

elements to the national regulatory framework. However, sometimes the EU legislation

led to a softening of the national standards that turned out to be hazardous. Against the

last development Germany more and more reduced its resistance and less and less used

national freedom for stricter rules.

One last word to the bigger and bigger flood of EU directives also after the Great

Recession: It looks like that the directives follow a kind of extreme piece-meal approach

reacting on problems developing in the financial system in the past. Financial regulations

and supervision in Europe and thus also in Germany is comparable to a multi-storey

building were several construction projects take place at the same time at different floors

without thinking about the consequence for the whole building and especially its stability.

The directives show that supervisors have been driven by developments in the financial

system without having a clue or a vision how a desirable financial system should look like

and what kind of regulation are needed for such desirable system.

170


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19 Appendix

Liberalisation of capital movements19.1

Directives andRegulations

Year ofdueimplementation

Nationals measures before EUlegislation

Year of nationalimplementation

Content of national implementation

1961

Law on Foreign Trade andPayments(Aussenwirtschaftsgesetz;28.04.1961)

Introduced the principle of freedom of capital movements

Government was still able to enact restrictions on capital movements under certain conditions

Existing restrictions were gradually removed until 1984. In 1981 the last quantitative restrictions were abolished. Withthe removal of the coupon tax on interest received by non-residents from domestic bonds, the last disincentives forforeign investors in Germany were removed

88/361/EEC 1990 Already in compliance Directive demands full liberalization of capital movements between Member States

Germany was already in compliance with the directive when it was passed

2009

Thirteenth Act Amending theForeign Trade Payments Actand the Foreign Trade andPayments Regulation(Dreizehntes Gesetz zurÄnderung desAußenwirtschaftsgesetzes undderAußenwirtschaftsverordnung;18.04.2009)

Discussion about investment restrictions for companies was triggered by increased activity of sovereign wealth funds

Under the amended law the Federal Ministry of Economics and Technology is able to review investments frominvestors outside the EU and the EFTA who wish to acquire 25 per cent or more of the voting rights of a Germancompany. If the acquisition threatens Germany’s public policy or public security it can be restricted

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Cross-border competition and permitted activities19.2






77/780/EEC 1979Already in compliance

The First Banking Directive was the first step towards the harmonization of banking on the EU -level. It defines creditinstitutions and lays out minimum criteria for their licensing. Also, it demands the existence of independent own funds, aminimum of two directors and the existence of a business plan.No steps on a national level were necessary, as Germany already complied with the requirements.

89/646/EEC 1993

In the former version of theBanking Act there was noprovision for the reliabilitycheck of owners that holdsubstantial stakes in a bank

The former version of thebanking act had someprovisions to keep banks liquidand limited their investmentinto fixed capital and shares tothe amount of equity

1993

Implementation by

Act for the Amendment of theBanking Act and of OtherBanking Regulations(Gesetz zur Änderung desGesetzes über das Kreditwesenund anderer Vorschriften überKreditinstitute, 21.12.1992)

Incl.

Fourth Amendment ofthe Banking Act

Change of Principle I

The Second Banking Directive aimed at further harmonization of minimum requirements.

The relevant issues were:

Introduction of minimum initial capital

Disclosure requirements for shareholders

Reliability control of substantial shareholders, which need to fulfil the requirements necessary for a solid managementof the institution (protection of creditors and prevention of money laundering)

Limits on the participation of credit institutions in non-financial firms (shareholding of banks has been limited to 15 percent of a bank’s liable capital in one company)

The most relevant change is the introduction of the European Passport for banks which offers the opportunity to set upbusiness in other EC-countries under the principle of home-country control. German banks were allowed to open abranch in another EC-country simply by declaring it to the Federal Banking Supervisory Office and the Bundesbank. ForGermany that meant that foreign credit institutions with the European passport are able to open branches in Germanyunder similar conditions

93/22/EEC 1995

Some investment services didcount as banking services andfirms conducting them fellunder the banking regulation

Investment services that didnot count as banking fellunder the regulation of thegeneral Trade, Commerce andIndustry Regulation Act(Gewerbeordnung)

1997

Implementation byAct for the Implementation ofEC Directives Regarding theHarmonization of Bank- andSecurity Related Regulations(Gesetz zur Umsetzung vonEG-Richtlinien zurHarmonisierung bank- undwertpapieraufsichtrechtlicherVorschriften; 22.10.1997)Incl.

Sixth Amendment of theBanking Act

Amendment of the

The Investment Service Directive aimed at creating a level playing field between universal banks and investment firms.

German supervisory law now distinguishes between banking and financial service business (the definition of theinstitutions is different from the definition in the Investment Services Act, so that a slightly wider range of institutionsis covered and falls therefore under the regulations of the Banking Act)

German financial service institutions are now allowed to provide their services union wide either by the establishmentof a subsidiary or from a distance (European passport)

Financial service institutions are now subject to the supervision of the Federal Banking Supervisory Office (BaKred) andthe Federal Supervisory Office for Securities Trading (BaWe)

The BaKred is mainly responsible for the licensing of the financial service institutions

The BaWe is mainly responsible for market supervision e.g. the compliance with the rules of conduct

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Securities Trading Act

188


Capital requirements19.3






89/299/EEC 1993

Only capital that fulfils thefollowing requirements wasrecognized as regulatorycapital:

Fully paid up

Capable of meetingcurrent losses

Permanently available

1993

Implementation by

Act for the Amendment of theBanking Act and of OtherBanking Regulations(Gesetz zur Änderung desGesetzes über das Kreditwesenund anderer Vorschriften überKreditinstitute; 21.12.1992)

Incl.

Fourth Amendment ofthe Banking Act

Change of Principle I

The main change has been a broadening of the eligible capital base that banks could use to cover their regulatoryrequirements. This implied a softening of the established eligibility criteria in Germany. Own funds have been divided intocore and additional capital. The 8 per cent of the risk weighted assets now had to be backed with core and additional capital,whereby the amount of core capital needs to be higher.

89/647/EEC 1993

Equity requirements of 5.5%of the relevant assets

Supervisory equityrequirements for book creditand equity holdings andtraditional off-balance sheettransactions

Lower equity requirements forpositions that were perceivedas of lower risk already existed

1993

Implementation by

Change of Principle I inOctober 1990

Act for the Amendment of theBanking Act and of OtherBanking Regulations(Gesetz zur Änderung desGesetzes über das Kreditwesenund anderer Vorschriften überKreditinstitute; 21.12.1992)

Incl.

Fourth Amendment ofthe Banking act

Further change of Principle I

Principle I was changed in October 1990 to include off-balance sheet operations in derivative markets. For thecalculation of the cover loss the Original Exposure Method and the Marking to Market Method were allowed.Therefore, Principle I was extended from dealing with credit risk to dealing with counterparty risk in general. Germansupervisors imposed stricter regulations than the directive required and also demanded contracts with other price risksto be backed with capital (directive only concerned with currency and interest contracts)

With the changes in 1992 Principle I was amended to include now almost all asset items. In particular all securities andtangible assets were now included and had to be backed with capital

Traditional off-balance sheet positions, like guarantees, were differentiated and weighted according to risk categoriesof 100, 50, 20 and 0%

The minimum capital coefficient was raised from 5.56% to 8%

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1995

Minimum Requirements forthe Trading Activities of CreditInstitutions(Mindestanforderungen andas Betreiben vonHandelsgeschäftender Kreditinstitute;23.10.1995)

The existing Minimum Requirements for the Internal Control Rules for Foreign Exchange Transactions and the MinimumRequirements for Security Trading have been replaced and extended to include all trading activities, especially moneymarket and precious metal transactions and trading derivates.Here for the first time banks had to establish risk management systems for their trading activities, including systems for theinternal measurement of the risk of their trading positions. While those were only for internal use, it was planned to usethem later for the determination of capital requirements for market risks.

93/6/EEC (CAD)1996

Eligible own funds determinedby previous annual accounts

Core and additional capitaleligible as supervisory equity

No distinguishing betweentrading and banking book

Positions with market pricerisk were limited by PrincipleIa

1997

Implementation by

Act on the Implementation ofDirectives for theHarmonization of Bank andSecurity Related Regulations(Gesetz zur Umsetzung vonEG-Richtlinien zurHarmonisierung bank- undwertpapieraufsichtrechtlicherVorschriften vom 22/10/1997)

Incl.

Sixth Act Amending theBanking Act

Change of the SecuritiesTrading Act

Change of Principle I andPrinciple Ia

The Capital Adequacy Directive aimed at establishing uniform capital requirements for banks and investment firms with theobjective of covering market risks arising from the securities and foreign exchange trading activities of these institutions.

Financial service institutions fall under the regulation of the Banking Act and Principle I

Changes in the definition and determination of own funds- Introduction of automatic adjustment mechanism for the determination of own funds, so that banks constantly

have to determine their current capital base- Tier-3 capital was introduced (net-profits of trading book and short-term subordinated liabilities) and can be used

in particular to cover risks from the trading book

Introduction of a “trading book” for banks- All own–account positions in financial instruments, marketable assets and equities taken on by the institution for

profiting in the short-term from price variations have to be included in the trading book- Institutions with trading book business below 5% of entire business can be exempt and use banking book rules

also for trading book positions

Market price risk has to be covered with capital- Market price risk of foreign exchange and commodity positions has to be determined and covered with own

funds- Trading book institutions have to determine the market price risk of their trading book positions and cover it with

own funds

Determination of market price risk with standard method or internal risk models- Market price risk can be determined by a standard method or by banks’ internal risk models- If internal risk models are used, they have to be approved by the supervisory authority

98/31/EC 2000

2000

Announcement of theAmendment andSupplementation of thePrinciples Regarding Equityand Liquidity(Bekanntmachung über dieÄnderung und Ergänzung derGrundsätze über dieEigenmittel und die Liquidität

Most of the content of the directive was already introduced with the sixth amendment of the banking act and the changes inprinciple I in 1997. Therefore, only some minor changes were necessary to conform to the directive.

The rules regarding the calculation of the capital charges for market risk stemming from commodity business and frombusiness in commodity related financial instruments were already included. Therefore only the rules regarding thecounterparty risk of the trading book were adapted

Also the rules regarding the use of internal risk measurement models for the determination of general and specificprice risks in the trading book were already included. Only some rules for their use to determine the specific risk of netinterest- and net stock positions had to be added

190


der Institute; 20.07.2000)

2002

Fourth Financial MarketsPromotion Act(Gesetz zur weiterenFortentwicklung desFinanzplatzes Deutschland(ViertesFinanzmarktförderungsgesetz); 21.07.2002)

Principle I was changed from being an administrative order to be a statutory regulation

The distinction between the trading book and the banking book will in the future be established by a regulation toadapt the rules more speedily to EC directives

2002

Minimum Requirements forthe Credit Business of CreditInstitutions(Mindestanforderungen andas Kreditgeschäft derKreditinstitute; 20.12.2002)

The Minimum Requirements for the Credit Business of Credit Institutions substantiate the general requirements of aproper business organization, of adequate internal control mechanisms and rules for the management, supervision andcontrol of risks

The establishment of proper risk classification systems was demanded also for credit risk. Even though the regulationdid not ask for Basel II compliant internal rating systems, banks that wanted to use the internal rating based approachlater, it was sensible to establish such models already by then

2006/48/ECand2006/49/EC(CRD I)

2007/8

2006

Implementation by

Act implementing the RevisedBanking Directive and theRevised Capital AdequacyDirective(Gesetz zur Umsetzung derneu gefassten Bankenrichtlinieund der neu gefasstenKapitaladäquanzrichtlinie;22.11.2006)

Incl.

Changes in the Banking

The Directives served to translate essential contents of Basel II into national law.

Introduction of modified capital as the new basis for the calculation of capital adequacy- Compared to the former definition of capital, modified capital has some additional add-ons and deductions for

example for large exposures, etc.

Operational risk has now to be explicitly calculated and covered

New methods to calculate credit risk- Choice between standardised approach or internal rating based approach (IRB)- Standardised approach based on external ratings of rating agencies; for unrated positions there are risk weights

applied across the board; retail business and some SMEs weighted with only 75%; lower risk weights for claimssecured by residential real estate (35% instead of 50%); banks are rated according to the second option of theDirective so that they are rated one class below the rating class of the country of domicile

- Alternatively banks can use an internal rating based approach; here there is a choice between a simple version,where only the probability of default is determined internally and other factors are provided by the supervisorand an advanced version were all relevant factors are determined by internal systems

191


Act

Replacement of Principle I bythe new Solvency Regulation

Replacement of the PrinciplesII and III by the new LiquidityRegulation

Amendment of the LargeExposure Regulation

Extension of the calculation approaches for the credit equivalent amounts of risk exposure in derivatives- Besides the original exposure method and the mark-to-market method an internal model approach and a

standardised method can be used

Range of recognized risk reducing collaterals was extended- Institutions using the standard approach are allowed to use most financial collateral- Institutions using the advanced approach can use any kind of collateral as long as they can determine reliable

estimates of the asset value

Rules for capital requirement for securitization transactions were adopted from the directive

New standard approach for the determination of market risks for positions not taken account for in earlier regulation,such as financial transactions based on weather variables, CO2 emissions or other macroeconomic variables. Theapproach is based on historical simulations

Directive2009/111/EC(CRD II)

2010

2010

Implementation by

Act Implementing theAmended Banking Directiveand the Amended CapitalAdequacy Directive (Gesetzzur Umsetzung der geändertenBankenrichtlinie und dergeänderten Kapitaladäquanz-richtlinie; 24.11.2010)

Incl.

Changes in the BankingAct

Regulation FurtherImplementing the AmendedBanking Directive and theAmended Capital AdequacyDirective (Verordnung zurweiteren Umsetzung dergeänderten Bankenrichtlinieund der geändertenKapitaladäquanzrichtlinie;05.10.2010)

Incl.

changes in the LargeExposures Regulation

changes in the SolvencyRegulation

Rules for the allowance of hybrid capital as core capital changed- German rules based allowance on the form of capital and allowed jouissance right capital and capital by silent

partners- Replaced in accordance with the directive by a principle based system focusing on the qualitative characteristics

of the instrument- Differentiated upper limits for hybrid capital that is allowed as core capital based on qualitative characteristics

such as permanence and loss bearing capacity- Total and hybrid capital with highest quality can make up at maximum 50% of core capital (for lower qualities

lower limits)

Changes in the allowance of investment fund shares and life insurance policies as collateral

Directive2010/76/EU

2011December 2011 Increased own funds requirements for trading book position

- Institutes that use their own risk models have to hold additional equity to cover stressed-VaR (which relates to a

192


(CRD III) Implementation by

Second Regulation FurtherImplementing the AmendedBanking Directive and theAmended Capital AdequacyDirective (Zweite Verordnungzur weiteren Umsetzung dergeänderten Bankenrichtlinieund der geändertenKapitaladäquanzrichtlinie;26.10.2011)

Incl.

Changes in the SolvencyRegulation

crisis-like market development)- Institutes that use their own risk models to calculate the specific risk of interest bearing instruments have to hold

additional equity to cover default and migration risk (Incremental risk charge)- It is drawn into doubt whether institutes are able to calculate the risk of securitized positions adequately.

Therefore the specific risk for securitized positions in the trading book has now to be calculated by a standardmethod, similar to that already used for banking book positions. For positions with highly liquid underlyings(Correlation Trading Portfolios) a modified method is introduced and under certain conditions they can use ownmodels (so called Comprehensive Risk Measure, CRM)

- For institutes not using own risk models the new rules increase the capital requirements for shares to 8% (2% or4% before)

Increased own funds for re-securitized assets- An increased risk weight for re-securitized positions is introduced in the credit risk standard and in the internal

rating based approaches

Increased publication requirements- regarding calculated market risk and calculation method- regarding securitized assets

Regulation575/2013 CRR

2014

The regulation applies directly. There are changes necessary to remove superfluous or conflicting national rules. The CRRallows for some national options. These will be made with the CRDIV Implementation act, which is currently in the legislativeprocess and will mainly change the Banking Act. Among others, §10 which until then regulated capital requirements willlargely be removed and be replaced by the authority to issue a regulation regarding solvency rules – which still need to befleshed out at the national level – as well as rules governing the imposition of stricter capital adequacy requirements by theBaFin.There will also be changes necessary in the Solvency Regulation, the Liquidity Regulation and the Large Exposure Regulation.The effective implementation dates for the new rules depend on the coming into effect of the CRR.The CRR is only applicable to enterprises that conduct deposit and lending business, the current definition of a creditinstitution in the banking act is broader. Also the definition of a financial service institution is broader in the banking act thanwhat is covered in the CRR as an investment firm. A provision in the banking act is made that also the institutes not coveredfrom the CRR directly have to apply the new rules (with some exceptions).

The CRR will lead to the following main changes:

New definition of capital- There will be only 3 categories of capital: tier-1 capital, additional tier-1 capital and tier-2 capital- Tier-1 capital is composed only of paid-in capital instruments and disclosed reserves; it has to be available for

unrestricted and immediate use to cover risks or losses; there are 13 characteristics outlined in the CRR thatcapital instruments have to fulfill to count as tier-1 capital

- Additional tier-1 capital should be continuously available for loss absorbency purposes, thereby enabling the bankto continue on a going-concern basis; further characteristics are that the capital is subordinated, perpetual, andthat distributions is fully discretionary; the instrument has to be convertible to capital or depreciate if tier-1capital falls below 5.125%

- Tier-2 capital’s function is limited to capital protection in case of bankruptcy. The following requirements apply:minimum original maturity of 5 years, subordinated in case of bankruptcy, no incentives to redeem, redemptionbefore maturity only with the consent of the supervisor

- Tier-3 capital is eliminated in the new capital structure

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- Deduction rules have been tightened

Higher quality capital necessary to fulfil 8% capital requirements- Minimum tier-1 capital increases from 2% to 4.5% of risk weighted assets- Minimum additional tier-1 capital of 1.5% of risk weighted assets- Tier-2 capital only up to a maximum of 2% of risk weighted assets- Transition period until 2018 with decreasing allowance for existing capital elements

Higher capital requirements for derivative trades- Realization that most losses from derivatives were not due to default of counterparty, but due to losses in market

value of the instrument caused by a deterioration of credit-worthiness of the counterparty- Therefore additional capital charge will be introduced for derivatives not traded through a central counterparty

to cover such losses – Credit Valuation Adjustments- Far-reaching exemptions: some trades with non-financial corporations and certain intra-group transactions are

excluded. Additionally, deals with pension funds, central banks, sovereigns and certain public sector entities areexempt

- Also for derivatives cleared through a central counterparty a small capital charge is introduced

Introduction of a Leverage Ratio- It is planned to introduce a leverage ratio that is tier-1 capital over total exposure- Differently from the risk-based capital requirements for the calculation of the leverage ratio, the positions enter

with their nominal value- From 2015 on all institutes are supposed to publish the leverage ratio- No minimum requirement, but observation phase until January 2017. Thereafter a decision on whether to set a

binding minimum value for the leverage ratio and, if so, how high that level should be, is made

Higher capital charges for systemic risk- To address systemic risk on a national level the member states have the possibility to tighten certain

requirements, among them capital requirements. However, that has to be communicated to the EuropeanParliament, the European Commission, the Council, the ESRB and the EBA and justification has to be submitted

- The council can veto the measure under certain conditions- However, there are certain measures that the member states can always take: increasing the risk weight for real

estate and interbank loans by 25% and lowering the upper limit for large exposures by 15 percentage points- The regulation gives the commission the possibility to tighten requirements for the EU as a whole, if all member

states are affected

Lower capital charges for small and medium-sized enterprises (SMEs)- The capital requirements for SMEs are multiplied with a factor of 0.7619, which is basically neutralizing the newly

introduced capital conservation buffer of 2.5%- SMEs are defined as having annual revenues below 50 million euro; additionally the exposure of one institute

against one SME is not to exceed 1.5 million euro

Directive2013/36/EU(CRD IV)

2014

The directive contains the elements of Basel III and some further European initiatives that still need to be implemented on anational level. The CRDIV is implemented by the CRDIV Implementation act, which is currently in the legislative process andwill mainly change the Banking Act. Additionally, there are changes in the solvency regulation necessary.

Capital conservation buffer is introduced- This buffer consists of tier-1 capital and is 2.5% of risk weighted assets. It has to be held additionally to the 4.5%

tier -1 capital and has to be build up gradually from 2015 until 2018- If an institute falls below its conservation factor an gradually increasing restriction on the distribution of profits

194


and bonuses applies

Countercyclical buffer is introduced- This buffer is between 0% and 2.5%. It is increased when the financial sector is growing excessively- The rate applied depends on the country the claim is against, e.g. if a German bank lends to a French company,

the French countercyclical capital buffer has to be applied- The BaFin does determine the rate for Germany and can determine the rates for third countries that do not apply

such a rate. If a country increases rates to above 2.5%, an acknowledgement of the BaFin is necessary to makethe rate binding for German institutes

Systemic risk buffer is introduced- This buffer is at least 1% and can be applied flexibly. It can be applied to specific groups of institutions or specific

claims and is supposed to address long-term, non-cyclical, systemic or macro prudential risks on the national level- Depending on the size and type of buffer different procedures have to be followed to be allowed to apply the

buffer. Up to 3% a simple notification and the deployment of the reasons for the buffer to the EuropeanCommission, the EBA, the ESRB and foreign authorities affected is sufficient

- Systemic risk buffers from other member states can be acknowledged by national supervisors and would thenalso apply to national institutes

Introduction of buffer for systemically important institution- As from 2016, global systemically important institution (G- SIIs) will be required to maintain, on a consolidated

basis, an additional systemic risk buffer, which, depending on the systemic importance of the group in question,is between 1% and 3.5% of risk weighted assets

- G- SIIs are identified by internationally agreed on criteria- National supervisory authorities likewise have the option of imposing an additional capital buffer of up to 2% on

other systemically important institutions (O- SIIs) as from 2016- If a buffer is impose on O-SIIs the national authority must notify and justify the planned measure to the European

Commission, the EBA and the ESRB as well as to the competent authorities of any member state affected

Sanctions if combined buffers are not fulfilled- If an institution fails to fulfill its combined buffer requirements restrictions on the distribution of profits apply- Additionally, a capital conservation plan has to be worked out and submitted to the BaFin and the Bundesbank

195


Supervision on a consolidated basis19.4






83/350/EEC 1985

Voluntary agreement of bankto submit consolidated figuresfor banking groups. Thethreshold for consolidationwas 100% or close to 100%

1984

Implementation by

Third Act Amending theBanking Act(Drittes Gesetz zur Änderungdes Gesetzes über dasKreditwesen; 20.12.1984)

Principle I (equity regulations) now have to be fulfilled by each single bank, but also by a banking group as a whole

Consolidation rules were defined- Domestic and foreign banking daughters, mortgage banks, leasing and factoring companies have to be

consolidated- Consolidation necessary if a bank holds directly or indirectly a share of 40% or more in the respective firm or if a

dominating influence can be exerted- Pro rata consolidation method has to be used

Also large exposure guidelines have to be met on a consolidated base (here consolidation threshold of 50%)

Monthly balance sheet reports now also have to be submitted on a consolidated base (here consolidation threshold of50%)

Long transition periods (up until 1991)

92/30/EEC 1993

1992-94

Implementation by

Act Amending the Banking Actand other Banking Regulations(Gesetz zur Änderung desGesetzes über das Kreditwesenund anderer Vorschriften überKreditinstitute; 21.12.1992)

Banking Act(Gesetz über das Kreditwesen;24.02.1990)


Extension of types of companies that have to be included in consolidation- Wide range of financial institutions that are not defined as banks according to the banking act (e.g. money

brokers)- Companies that perform ancillary banking services

Financial holding groups also have to provide consolidated accounts to the supervisory authority

Full consolidation method is now mandatory, pro rata consolidation only for minority participating interests

95/26/EC 1996

1997

Implementation by

The amendment made by those laws in Germany referred partly to the directive 95/26/EC, but also implemented changes tothe consolidation rules necessary due to the directive 93/22/EEC, which put financial service institutions under theregulations of the Banking Act.

196


Act on the Implementation ofDirectives for theHarmonization of Bank andSecurity Related Regulations(Gesetz zur Umsetzung vonEG-Richtlinien zurHarmonisierung bank- undwertpapieraufsichtsrechtlicherVorschriften; 22.10.1997)Incl.

Sixth Act Amending theBanking Act

Change of the SecuritiesTrading Act

Large Exposure Regulation(Verordnung über dieErfassung, Bemessung,Gewichtung und Anzeige vonKrediten im Bereich derGroßkredit- undMillionenkreditvorschriftendes Gesetzes über dasKreditwesen (Großkredit- undMillionenkreditverordnung);29.12.1997)

Licensing for banks can be refused if its organization or its ownership structure undermines the effective supervision bythe responsible authorities

Financial service institutions can be the parent organization of a group. It is no longer constitutive that a deposit takingcredit institution is part of a group, but sufficient that an investment trading house belongs to it

The stricter 40% threshold for consolidation was abandoned. From now on, for consolidation only majority stakes ordominant influences were relevant

197


Supervision of financial groups and conglomerates19.5






2002/87/EC 2004

There were no specificregulations for theconsolidated supervision ofgroups and conglomerates.

Since 2002 the new FederalFinancial SupervisoryAuthority (BaFin) is howeverresponsible for the supervisionof all parts of the financialsector. It has separatedepartments for insurance,banking and securitysupervision. However, thereare cross-departments toallow for cooperation.

2005

Implementation by

Act Implementing theFinancial ConglomeratesDirective(Gesetz zur Umsetzung derRichtlinie 2002/87/EG desEuropäischen Parlaments unddes Rates (Finanz-konglomeraterichtlinie-Umsetzungsgesetz);16.12.2002)

Incl.

Amendement of theBanking Act

Amendement of theInsurance SupervisoryAct

The act established regulations for financial conglomerates in four main areas.

Equity requirements- Financial conglomerates have to have sufficient equity as a whole- This requirement was substantiated by the Financial Conglomerates Solvency Regulation ( Finanzkonglomerate-

Solvabilitätsverordnung), enacted by the BaFin and the Bundesbank in September 2005- According to the regulation for Germany only two calculation methods were permitted: calculation based on

consolidated accounts or deduction and aggregation method

Risk concentration- The ministry of finance and the Bundesbank were allowed to enact detailed regulation; until then the act

provides some preliminary rules- The preliminary rules state that if risks according to the Banking Act or the Insurance Supervisory Act reach

individually or in sum 10% of the conglomerates equity the supervisory authority has to be informed. It candecide then that the risk has to be covered by equity

Intra-group transactions- The ministry of finance and the Bundesbank were allowed to enact detailed regulation; until then the act

provides some preliminary rules- The preliminary rules state that all single transactions exceeding 5% of the conglomerates equity have to be

reported

Internal risk management- The conglomerates have to establish on the level of the conglomerate an appropriate risk management and

adequate internal control mechanisms, including a proper business organization and proper accountingprocedures

2007/44/EC 2009

The Banking Act alreadycontained rules regarding thereporting and the control ofqualified owners in thebanking sector

2009

Implementation by

Act Implementing theQualifying Holdings Directive(Gesetz zur Umsetzung derBeteiligungsrichtlinie;17.03.2009)

The Guidelines of the

The overall aim was to reduce obstacles to mergers and acquisitions in the financial sector and to contribute to a fast andpredictable control process with a high degree of legal certainty.

With the implementation the following main changes were enacted:

The control process of participation became more formalised- Clear rules in form and content for the authorization process were established- Binding time limits for the supervisory authority in which it has to finish the authorization procedure- The Ownership Control Regulation prescribes bindingly the documents and statements that have to be submitted

for an acquisition attempt or for the increase of a qualified majority stake

Catalogue of reasons for not granting permission was extended

Duty for supervisory authorities to coordinate and cooperate if an acquisition is planned between institutions located

198


Committee of EuropeanBanking Supervisors, whichwere published in December2008 were transposed intoGerman law by the Regulationregarding the furtherimplementation of theDirective on the supervisoryassessment of acquisitions inthe financial sector(Verordnung zur weiterenUmsetzung derBeteiligungsrichtlinie;20.03.2009)Incl.

Change of theOwnership ControlRegulation(Inhaberkontroll-verordnung)

Change of the ReportingRegulation(Anzeigenverordnung)

in EU member states

199


Large exposures19.6






92/121/EEC 1994

Rules regarding largeexposures existed since theenactment of the Banking Actin 1962.

The last important revision ofthe rules was in 1984.Accordingly a large loan wasdefined as a loan exceeding15% of a bank’s equity.A loan to one entity was notallowed to exceed 50% of abank’s equity.All large loans together werenot allowed to exceed 800%.

1996


Incl.

Fifth Amendment of theBanking Act

Changed thresholds in the large loan regulations- Large loan defined as a loan that exceeds 10% of a bank’s equity- Large loans to one entity are not allowed to exceed 25% of a bank’s equity- 800% limit for all large loans together- Transition period until 1998 so that 15% and 40% limits were valid until then

Changed definition of equity- Equity definition was changed to the new wider definition that was valid for capital requirements since the 4 th

amendment of the Banking Act

Changed definition of loan- While before the amendment mainly money loans and guarantees were included in the large loan threshold, the

new rules use the wider definition of the Solvency Directive so that almost all assets that can be assigned to adebtor are included now (e.g. also equity, bonds, options, etc.)

Wider definition of a borrower unit is introduced

Introduction of the general allowance to exceed the defined limits, if for the exceeding amount equity is put aside

1997

Sixth Amendment of theBanking Act (Sechste Gesetzzur Änderung des Gesetzesüber das Kreditwesen; 22.Oktober 1997)

With the introduction of the trading book with the sixth amendment of the Banking Act, some amendments of the rules onlarge exposures were necessary.

Changed basis for the calculation of the limits- For trading book institutions the limits for overall business (trading and banking book) are now based on own

funds instead of liable capital- The limits for the banking books are still based on liable capital

Change of reporting rules from ad-hoc reports to quarterly summary reports

Additionally, the act includes a passage that allows the supervisory authorities to enact a more detailed regulationregarding notification rules, the calculation of credit equivalents and the weighting of different assets. Therefore, manyof the detailed rules regarding large exposures were now laid down in the Large Exposure Regulation ( Großkredit- undMillionenkreditverordnung)

2006/48/EC and2006/49/EC

2006

Implementation by

Act implementing the RevisedBanking Directive and theRevised Capital AdequacyDirective(Gesetz zur Umsetzung der

Definition of risk is based on the new definition in the Solvency Regulation

Risk reduction techniques similar to the ones valid for capital requirements can be applied

For the calculation of credit equivalent amounts for derivatives the Standardised Method and the Internal ModelMethod, which are also used for the risk determination for capital requirements can be used

200


neu gefassten Bankenrichtlinieund der neu gefasstenKapitaladäquanzrichtlinie;22.11.2006)

Incl.

Change of the BankingAct

Replacement of Principle I bythe new Solvency Regulation

Replacement of the PrinciplesII and III by the new LiquidityRegulation

Amendment of the LargeExposure Regulation

Directive2009/111/EC(CRD II)

2010

2010

Implementation by

Act Implementing theAmended Banking Directiveand the Amended CapitalAdequacy Directive(Gesetz zur Umsetzung dergeänderten Bankenrichtlinieund der geändertenKapitaladäquanzrichtlinie;19.11.2010)

Incl.

Changes in the BankingAct

Regulation FurtherImplementing the AmendedBanking Directive and theAmended Capital AdequacyDirective(Verordnung zur weiterenUmsetzung der geändertenBankenrichtlinie und dergeändertenKapitaladäquanzrichtlinie;05.10.2010)

Complete abolishment of the preferential treatment regarding interbank claims- Some exceptions for claims related to payment transactions and securities processing- Introduction of general allowance of 150 million euro

New rules for the allowance to consider collateral- Only financial securities possible- Three techniques for the calculation of the allowance:

Substitution technique (new)Comprehensive method (old)Estimation of the financial securities based on the Loss-Given-Default in the advanced IRBA

Tightening of the rules regarding the generation of borrower units- A borrower unit is already constituted if unilateral dependency exists, before cross-dependency was necessary- Now for claims against certain investment structures (e.g. funds), not only the investment structure has to be

seen as a borrower, but also the assets held by the borrower have to be considered

Abolishment of the limit of 800% of equity for total exposures

Abolishment of the reduced limit of 20% of equity for related entities

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Incl.

Changes in the LargeExposures Regulation

Changes in the SolvencyRegulation

Directive2013/36/EU(CRDIV) andRegulation575/2013 CRR

Gesetz zur Umsetzung derRichtlinie 2013/36/EU überden Zugang zur Tätigkeit vonKreditinstituten und dieBeaufsichtigung vonKreditinstituten undWertpapierfirmen und zurAnpassung des Aufsichtsrechtsan die Verordnung (EU) Nr.575/2013 überAufsichtsanforderungen anKreditinstitute undWertpapierfirmen (CRD IV-Umsetzungsgesetz)

Large parts of the regulation regarding large exposures are now included in the CRR. Therefore, in the Large ExposuresRegulation the definitions for large exposures, the corresponding limitations, the calculation methods and the rulesregarding exemptions and collaterals are deleted, since those regulations will be included in the CRR

The Large Exposures Regulation will mainly be concerned with the national options of the CRR and some nationalspecifics

One of the main alterations is the limitation of intergroup claims to 50% of capital (until now under certaincircumstances exempt)

202


Investment services19.7






93/22/EEC 1995

Some investment services didcount as banking services andfirms conducting them fellunder the banking regulation

Investment services that didnot count as banking fellunder the regulation of thegeneral Trade, Commerce andIndustry Regulation Act(Gewerbeordnung)

1997

Implementation by

Second Financial MarketsPromotion Act(Gesetz über denWertpapierhandel und zurÄnderung derbörsenrechtlichen undwertpapierrechtlichenVorschriften (ZweitesFinanzmarktförderungsgesetz); 26.07.1994)

Act for the Implementation ofEC Directives Regarding theHarmonization of Bank- andSecurity Related Regulations(Gesetz zur Umsetzung vonEG-Richtlinien zurHarmonisierung bank- undwertpapieraufsichtsrechtlicherVorschriften; 22.10.1997)Incl.

Sixth Amendment of theBanking Act

Amendment of theSecurities Trading Act

Large Exposure Regulation(Großkredit- undMillionenkreditverordnung;29.12.1997)

The Investment services Directive was mainly aiming at creating a level playing field for investment firms and banks andtherefore adapts the authorization procedures and prudential rules for investment firms to those of banks.

German supervisory law now distinguishes between banking and financial service business (the definition of theinstitutions are different from the definition in the Investment Services Act, so that a slightly wider range of institutionsis covered and falls therefore under the regulations of the Banking Act)

German financial service institutions are now allowed to provide their services union-wide either by the establishmentof a subsidiary or from a distance (European passport)

Financial service institutions are now subject to the supervision of the Federal Banking Supervisory Office (BaKred) andthe Federal Supervisory Office for Securities Trading (BaWe)

The BaKred is mainly responsible for the licensing of the financial service institutions

The BaWe is mainly responsible for market supervision e.g. the compliance with the rules of conduct

203


2003/6/EC(MAD)

2004The issues concerned wereregulated in the SecuritiesTrading Act (WPHG)

2004

Investor ProtectionImprovement Act(Gesetz zur Verbesserung desAnlegerschutzes(Anlegerschutzverbesserungsgesetz); 29.10.2004)

Incl.

Amendment of theSecurities Trading Act

Amendment of theProspectus ActAmendment of the StockExchange Act

Amendment of someother regulations

Introduction of the term “financial instrument” (Finanzinstrument)

Exclusion of certain transactions from being subject to the new rules (certain share buyback measures and share pricestabilization programs and transactions from certain public institutions)

Changes regarding insider trading- The insider trading ban is now applicable to a wider range of financial instruments, incl. derivatives- Introduction of administrative offences (Ordnungswidrigkeiten) for secondary insiders if they forward insider

information or buy- and sell-recommendations based on such information- The attempt to buy or sell insider securities is already punishable

Changes regarding Ad-hoc news- The regulations about ad-hoc publicity are now based on the definition of “inside information”- Issuers of financial instruments inform the public as soon as possible of inside information which directly

concerns the said issuers- Leaves it to the discretion of the issuer to decide upon the postponing of making an information public, which is

allowed under certain circumstances. This was before only possible after prior approval by the BaFin

Changes regarding market manipulation- the already existing prohibitions were extended by the new European definition of market manipulation- until the change the intention of manipulation was a defining feature, now the possibility of giving misleading

signals is sufficient

Changes regarding financial analyses- The regulations regarding financial analysis, which were introduced with the Fourth Financial Market Promotion

Act, are now extended to all financial analyses, which were produced or forwarded in a professional context(before that did only concern investment trading firms)

Changes regarding the rights of the BaFin- The inspection and supervision rights of the BaFin were extended in line with the directive- A rule regarding international cooperation among European supervisory authorities in the prosecution of insider

trading and market manipulation was established

2004/39/EC(MIFID)

2007

2007

Implementation by

Act Implementing the Marketsin Financial InstrumentsDirective and ImplementingDirective of the Commission(Gesetz zur Umsetzung derRichtlinie über Märkte fürFinanzinstrumente und derDurchführungsrichtlinie derKommission(Finanzmarktrichtlinie-Umsetzungsgesetz);19.07.2007)

Incl.

Amendment of the

The directive was largely implemented one-to-one.

The catalogue of financial services that require a license was extended by investment consulting and operation ofmultilateral trading facilities

Extensive changes in the requirements of credit and financial services institutions in respect to the furnishing ofinformation, conduct, record-keeping and organisation as stipulated in sections 31 ff. of the Securities Trading Act

The act further specifies and differentiates these information and reporting requirements for gathering customer dataand the best execution of customer orders

A further change involves the classification according to the type of investor and to the complexity of the tradedinstrument, for example requirements regarding conduct vis-à-vis private customers are stricter than those in respectof professional customers

Explicit ban on accepting financial or other inducements from third parties, or from granting such inducements, unlessthey are disclosed to the customer and are basically intended to improve the quality of the service

Introduction of “Best Execution” rule, i.e. the most advantageous way of executing the order should be chosen (beforethere was a prioritization of organized exchanges according to the Stock Market Act)

204


Securities Trading Act

Amendment of the StockExchange Act

Amendment of theBanking Act

2006/73/EC andRegulation1287/2006

2007

The rules of conduct,guidelines on compliance andgeneral principles for tradingby employees(Wohlverhaltens-Richtlinie,Compliance-Richtlinie,Mitarbeiter-Leitsätze) set rulesin these areas until then. Theywere repealed and replacedby the new regulation.

2007

Implementation by

Regulation Specifying Rules ofConduct and OrganisationRequirements for InvestmentServices Enterprises(Verordnung zurKonkretisierung derVerhaltensregeln undOrganisationsanforderungenfür Wertpapier-dienstleistungsunternehmen(Wertpapierdienstleistungs-Verhaltens- undOrganisationsverordnung);23.07.2007)

First Regulation Amending theFinancial Analysis Ordinance(Erste Verordnung zurÄnderung derFinanzanalyseverordnung;23.07.2007)

Specifies provisions, which have been amended and integrated by the FRUG relating to the rules of conduct for lendingand financial services institutions and for financial analyses. It thus includes detailed regulations on requirementsconcerning the furnishing of information and reports by investment services enterprises to their clients, on thegathering of customer data for the assessment of suitability and appropriateness of dealings in financial instruments,and on the best execution requirement of institutions for client orders

Contains organisational requirements of the company for supervising compliance with statutory requirementsthemselves, dealing with conflicts of interest and providing reports on investment services

Provisions for procedures for classifying clients as private customers, professionals or eligible third parties aretransposed from the MiFID itself

Further changes were necessary in the- Ordinance on the Examination of Investment Services Enterprises- Ordinance on the Analysis of Financial Instruments- Securities Trading Reporting Ordinance- Market Access Information Ordinance

205


Deposit guarantee19.8






94/19/EC 1995

There was no law that forcedbanks to belong to a depositinsurance scheme. However,all banking groups had set upseparate and privatelyorganized deposit protectionschemes.

The private banks establisheda guarantee fund in 1976which covered a wide range ofdeposits (all sight, time andsaving deposits) and had avery high coverage of up to30% of a bank’s equity perdepositor.

The savings bank group andthe cooperative bank grouphad each set up systems ofinstitutional insurance, whichguaranteed the viability ofeach separate bank in thegroup so that all deposits wereinsured indirectly.

The public banks that werenot part of the savings bankgroup set up a scheme in1994, which is similar instructure to the system of theprivate banks and insuresdeposits, but not the viabilityof institutions.

There was no system forfinancial service institutions

1998

Deposit Guarantee andInvestor Compensation Act(Gesetz zur Umsetzung der EG-Einlagensicherungs-richtlinieund der EG-Anlegerentschädigungs-richtlinie; 16.07.1998)

The EU system was incompatible with the existing German system and Germany filled a law suit against the directive. Thislaw suit was rejected by the European Court of Justice in 1997. Therefore, the implementation was delayed. In themeantime the Directive 97/9/EC on investor-compensation schemes was passed, so that both directives were implementedtogether.

Therefore, for the first time a statutory system of deposit insurance was set up in Germany. However, since the Germanlegislators were confident with the existing private systems, only the minimum changes necessary to comply with thedirective were introduced:

Membership in a statutory system for banks and investment service firms required

Protection limited to 20,000 euro per depositor; retention of 10% was introduced

No coverage for most financial institutions, public bodies, medium-sized and large incorporated enterprises. Insurancecorporations and creditors that are in certain group relations

The option to release the institutions that are part of an institutional protection scheme of the duty to becomemember in a statutory system was used

The new legislation led in Germany to the introduction of three new schemes: One for private banks, one for public banksand one for investment firms. The scheme for the private and the public banks were organized at their respective federalassociations, which already were responsible for the existing privately organized schemes. The scheme for the investmentfirms was established at the German Reconstruction and Loan Corporation. The existing private schemes have beenamended so that they top up the statutory systems now, so that for depositors the level of protection had not changed.Members of the cooperative bank group and the savings bank group did not have to join any statutory system, since theywere members of systems that guaranteed institutional viability.

206


Generally, the Germansystems were based onvoluntary membership.However, since the 1986recommendation of thecommission, banks that arenot members of any insurancescheme have a duty to informabout this fact.

2008 Public Declaration Chancellor Angela Merkel and Finance Minister Peer Steinbrück guarantee in a public declaration all deposits

Directive2009/14/EC(DepositGuaranteeSchemes)

2009 2009

Implementation by

Act for the Amendment of theDeposit Guarantee andInvestor Compensation Actand of other Acts(Gesetz zur Änderung desEinlagensicherungs- undAnlegerentschädigungs-gesetzes und anderer Gesetze;25.06.2009)

Increased minimum coverage- Deposits up to a minimum of 50,000 euro are insured (from the 30th of June 2009)- Deposits up to a minimum of 100,000 euro are insured (from the 31st of December 2010)

Retention rate of 10% abolished- The retention rate of 10% is abolished (from the 30th of June 2009)

Pay-out delay reduced to a maximum of 30 days- The payout delay is reduced to 30 days (from the 1st of January 2011)

Increased focus on early identification of imminent compensation cases- Compensation schemes are obliged to conduct regular audits of their member institutions to assess the risk of a

compensation case arising- BaFin has to inform the affected compensation scheme if it obtains information suggesting that a compensation

case could occur at a particular institution

New system for levying contributions- The risk of the institutions triggering a compensation case must be taken into account when calculating

contributions and payments- New rules on levying special contributions

2013 Public Declaration Government Spokesman Steffen Seibert confirms the continued validity of the guarantee given in 2008.

207


Crisis management schemes19.9






2001/24/EC 2004

§45 of the Banking Act hasprovisions that allow the BaFinto put certain restrictions on abank if it does not comply withthe equity or liquidityrequirements. It can inparticular prohibit the payoutof profits and the granting ofnew loans. Additionally, it canprohibit the bank to invest incertain assets.

§46 allows the BaFin to takecertain measure if a bank getsendangered. It can prohibitthe acceptance of depositsand the granting of loans. Itcan ban owners and managersfrom doing business for thebank and order acommissioner.Also it is allowed under certainconditions enact amoratorium for certain banksor to enact a general.Also it is the only entity thatcan file for insolvency at theresponsible court. If otherlaws would force themanagement to file forinsolvency, a duty to givenotice to the BaFin appliesinstead.

section 343 (1) of theInsolvency Code allowsGerman authorities not torecognize insolvency

2003

Act Implementing theRegulatory Provisions for theRemediation and Liquidationof Insurance Companies andCredit Institutions(Gesetz zur UmsetzungaufsichtsrechtlicherBestimmungen zur Sanierungund Liquidation vonVersicherungsunternehmenund Kreditinstituten;16.12.2003)

Insolvency proceedings within the EU- Only the responsible authorities or courts of the mother country are allowed to start the insolvency proceedings

of a deposit taking credit institution or an E-money institute domiciled within the EU- If insolvency proceedings against an institution are commenced in another member state, the Federal Republic of

Germany must recognize these proceedings irrespective of the rules set forth in section 343 (1) of the InsolvencyCode

- Territorial proceedings are not possible any more for those institutions

Information duties for insolvency proceedings within the EU- If possible prior to, but in any case directly following the ordering of reorganization measures, BaFin is required to

notify the competent authorities of the other EEA states in order that any required accompanying measures canbe initiated for other entities under supervision

- Reorganizations must be made public to ensure that legal remedies can be sought in the event that the interestsof third parties are impaired

- Comprehensive rights for information for creditors and informational obligations for courts and liquidators havebeen introduced

- Information duties are introduced that ensure that the different supervisory authorities inform each other in casethat the branch of a member state institution domiciled outside of the EU encounters problems

Additional changes- Introduction of the insolvency cause “imminent illiquidity”- BaFin has to be consulted before the appointment of a liquidator- BaFin has the right to be informed by the liquidator upon request

208


proceedings opened in othercountries under certainconditions

Act establishing a package ofmeasures for the stabilizationof the financial market(Gesetz zur Umsetzung einesMaßnahmenpakets zurStabilisierung desFinanzmarktes; 17.10.2008)

Article 1 of the law is the Act Establishing the Financial Market Stabilization Fund (Gesetz zur Errichtung einesFinanzmarktstabilisierungsfonds).- It established the Special Fund for Financial Market Stabilization (Sonderfonds Finanzmarktstabilisierung, SoFFin )

and the Agency for Financial Market Stabilization (Finanzmarktstbilisierungsanstalt, FMSA)- The FMSA is operating the SoFFin- Any company that is part of the financial sector can apply for stabilization aid- The fund has three different instruments available: guarantees, recapitalizations and risk assumptions- It has a volume of 400 billion euro for guarantees and 80 billion euro for recapitalization measures- Its activities are constricted until December 2009- On institutes that are aided by the fund certain restrictions are imposed. These include a cap for management

salaries, no bonus payments and no profit payouts

Article 2 of the law is the German Act on the Acceleration and Simplification of the Acquisition of Shares and RiskPositions of Financial Sector Enterprises by the Fund (Gesetz zur Beschleunigung und Vereinfachung des Erwerbs vonAnteilen an sowie Risikopositionen von Unternehmen des Finanzsektors durch den Fonds"Finanzmarktstabilisierungsfonds - FMS" (Finanzmarktstabilisierungsbeschleunigungsgesetz))- The law simplifies the acquisition of shares in a financial institute by the fund; in particular hurdles from

corporate law are removed- The main instruments are: a fast capital increase by the creation of a legally authorized capital, alternatively a

regular increase in capital by a simple convocation of the general meeting, a simplified creation of jouissancerights and the application of the aforementioned instruments also for credit institutions in other legal forms. Forexample, until the 2011 the management board of a stock corporation of the financial sector can increase itsshare capital by 50% by issuing new shares and selling them to the fund, for the convocation of the generalmeeting the notice period was lowered to one day

- Those rules are accompanied by a variety of exceptions, which annul other rules from general business law thatmay inhibit fast action by the fund, for example the duty to make a takeover bid according to the SecuritiesTrading Act does not apply to the fund’s participation

- There are also rules laid out for the organized reduction of the participation, when stabilization is achieved

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Act for Further Stabilisation ofthe Financial Market(Gesetz zur weiterenStabilisierung desFinanzmarktes; 19.04.2009)

The act introduces the Rescue Takeover Act (Rettungsübernahmegesetz)- It increased the maximal maturity of guarantees of the SoFFin from 36 to 60 months- It amends corporate and takeover laws regarding different instruments of the SoFFin, for example the

participation in a financial corporation- The purchase of risky assets by the SoFFin was facilitated and fastened- Eventually it enacted an allowance for the nationalization and expropriation until the 30th of June 2009

Act for the ContinuedStabilization of the FinancialMarkets(Gesetz zur Fortentwicklungder Finanzmarktstabilisierung;16.07.2009)

This act was also called the “Bad Bank” – Law

It the SoFFin with two additional instruments that help to clean up the bank balance sheets from toxic assets

One option is the founding of a special purpose vehicle, owned by the institute. The institute can transfer structuredsecurities to the special purpose vehicle and receives bonds guaranteed by the SoFFin in return. Since for those there isno equity requirement this will set free some of the banks equity. Additionally, the bonds can be used for refinancingat the ECB. The SoFFin is to be compensated for its guarantee and the institutes have to pay for losses made by thespecial purpose vehicle

Another option is the consolidation model. Here also a special purpose vehicle is founded in which the institute cantransfer structured securities, but also other assets and whole business areas.

Restructuring Act(Gesetz zur Restrukturierungund geordneten Abwicklungvon Kreditinstituten, zurErrichtung einesRestrukturierungsfonds fürKreditinstitute und zurVerlängerung derVerjährungsfrist deraktienrechtlichenOrganhaftung(Restrukturierungsgesetz);09.12.10)

The new law has three important articles:- Article 1 introduces the Reorganization Law for Credit Institutions (Kreditinstitute-Reorganisationsgesetz)- Article 2 changes the Banking Act and gives the Federal different options to intervene in endangered credit

institutions under certain conditions- Article 3 introduces the Restructuring Fund Act (Restrukturierungsfondsgesetz), which establishes a fund to

finance measures connected with the reorganization and rescue of credit institutions

The Reorganization Law for Credit Institutions makes two instruments available to credit institutions that are in needof rehabilitation: The recovery procedure (Sanierungsverfahren) and the reorganization procedure(Reorganisationverfahren)

Recovery procedure (first level)- Is triggered by a declaration of the institute to the federal financial supervisory agency- It is possible when the credit institution is in need of rehabilitation (for example failure to comply with equity or

liquidity requirements)- With the declaration a rehabilitation commissioner has to be named and a rehabilitation plan needs to be set up- The plan will be examined by the federal financial supervisory agency and the responsible higher regional court in

Frankfurt (OLG Frankfurt)- Gives the institute the possibility to recover under the protection of an orderly, judicial procedure

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Reorganization procedure (second level)- Credit institution can start this procedure if it regards the rehabilitation procedure as unpromising or if this

procedure had failed already- The rehabilitation commissioner can with the consent of the credit institution trigger the reorganization

procedure by a declaration to the federal financial supervisory agency- A reorganization commissioner needs to be named and a reorganization plan has to be set up- In the reorganization plan the legal rights of third parties can be changed; how this should happen in the process

of reorganization has to be detailed in the reorganization plan- If the federal financial supervisory agency recognizes the threat to the viability of the institution and conceives its

potential failure as a systemic threat it forwards the declaration to the higher regional court in Frankfurt (OLGFrankfurt)

- The court orders the execution of the plan. With the agreement of the concerned third parties the planedreorganization measures come into force

The changes in the Banking Act give the federal financial supervisory agency a range of possibilities to intervene introubled institutions- It is allowed to ask credit institutions to implement rehabilitation measures relatively early- It can order a special deputy at an institution- The central change, however, is the ability to implement a transfer procedure

The transfer procedure (Übertragungsverfahren)- It allows the federal financial supervisory agency to transfer the liabilities and assets of an institution to a

different legal entity, if a reorganization procedure cannot be implemented and executed sufficiently fast- Partial or full transfer is possible- Can be implemented if the viability of an institution is endangered, if the failure of the institution poses a

systemic threat and if no other measure can prevent this systemic threat (ultima-ratio condition)- A compensation has to be paid from the new legal entity to the credit institution if the value of the transferred

positions was positive and from the credit institution to the new legal entity if it was negative

The Restructuring Fund Act established a fund at the Federal Agency for Financial Market Stabilisation (FMSA)- It is stocked by a charge applied to all credit institutions- The contribution rules are detailed in the Restructuring Regulation- The funds can be used for the establishment of bridge banks and for the purchase of participations, for

guarantees, for recapitalization measures and for other measures according to §8 of the Restructuring Fund Act

The BaFin plans to release in 2013 a circular defining the minimum requirements for recovery plans. It will demand theinstitutes to establish recovery plans with the following structure:- Strategic analysis (company structure, business activities)- Options for recovery action (general overview, stress test, recovery indicators and escalation processes)- Plans for the implementation of the identified need for action

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Second Financial MarketStabilization Act(Zweites Gesetz zurUmsetzung einesMaßnahmenpakets zurStabilisierung desFinanzmarktes (ZweitesFinanzmarktstabilisierungs-gesetz); 24.02.2012)

The law extends the existence and activity of the SoFFin until the end of 2012.

Third Financial MarketStabilization Act(Drittes Gesetz zur Umsetzungeines Maßnahmenpakets zurStabilisierung desFinanzmarktes (DrittesFinanzmarktstabilisierungsgesetz); 20.12.2012)

The law extended the activity of the SoFFin until the end of 2014

Act on the Shielding of Riskand the Planning of Recoveryand Resolution of CreditInstitutions and FinancialGroups(Gesetz zur Abschirmung vonRisiken und zur Planung derSanierung und Abwicklung vonKreditinstituten undFinanzgruppen; 07.06.2013)

Recovery plans have to be drawn- All credit institutions that pose a potential systemic risk must compile recovery plans- Groups of institutions or financial groups have to prepare recovery plans for the entire group- Whether an institution poses a potential systemic risk is assessed jointly by the BaFin and the Bundesbank- The BaFin can order an institution to initiate and implement recovery measures

BaFin develops resolution plans- Under the new act, the BaFin will establish a special unit that develops resolution plans and takes other

preventive resolution planning measures for credit institutions that pose a potential systemic risk- The unit will assess the resolvability of banks and financial groups and work towards ensuring that the entity

concerned eliminates potential impediments. If it fails to do so, the BaFin can order measures on an discretionarybasis

Separation of commercial and investment banking- Article 2 of the new Act prohibits certain high-risk activities, defined in the Act- BaFin will be able to prohibit further types of activities carried out by specific institutions, if this threatens to

endanger the solvency of an institution- Groups may continue such activities only if they ring fence them and transfer them to a separate financial trading

institution- The provision applies to large (trading portfolio and liquidity reserve either exceed €100 billion or exceed 20% of

total assets and amount to at least €90 billion) credit institutions that accept deposits and other repayable fundsand grant loans for their own account.

- The prohibition does not apply to hedging activities performed to hedge transactions with clients, to manageinterest rates, currencies and liquidity, or to buy or sell long-term equity investments

- The separate unit needs to be economically and legally separate; it has to refinance itself independently andwithout guarantees of the head organization

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Sanctions for risk management shortcomings- Risk management duties of senior managers of credit and financial services institutions and insurance

undertakings are set out- Act provides for the criminal liability of senior managers who fail in their risk management duties where such

failure contributes to an extremely strained financial situation at the bank

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Accounting19.10






86/635/EEC 1993

The special accounting rulesfor banks existed largelyunchanged since theirestablishment in 1968.German accounting rules forcredit institutions were set outin the Banking Act, in a formsordinance(Formblattverordnung), inaccounting guidelines issuedby the FBSO and in variousFederal and Länder laws,special regulations and orders.

1990-92

Implementation by

Banks Accounting DirectiveAct (Bankbilanzrichtlinie-Gesetz; 30.11.1990)

Incl.

Change of theCommercial Code

Amendment of a rangeof other laws

Accounting Regulation(Verordnung über dieRechnungslegung derKreditinstitute (RechKredV);10.02.1992)

All relevant rules are now contained in the third book of the Commercial Code which was extended by a fourth paragraphconcerned with the complementary regulations for credit institutions and in the Accounting Regulation.

Main changes have been:

Accounting of securities- Reformulation of the concept of securities, which now uses the marketability as a major defining feature- Categorization of securities regarding their purpose (securities of the trading portfolio, securities held as fixed

assets and securities of the liquidity reserve) with corresponding different valuation rules

Accounting of sale and repurchase transactions- Banks have to distinguish between genuine sale and repurchase transactions (echte Pensionsgeschäfte) and sales

with an option to repurchase (unechte Pensionsgeschäfte)- The category “unechte echte Pensionsgeschäfte” was abolished

Accounting of trust funds- All assets and debts administered in the credit institution’s own name have to be disclosed

Bank balance sheet format has changed- Number of asset items reduced from 22 to 17- Number of liability items reduced from 15 to 12

Limitations on the creation of undisclosed reserves- Limited to the securities of the liquidity reserve- Cross-compensation – i.e. the compensation across business lines, between expenses and receipts in the area of

lending and securities - was limited to the securities of the liquidity reserve and only partial cross-compensation isallowed

Introduction of the fund for general banking risk- Allows for the unlimited and disclosed build-up of reserves- Recognized as core capital

A provision regarding currency translation is introduced

Changes in the profit and loss accounting- Separate disclosure of extraordinary profits and losses- Separation of trading and valuation profits and losses depending of the categorization of the security

Breakdown of assets and liabilities by maturity based on remaining maturity instead of initial maturity

Notes on the accounts (Bilanzanhang) became obligatory with a substantial amount of additional informationobligatory:- Disclosure of the accounting and valuation methods- Disclosure and justification of deviations from the accounting and valuation methods, and description of their

impact on the assets and liabilities, financial position and profits and losses- Breakdown of the operating income by geographic markets- Disclosure of the range of principal services offered- Report on calls under placing and underwriting commitments

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- Disclosure of the basis of the translation of foreign exchange amounts- Disclosure of the total Deutsche Mark amount of the assets and liabilities denominated in foreign currency- List of the types of uncompleted forward transactions and disclosure of the extent to which these contracts were

concluded for purposes of hedging or speculation

1998

Law of the Facilation of CapitalAcquisition (Gesetz zurVerbesserung derWettbewerbsfähigkeitdeutscher Konzerne aninternationalenKapitalmärkten und zurErleichterung der Aufnahmevon Gesellschafterdarlehen(Kapitalaufnahmeerleichterungsgesetz); 13.02.1998)

Allowance for listed firms to use IAS or US-GAAP for the drawing up of the consolidated accounts- Exempting effect on the duty to prepare consolidated accounts in accordance with the Commercial Code- Only valid until 2004

EC 1606/2002(Regulation) and2003/51/EC

2005/6

Law on the Facilitation ofCapital Acquisitions allowedlisted companies to draw uptheir annual consolidatedaccount using IAS or US-GAAP.This had an exemption effecton the duty to draw up thoseaccounts in accordance withthe Commercial Code.

2004

Implementation by

Law on the Introduction ofInternational AccountingStandards and on theProtection of the Quality ofAudits(Gesetz zur EinführunginternationalerRechnungslegungsstandardsund zur Sicherung der Qualitätder Abschlussprüfung(Bilanzrechtsreformgesetz);09.12.2004)

Accounting standards for annual and consolidated accounts were changed- With the regulation 1606/2002 it became obligatory for capital market oriented enterprises to draw up their

consolidated accounts according to International Accounting Standards (IAS) starting from 2005 (and for somecases from 2007). It left it to the discretion of the member states according to which standards the annualaccounts of capital market oriented enterprises and the annual and consolidated accounts of non-capital marketoriented enterprises should be drawn up

- The Act to Reform Accounting Law concretised the regulation 1606/2002- Regarding the options in regulation 1606/2002 for the drawing up of the annual accounts German legislators

decided that the usage of IAS is not possible. For the calculation of tax and for profit-distribution the basis is stillthe accounts based on the Commercial Code

- For the consolidated accounts, non-capital market oriented enterprises have a choice to use the IAS- It became obligatory that the consolidated accounts have to be drawn up according to international accounting

standards as soon as an enterprise applies for admission of a security to a domestic organized market- Sub groups have to draw up their own consolidated accounts. The drawing up of consolidated accounts on a

higher level in the group does not have an exempting effect anymore

From the Modernisation directive only the necessary parts were introduced. Those include the regulations regardingmanagement reporting, audit certificate, transparency requirements- The management report was extended and had now to include additionally:

Opportunities and risks of the company Aims and strategies Comparison of actual vs. target performance Most relevant non-financial indicators

The Act to Reform Accounting Law also introduced the Fair Value Directive 2001/65/EC and the Threshold Directive2003/38/EC into German law- The threshold directive increased the thresholds from which a company counts as small and medium sized and so

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allowed a larger number of companies to profit from less demanding accounting standards- From the Fair Value Directive only the necessary parts were introduced. The changes mainly affected the

information provided in the notes on the balance sheet and in the management report. Information aboutderivatives has to be disclosed now. In particular the fair value of financial assets and instruments has to bepublished. In the management report information about the use of financial instrument have to be published

Accounting LawModernisation Act(Gesetz zur Modernisierungdes Bilanzrechts(Bilanzrechtsmodernisierungsgesetz); 25.05.2009)

The accounting modernization act had as a target an internationalization of accounting standards. It made the Germanaccounting rules converge towards international standards. Additionally, it implemented some European harmonizationrequirements.For financial institutions the new accounting rules also brought some relevant changes.

Accounting of financial instruments of the trading portfolio according to the fair value principle corrected by a haircut- New accounting category “Trading Book” is introduced, where financial instruments of the trading portfolio enter- Definition of the trading portfolio follows the definition in the Banking Act- Under the accounting rules all financial instruments that are not held as current assets, liquidity reserve or fixed

assets belong to the trading portfolio- Assets in the trading portfolio will be valued with their fair value (for this segment the amortized cost principle

has been removed)- Two safeguards are introduced: haircut on the market price and block of dividend payments

Hair cut will be calculated according to the default probability of the unrealized profits The block of dividends is achieved by forcing banks to generate a risk reserve. 10% of net income from the

trading portfolio must be allocated to this reserve item each financial year. Allocations must be continueduntil 50% of the average net annual income from the trading portfolio over the last five years has beenreached

- Positive and negative fair values in derivative trades have to be included- Unrealized trading gains are recognized as regulatory capital- Subsequent reallocations between trading portfolio and other accounting categories very limited and only under

certain conditions

Introduction of a hierarchy of fair value determination- In general the fair value is equivalent to the market price of the asset in an active market- If there is no active market the fair value has to be determined by generally accepted valuation models- As a fall back the act stipulates the amortized cost valuation methodology (last determined fair value is deemed

to be amortized costs)

Accounting of hedging relations- Valuation units can be entered in the balance sheet- Purpose of a valuation unit is to report a hedging relationship- The need for valuation units stems from the fact that losses from on-balance sheet risks lead to write-offs, while

the compensating gains from the hedge are not affecting income

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- The range of hedgeable items is relatively wide; assets, debt as well as firm commitments and also highlyprobable transactions can be hedged

- Generally, micro-, portfolio and macro hedges are possible- As hedging instruments derivatives and non-derivative financial instruments can be used- For the constitution of a valuation unit it is mandatory that the hedged item and the hedging instrument respond

to the same risk, but in opposite ways- Effectiveness of the hedge (in offsetting valuation changes fully or partially) has to be measured- Two options for reporting valuation units in the balance sheet: freezing method and booking through method

The freezing method makes it unnecessary, when the hedge is effective, to adjust the instrument and toexplicitly recognize the hedging relationship in the balance sheet

In the booking through method all changes in value are recognized. In the profit and loss account the valuechanges balance each other out

New stricter consolidation rules- Obligation to consolidate of a potential daughter is according to the new rules already triggered if domination is

possible- The definition of domination is extended by a definition targeted at special purpose vehicles. Domination is

assumed if the parent company bears most of the risks and opportunities of a daughter company- This change in accounting rules largely was taken over to the consolidation principles for supervisory purposes

(equity, large exposures, etc.)

Extension of the information provided in the required notes to the accounts- More extensive information is required on off-balance sheet transactions, derivative instruments and valuation

units

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Corporate governance19.11



National measures before EUlegislation



2005

Minimum Requirements forRisk Management(Mindestanforderungen andas Risikomanagement(MaRisk); 20.12.2005)

The Minimum Requirements for Risk Management require that remuneration and incentive schemes do not contradict theaims set forth in the bank’s strategy

2009

Revision of the MinimumRequirements for RiskManagement

The new MaRisk contain more explicit requirements for banks’ remuneration systems.

The remuneration and incentive schemes should now be structured in a way that precludes any possibility formanipulation and avoids negative incentives

The variable compensation for staff members in risk-relevant positions should take account of the risk taken

The level of variable compensation should be based on the long-term performance and also take into account negativebusiness trends

The structure of the incentive system should not only take into account the success of single employees, but also thesuccess of the business unit and the institute as a whole

A remuneration committee is established in banks, which is responsible for the structure and development of thecompensation schemes

2009

Self-commitment of 8 bigbanks and the 3 largestinsurance companies

The institutes commit themselves in December 2009 to direct their compensation systems towards sustainability. They willimplement the agreed G20 standards and the derived FSB principles as soon as possible.

)

2009

Circular of the Federal Agencyfor Financial MarketSupervision regarding therequirements of remunerationsystems(Rundschreiben derBundesanstalt fürFinanzdienstleistungsaufsichtzu den Anforderungen anVergütungssysteme;

The requirements of the MaRisk were replaced by a separate circular by the German federal financial supervisory agency.This became necessary after the release of Implementation Standards for the Principles for Sound Compensation Practices(released in April 2009) by the Financial Stability Board.

The circular has two parts. The general part has to be applied by all institutes. The specific part has only to be appliedby some institutes. Whether the specific requirements have to be applied depends on a self-assessment based on type,size, complexity, risk and internationality of the incurred business

General part- Responsibility for the structure of the general compensation schemes is put with the management board, the

compensation scheme of the management board is put with the supervisory board- The compensation schemes have to be in accordance with the institutes’ strategy- Negative incentives to take excessive risk have to be avoided

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21.12.2009) - Compensation schemes of the control units in an institute have to be set up in a way that guarantees a sufficientmanning of the controlling departments and avoids conflict of interest

- Additionally certain information duties are established

The specific part largely aims at management boards and employees that can incur high risk positions (“risk takers”).- Variable and fixed compensation elements combined in a balanced way- The variable compensation of risk takers should depend on overall success of the institute and business unit, but

also at individual contribution. Additionally, non-financial parameters and the sustainability of the success shouldalso be taken into account

- At least 40% of the variable compensation have to be paid out over a period of at least 3 years; the payoutdepends on the long-term success of the institute and there should also be negative corrections possible

- The establishment of a compensation committee is necessary- There are certain publication requirements

Directive2010/76/EU(CRD III)

2011

October 2010

Implementation by

Act on the SupervisoryRequirements for Institutions'and Insurance Companies’Remuneration Systems(Gesetz über dieaufsichtsrechtlichenAnforderungen an dieVergütungssysteme vonInstituten undVersicherungsunternehmen;21.07.2010)

Incl.

change of the BankingAct

Regulation GoverningRemuneration at Institutes(Institutsvergütungs-verordnung; 07.10.2010)

The Act introduced a new section in §25 (which deals with organizational requirements of institutes) and defines nowthat the required risk management also includes a compensation practice for employees and members of themanagement board in institutions that is transparent, suitable and aims towards a sustainable development of theinstitute

Also, a section was introduced that allows the supervisory authority to limit or forbid the pay out of variablecompensation elements if the institute’s equity or liquidity situation is insufficient

Additionally, a mandate for the Ministry of Finance is included to implement in accordance with the Bundesbank aRegulation Governing Remuneration at Institutes, which defines and substantiates the required standards. This was done inOctober 2010. The new regulation replaced the circular from December 2009. The new regulation is in many regards similarto the circular, but also includes some new parts.

Again there is a specific part and a general part. The specific part has only to be applied by relevant institutes. A relevantinstitute is assumed if the balance sheet exceeds 40 billion euro or if the institute has a balance sheet size above 10 billioneuro and its risk analysis suggests that it is a relevant institution.

The general part includes the following requirements for the structure of the compensation schemes:- Alignment with aims and strategies of the institute- Requirements for the compensation of the management board- Suitability of the compensation schemes- Avoidance of incentives to incur unreasonable risks- Relation of fixed and variable compensation- Compensation of control units- Ban of guaranteed variable compensations- Ban of safeguards contradicting the intended risk oriented compensation structure- Disclosure- Information policies towards administrative or supervisory bodies- Total variable compensation is not allowed to limit the ability of an institute to regain or preserve equity

In relevant institutes for the management board and the employees with substantial influence on the risk profile of theinstitution there are additional rules

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- Variable compensation is even more regulated; in particular the pay out of variable compensation parts is limited.A minimum of 40% can not be paid out for a retention period of 3 to 5 years

- For management board members and subsequent higher employees the rules are even stricter, so that a part ofthe retained compensation has to be paid in shares or has to be paid out based on the development of certaineconomic indicators

- The sustainability has to be related to the retained and the not retained part of the compensation.- Negative developments should lead to cuts in variable compensations- Additionally, a compensation committee has to be established

Directive2013/36/EU(CRDIV)

2014

Still in legislative process

Implementation anticipated inthe Banking Act (§25) and theRegulation GoverningRemuneration at Institutes(Institutsvergütungs-verordnung)

Restrictions on variable remuneration- For the first time the banking act will include restrictions regarding the variable remuneration of employees and

members of the management board in institutions directly- An upper limit on variable remuneration of 100% of the fixed remuneration, which may be raised to 200% with

shareholder approval, is introduced

Remuneration practices have to be based on sustainability- Institutions are required to base their remuneration policies on sustainability- The rules governing the structure of remuneration policies, particularly regarding the retention, reduction or

cancellation of bonus payments, will be fleshed out in the Regulation Governing Remuneration at Institutions,which is to be amended during 2013

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National regulation19.12

Items Evolution of content

Antitrust enforcement / competition

policy

There were restraints on competition already since the second half of the 19th century, but mainly in the private banking sector- Regional interest rate syndicate were formed, following the example of the 1894 Berliner Stempelvereinigung

In 1913 the General Agreement of the Association of Banks and Bankers ( Allgemeine Abmachung der Vereinigung von Banken undBankiers). It aimed at increasing profitability of banks to reduce their use of the Reichbank’s gold and currency reserves –restrictions and coordination in many areas (fees, interests, etc.)

The savings banks and the cooperative banks did not participate in the private cartelization attempts. Only in 1928 their headorganizations agreed with the private banks on the Competition Agreement ( Wettbewerbsabkommen). It mainly was concernedwith rules regarding the banks’ advertisement

First governmental interventions in 1931 as a result of the crisis, which ended in establishing a compulsory cartel among thebanks. It influenced many areas of banking; among others banks’ price policy was influenced heavily. This cartel basically stayedin existence until 1967

The new Banking Act from 1961 included a provision (§23) which allowed authorities by establishing an ordinance to interfere inthe conditions for which banks are allowed to grant loans and accepted deposits. An ordinance was established in 1965, butalready abolished in 1967. In 1984 the empowerment to establish such ordinances was deleted without replacement

In 1957 the Act against Restraints of Competition (Gesetz gegen Wettbewerbsbeschränkungen, GWB) was introduced. With §102credit institutions were exempt from some of the regulations of the GWB under certain conditions. For examplerecommendations, contracts and decision among single banks or banking groups and associations can be exempt, if they arerecognized by the supervisors and if they are advantageous for the national economy. Any measures still need to be declared toand accepted by the cartel authority

Generally, there is no freedom of trade in the banking sector. The Banking Act in §32 has a provision, so that only after licensingby the supervisory authority the banking business can be taken up. However, this provision does not aim at restrictingcompetition, but rather shall insure the reliability and stability of the licensed institution. If the stated requirements are fulfilledthe supervisory authorities have only limited and clearly defined criteria to refuse the licensing. This was different until 1958where there was also a needs test before a bank was granted a license

Asset restrictions §12 of the banking act restricted asset holdings of banks- Permanent holdings of land, buildings, ships and participations in companies are not allowed to exceed equity

Changes with the third amendment of the Banking Act in January 1985- The qualification of permanence was abandoned and now every holding in another bank or other companies exceeding 10%

are included in the relation of §12- Jouissance rights are considered participations- Fixtures and furnishing (Betriebs- und Geschäftsausstattung) need to be included

Changes with the fourth amendment of the Banking Act in January 1993- Deposit taking credit institutions are not allowed to hold a qualified participating interest in one single company that is not a

bank, a financial institution or an insurance company that exceeds 15 per cent of its equity- The sum of all such qualified participations is not allowed to exceed 60 per cent of the institution’s equity- If it exceeds one of the thresholds, the exceeding amount has to be covered completely with equity, which then is not

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available for other purposes anymore (e.g. for fulfilling capital requirements)- Transition period until the end of 2002

Changes with the fourth Financial Market Promotion Act in July 2002- The act introduced e-money institutions- An explicit ban of holding participations in other companies, unless those participations are related to the operations of the

institute, was introduced in §12 for e-money institutions

Conflict of interest rules 1977 – early regulation based on §6 of the European code of conduct relating to transactions in transferable securities

1980 – Federal Banking Supervisory Office communicates that it sees functional separation of trading (Handel), execution(Abwicklung) and control as a basic principle to comply with the code of conduct

1994 – Second Financial Market Promotion Act introduces Securities Trading Act- §31 – §33 contain regulations regarding general and special rules of conduct and organizational duties- According to §31 a financial service institution has work towards the avoidance of conflicts of interest. If conflicts of interest

are unavoidable, it has to make sure that the order is fulfilled in the interest of the customer- According to §32 a financial service institution or a connected undertaking is not allowed to recommend a customer the

purchasing or selling of a security or a derivative, if it is not in the interest of the customer- According to §33 it has to organize in such a way that the conflicts of interest between the institution and its customers and

among different customers of this institution are minimized- The Federal Securities Supervisory Office confirms that it also sees the separation of the trading, execution and control as a

basic principle for compliance with §33

1998 - Federal Securities Supervisory Office released the Ordinance Concretizing the Organizational Obligations of InvestmentServices Enterprises pursuant to Section 33 of the German Securities Trading Act that concretized the requirements a creditinstitution has to fulfill to comply with §31 - §33- Among other thing it asks for the imposition of “Chinese walls” and the implementation of a compliance department

1999 – Ordinance was replaced by one that also included financial service institutions. It makes clear that for smaller institutionsthe rules are partly too demanding and that for them a “basic compliance” would be sufficient. Also the outsourcing of thecompliance function was made possible

2007 - The ordinance was abolished. However, the BaFin suggested that the laid down rules can still be seen as a best practiceexample and be used to comply with §31 - §33

The rules were transferred largely into the Ordinance for the Concretion of Rules of Conduct and the OrganizationalRequirements of Securities-Related Services Enterprises (Verordnung zur Konkretisierung der Verhaltensregeln undOrganisationsanforderungen für Wertpapierdienstleistungsunternehmen)- The ordinance contains detailed regulations of the directive 2006/73- Among many other topics it is concerned with the principles regarding the management of conflicts of interest

Customer suitability requirements 1994 – Second Financial Markets Promotion Act created the Securities Trading Act. The rules are largely based on the FinancialServices Directive 93/22/EC. §31 demands from financial service institutions to query their customers about their knowledge andexperience with the respective financial instruments, about their aims and about their financial circumstances

2007 - Markets in Financial Instruments Directive Implementation Act (Finanzmarktrichtlinie-Umsetzungsgesetz) did largelyimplement the MIFID. It contains more extensive and differentiated rules of conduct- Regarding the customer suitability requirements for investment advising and portfolio management the act now defines

exactly, when a product can be regarded as suitable and what information is necessary. Also it forbids making an investmentsuggestion if the necessary information cannot be obtained

- It also defines the information and suitability requirements that are necessary to conduct securities business other thanadvising and portfolio management for customers. Here the financial service institution is obliged to inform the customer ifit is not able to assess the suitability or regards the product as not suitable for the customer

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- Also it states the situations when a company is allowed to abstain from a suitability check- The new rules meet on the one hand the financial services industry’s demands for the ability to standardize the information

gatherings and suitability checks. On the other hand it accommodates the special needs of discount brokers, which onlyprovide very limited financial advisory services. Additionally, by extending the duties of the law to all financial serviceproviders it now also includes investment providers

- All over, the changes in the law about information requirements and suitability requirements are largely codifications ofexisting case law in Germany

Interest rate ceilings on deposits Interest rate regulations were established in Germany in 1931

§23 of the Banking Act of 1961 allowed the Ministry of Finance to establish interest rate regulations in accordance with theBundesbank. It delegated this task to the Federal Banking Supervisory Office

A regulation was enacted that fixed a maximum deposit interest rate in absolute terms. Changes of this ceiling were left to thediscretion of the Ministry of Economics in accordance with the Bundesbank

In July 1966 the interest rate ceiling for large deposits was abolished

In April 1967 interest rate regulations were fully abolished

Interest rate ceilings on loans Interest rate regulations were established in Germany in 1931

§23 of the Banking Act of 1961 allowed the ministry of finance in accordance with the Bundesbank to establish interest rateregulations. It delegated this task to the Federal Banking Supervisory Office

A regulation was enacted that fixed maximum lending rates relative to the central bank’s discount rate

In April 1967 interest rate regulations were fully abolished

Liquidity requirements As with the capital requirements there were relatively early liquidity requirements in Germany. The Reichsgesetz from 1934already included a covering law, which however, was never complemented by accordant ordinances

The Bank of the German States (Bank deutscher Länder, forerunner of the Bundesbank) announced in 1951 some informal rulesabout appropriate liquidity for banks that wanted to make use of its refinancing facility. Those were largely accepted and appliedby the banks

The Banking Act of 1961 then in §11 stated that banks are obliged to invest their funds such that adequate liquidity for paymentpurposes is guaranteed at all times- This provision was substantiated by ordinances released by the FBSO called Principle II and Principle III

Principle II stated that long term assets should be financed by long term liabilities. It also defines what is regarded aslong term assets and what appropriate long term liabilities are. It also allows including a certain proportion of the sightand savings deposits, despite their short de jure maturity, since it is assumed that they have a longer de facto maturity

Principle III is concerned with medium and short term assets that may be not realizable on short notice. It definesthose and they should not be higher than certain liabilities, also defined in Principle III

If the long term liabilities defined by Principle II are too high or too low, they can be used / need to be deducted fromthe liabilities in Principle III

The rule is not strictly enforceable. The Federal Banking Supervisory Office has the possibility to consider specialcircumstances of a non-conforming bank

Amendment of the principles in January 1969- Due to a change in the accounting principles, also the calculation and the positions that need to be included had to be

amended. There was no substantial change in the working of the principles. Some positions were amended and some of theweightings for the positions were changed. One of the most relevant changes for cooperative banks was the inclusion ofstocks of good as assets

Amendment of the principles in March 1973- Due to some changes in the accounting principles mentioned before Principle III was strongly lifted. This was mainly related

to interbank liabilities. Here a new weighting factor was introduced to balance this

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Amendment of the principles in January 1993- With the introduction of the European Passport, subsidiaries from banks from other European countries were exempt from

having an allotted capital. If they actually would get rid of this capital and replace it by long term liabilities against theirparent bank, this would lead according to the old rules to a deterioration of their supervisory liquidity position. The ruleswere adapted, so that for liquidity calculation positions vis-à-vis the parent banks are accounted for with their respectivematurities

Replacement of Principles II and III by a new Principle II in 1998 (earliest start in 1999 or 2000)- The old principles aimed at reducing the refinancing risk and were basically limiting the maturity transformations that banks

could undertake- The new principle instead aims at reducing the call risk. This means the unexpected use of credit lines or the withdrawal of

customer deposits. Banks have to compare the liquid assets with the expected and potential liquidity withdrawals over thenext 12 month. Financial institutions now have to construct a liquidity coefficient (liquid assets divided by expected liquiditywithdrawal) for the next month and also for the next 3, 6 and 12 months and report those to the Federal BankingSupervisory Office

- The new rules are based on remaining time to maturity, while the former principles were based on the original maturity- The new principles have also to be applied by financial service institutions, mortgage banks and home loan and saving

institutions

Replacement of the Principles I and II by the Liquidity Regulation (Liquiditätsverordnung) in 2007- According to the new Liquidity Regulation there are now two approaches for the supervision of liquidity risk. Banks can

choose the standard approach, which basically is the former Principle II- Alternatively they can decide to use their own internal liquidity risk management and control tools. Those have to be

authorized by the BaFin first. The reporting period to the BaFin is then determined on an individual basis

The Liquidity Requirements according to the CRR are not fully developed yet- They will be substantiated in 2014 and 2016 by guidelines and legal acts by the commission- The liquidity coverage ratio (LCR) is supposed to ensure short term liquidity

The amount of high quality liquid assets has to exceed the net cash flows over a 30 day horizon under a severe stressscenario

- The net stable funding ratio (NSFR) is supposed to ensure long term liquidity The amount of stable refinancing (liabilities) has to exceed the amount of assets that need stable refinancing It is related to a timeframe of 1 year Stress scenarios have to be assumed

- Additionally a range of supervisory indicators have to be reported, e.g. the refinancing concentration per relevantcounterparty or product, an LCR related to currency flows

- Until the full implementation of the rules according to the CRR, the existing rules according to the Liquidity Regulationremain valid

Restrictions on geographic reach There are no supervisory restrictions on geographical reach. But by their background some of the institutions in the savings banksgroup and the cooperative banking group have limitations on geographical reach.

The savings banks are bound by the so called “Regionalprinzip” (regional principle), which is derived from the savings banks law.That means they are in principle bound to do business only within the area of their guarantor. They are forbidden to actively tryto expand business to other geographical areas

Also the primary cooperative banks are focused on their area and normally try not to expand their business actively over this area

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Financialisation, Economy, Society and Sustainable Development (FESSUD) is a 10 million

euro project largely funded by a near 8 million euro grant from the European Commission

under Framework Programme 7 (contract number : 266800). The University of Leeds is the

lead co-ordinator for the research project with a budget of over 2 million euros.

THE ABSTRACT OF THE PROJECT IS:

The research programme will integrate diverse levels, methods and disciplinary traditions

with the aim of developing a comprehensive policy agenda for changing the role of the

financial system to help achieve a future which is sustainable in environmental, social and

economic terms. The programme involves an integrated and balanced consortium involving

partners from 14 countries that has unsurpassed experience of deploying diverse

perspectives both within economics and across disciplines inclusive of economics. The

programme is distinctively pluralistic, and aims to forge alliances across the social

sciences, so as to understand how finance can better serve economic, social and

environmental needs. The central issues addressed are the ways in which the growth and

performance of economies in the last 30 years have been dependent on the characteristics

of the processes of financialisation; how has financialisation impacted on the achievement

of specific economic, social, and environmental objectives?; the nature of the relationship

between financialisation and the sustainability of the financial system, economic

development and the environment?; the lessons to be drawn from the crisis about the

nature and impacts of financialisation? ; what are the requisites of a financial system able

to support a process of sustainable development, broadly conceived?’

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THE PARTNERS IN THE CONSORTIUM ARE:

Participant Number Participant organisation name Country

1 (Coordinator) University of Leeds UK

2 University of Siena Italy

3 School of Oriental and African Studies UK

4 Fondation Nationale des Sciences Politiques France

5 Pour la Solidarite, Brussels Belgium

6 Poznan University of Economics Poland

7 Tallin University of Technology Estonia

8 Berlin School of Economics and Law Germany

9 Centre for Social Studies, University of Coimbra Portugal

10 University of Pannonia, Veszprem Hungary

11 National and Kapodistrian University of Athens Greece

12 Middle East Technical University, Ankara Turkey

13 Lund University Sweden

14 University of Witwatersrand South Africa

15 University of the Basque Country, Bilbao Spain

The views expressed during the execution of the FESSUD project, in whatever form and orby whatever medium, are the sole responsibility of the authors. The European Union is notliable for any use that may be made of the information contained therein.

Published in Leeds, U.K. on behalf of the FESSUD project.

Documents

Financial Regulation in Germany FESSUD Working Paper 55fessud.eu/wp-content/uploads/2013/04/Financial-Regulation-in-Germany... · part of a series of papers that outline the development