Regulation and supervision of German cooperative … and supervision of German cooperative banks 06. June 2013 1 Dr. Marc Rennert, Representative of Deutsche Bundesbank in Latin America

Regulation and supervision ofGerman cooperative banks

06. June 2013 1

Dr. Marc Rennert,Representative of Deutsche Bundesbank in Latin America

Outline

1. Structure of the German banking sector

2. The German supervisory framework

3. The Application of the German framework

4. Basel III

5. Banking Union

06. June 2013 2

1. Structure of the German banking sector

2. The German supervisory framework

3. The Application of the German framework

4. Basel III

5. Banking Union

Structure of the German banking sector

Germany has a de-centralised banking system with importantbanks in each federal state

❙German Financial System dominated by universal bankswhich domicile in various places throughout the country

❙Consolidation and a redefinition of the value chain of theGerman banking industry is still in progress

❙Need for the same set of rules for all heterogeneous banks.

Germany has a de-centralised banking system with importantbanks in each federal state

❙German Financial System dominated by universal bankswhich domicile in various places throughout the country

❙Consolidation and a redefinition of the value chain of theGerman banking industry is still in progress

❙Need for the same set of rules for all heterogeneous banks.

06. June 2013 3


Banking Sectortotal number of institutions: 1868

274Private Sector

4 Big Banks163 Medium/Small Size107 Foreign Branches

432Public Sector

9 State Banks423 Savings Banks

1104Cooperative Sector

2 Coop Central Banks1102 Credit Cooperatives

58Specialised

Banks

18 Mortgage Banks22 Building and Loanassociations18 Special PurposeBanks

Uni

vers

al B

anks

06. June 2013 4

274Private Sector

4 Big Banks163 Medium/Small Size107 Foreign Branches

1104Cooperative Sector

2 Coop Central Banks1102 Credit Cooperatives

58Specialised

Banks

18 Mortgage Banks22 Building and Loanassociations18 Special PurposeBanks

Uni

vers

al B

anks

Resource: Bundesbank Monthly Report April 2013 (as of February 2013)


CooperativeSector

13%

SpecialisedBanks21% Private

Sector38%

PublicSector

28%

Volume of Business(Balance Sheet)

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CooperativeSector

13%

SpecialisedBanks21% Private

Sector38%

PublicSector

28%

Resource: Bundesbank Monthly Report April 2013 (as of February 2013)

The German supervisoryframework

06. June 2013 6

The German supervisory framework

❙Up to the market risk amendment to Basel I in 1996 bankingsupervision was purely rule based

❙Since then change of paradigm:“Take a look at the risks, not (only) at the rules”❙Assess bank’s risk measurement and management procedures

❙Idea:“Make sure that target is reached, do not prescribe the wayhow to get there”

❙Reduction of capital requirements possible by using internalmodels for regulatory purposes

06. June 2013 7

❙Up to the market risk amendment to Basel I in 1996 bankingsupervision was purely rule based

❙Since then change of paradigm:“Take a look at the risks, not (only) at the rules”❙Assess bank’s risk measurement and management procedures

❙Idea:“Make sure that target is reached, do not prescribe the wayhow to get there”

❙Reduction of capital requirements possible by using internalmodels for regulatory purposes

❙Advantage: allows for flexible adaptation of banking supervisionto technological and market developments (no need to change alaw for a “comma”)

❙“Disadvantage”: Institutions do not know whether or not they docomply, Supervisors need to know better the business of thebanks

❙Adequate principles based supervision cannot be designed at agreen desk only -> need to involve the industry to get to knowmarket practice

❙ Improves Quality, interpretation and application as well asacceptance among banks supervised


❙Advantage: allows for flexible adaptation of banking supervisionto technological and market developments (no need to change alaw for a “comma”)

❙“Disadvantage”: Institutions do not know whether or not they docomply, Supervisors need to know better the business of thebanks

❙Adequate principles based supervision cannot be designed at agreen desk only -> need to involve the industry to get to knowmarket practice

❙ Improves Quality, interpretation and application as well asacceptance among banks supervised

06. June 2013 8


❙ Basic principles of microprudential supervision inGermany:

1. Liberal supervision following market principles

2. Mixture of quantitative and qualitative supervision

3. Risk based supervision

4. Forward-looking supervision

5. Supervision in public interest only

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❙ Basic principles of microprudential supervision inGermany:

1. Liberal supervision following market principles

2. Mixture of quantitative and qualitative supervision

3. Risk based supervision

4. Forward-looking supervision

5. Supervision in public interest only


Credit risk

Market risk § 10 Solvency

General rules:Banking act

Primary legislation

Derived ordinanceon ...

Secondary legislation

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Operational risk

Concentration risk

Risk management

Liquidity risk

§ 13, 14

§ 25a (1)

§ 11

Large exposures

Risk management

Liquidity


❙No business without licensing❙Minimum initial capital❙Fitness and properness of managers❙Exceptions for certain banks

❙Ongoing supervision based on relevant information❙Annual reports❙Supervisory dialogue❙Monthly or quarterly reporting requirements (solvency ratio, liquidityratio, etc.)

❙ Insolvency❙can only be declared by the banking supervisory authority not the bankitself

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❙No business without licensing❙Minimum initial capital❙Fitness and properness of managers❙Exceptions for certain banks

❙Ongoing supervision based on relevant information❙Annual reports❙Supervisory dialogue❙Monthly or quarterly reporting requirements (solvency ratio, liquidityratio, etc.)

❙ Insolvency❙can only be declared by the banking supervisory authority not the bankitself


Credit risk

Market risk Solvency ratios- simple

-more elaborated- internal models

Supervisory ratiosto comply with Approaches

06. June 2013 12

Operational risk

Concentration risk

Liquidity risk

Large exp. ratio

Liquidity ratio

- simple-more elaborated- internal models

Limits for-single large exp.-total large exp.

Standardised app.

The German supervisory frameworkRisk management (MaRisk)

General part (AT)AT1 Preliminary remarksAT2 Scope of applicationAT3 Management responsibilityAT4 General requirements forrisk managementAT5 Organisational guidelines

AT 4.1 Risk-bearing capacityAT 4.2 StrategiesAT 4.3 Internal control systemAT 4.4 Special functionsAT 4.5 Risk management on group level

Special part (BT)BT1 Internal control system

- BT0 Organisational andoperational structure- BTR Risk managementand control

BT2 Internal audit

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General framework with a modular structure

Special part (BT)BT1 Internal control system

- BT0 Organisational andoperational structure- BTR Risk managementand control

BT2 Internal audit

BTR 1 Credit riskBTR 2 Market riskBTR 3 Liquidity riskBTR 4 Operational risk

❙ German model: Integrated model with central bank support

❙ Banking supervision conducted by two organizations:❙Federal Financial Supervisory authority (BaFin)❙Deutsche Bundesbank

❙ BaFin as the “competent authority” (“bad cop”)❙ Deutsche Bundesbank supporting BaFin („good cop“)

❙ Support also from the auditors' associations of the savingsbanks and the cooperative banks sector


❙ German model: Integrated model with central bank support

❙ Banking supervision conducted by two organizations:❙Federal Financial Supervisory authority (BaFin)❙Deutsche Bundesbank

❙ BaFin as the “competent authority” (“bad cop”)❙ Deutsche Bundesbank supporting BaFin („good cop“)

❙ Support also from the auditors' associations of the savingsbanks and the cooperative banks sector

06. June 2013 14

Cooperation between Bundesbank andFederal Financial Supervisory Authority

Integrated Supervision ofFinancial Services: Banking,Insurance, Securities Markets.

Legal acts, licensing,monitoring and closingindividual institutions.

Issuing principles andregulations in agreement withthe Bundesbank.

Bundesbank

Sec. 6: Functions of BaFin Sec. 7: Cooperation with BBK

06. June 2013 15

Integrated Supervision ofFinancial Services: Banking,Insurance, Securities Markets.

Legal acts, licensing,monitoring and closingindividual institutions.

Issuing principles andregulations in agreement withthe Bundesbank.

The Bundesbank is assignedmost of the operational tasks inbanking supervision.

Ongoing monitoring process. Regular audits of banking

operations. Routine and ad hoc prudential

discussions with the institutions.

The Application of the Germanframework

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The Application of the German framework

Two sides of the same medal

Bundesbank

Information gatheringSupervisory

roadmap

BaFin

Measures

06. June 2013 17

Information structuring

Supervisoryroadmap

Information evaluation Riskprofile

Decision on possible action

Information assessment

❙Contribution of theManagement❙Annual dialogue andsupervisory dialogue❙Statements❙Notifications

❙Contribution of the Auditor❙Annual audit report pursuantto the “PrüfBV” (if necessarywith focus given by BaFinaccording to Sec. 30Banking Act)❙Specific Inspections /Interval Inspections

The Application of the German framework

Risk profile and classification

❙Contribution of theManagement❙Annual dialogue andsupervisory dialogue❙Statements❙Notifications

❙Contribution of the Auditor❙Annual audit report pursuantto the “PrüfBV” (if necessarywith focus given by BaFinaccording to Sec. 30Banking Act)❙Specific Inspections /Interval Inspections

06. June 2013 18

Examinations ofOrganisations(qualitative)

Examinations ofMeasurementApproaches

Market Risk Minimumrequirements formarket riskmanagement

Internal riskmodels (value atrisk)

Credit Risk Minimumrequirements forcredit riskmanagement

Internal rating-systems (IRBA),sec. rules (IAA)

Total Bank ICAAP,interest rate riskfrom non-trading

Models for op.risk (AMA) andfor Liquidity risk

Specific Inspections

06. June 2013 19

Examinations ofOrganisations(qualitative)

Examinations ofMeasurementApproaches

Market Risk Minimumrequirements formarket riskmanagement

Internal riskmodels (value atrisk)

Credit Risk Minimumrequirements forcredit riskmanagement

Internal rating-systems (IRBA),sec. rules (IAA)

Total Bank ICAAP,interest rate riskfrom non-trading

Models for op.risk (AMA) andfor Liquidity risk

Examination Approach

How is the compliance with regulatory rules assured bythe internal control system“?

Emphasis on those areas where expect mostthreatening risks are expected.(But also scan other areas in case our assessment was wrong.)

Check individual cases to examine the functionality of theinternal control system.

Our approach is a„risk oriented system audit“,

not focused on individual cases.

06. June 2013 20

How is the compliance with regulatory rules assured bythe internal control system“?

Emphasis on those areas where expect mostthreatening risks are expected.(But also scan other areas in case our assessment was wrong.)

Check individual cases to examine the functionality of theinternal control system.

Examination Approach

We try to grasp the organisation and processes, portfolio andrisk situation through interviews and reports.

Relevant structures and processes are investigated anddocumented.

Documentation, reconciliations, confirmations and valuationsare checked in samples.

We use examination guidelines but we hate questionnaires.

06. June 2013 21

We try to grasp the organisation and processes, portfolio andrisk situation through interviews and reports.

Relevant structures and processes are investigated anddocumented.

Documentation, reconciliations, confirmations and valuationsare checked in samples.

We use examination guidelines but we hate questionnaires.

Organisation and Processof an Examination

ContactwithBAFin

Exami-nationOrderbyBAFin

Announ-cementbyBundes-bank

FirstmeetingwithBank

Start on-site

FinalmeetingwithBank

DraftingReport

SendingReportto BaFin

Followup offindings

06. June 2013 22

ContactwithBAFin

6 - 8Weeksbeforestart




Start on-site


DraftingReport


Followup offindings

Day 0

1 week3 monthsor longer

Qualityassurance


2 monthsafter finalmeeting

Pre-Examination Work

Planning Examinations: Man power Time frame Locations Main focuses Depth (e.g. size of the samples) Specification with regard to Products

Examination diary

Documentation ofplanning and

risk assessment

06. June 2013 23

Planning Examinations: Man power Time frame Locations Main focuses Depth (e.g. size of the samples) Specification with regard to Products

Documentation ofplanning and

risk assessment


Criteria for Choosing Staff :

Qualification of the employees Knowledge about the enterprise to be checked Continuity or scheduled change ? Temporal availability of the employees Independence of the employees concerning the enterprise to be

examined Experience in leadership

06. June 2013 24

Criteria for Choosing Staff :

Qualification of the employees Knowledge about the enterprise to be checked Continuity or scheduled change ? Temporal availability of the employees Independence of the employees concerning the enterprise to be

examined Experience in leadership


Evaluation of available information: Documents requested beforehand

Annual auditor’s report Analysis of the risk situation Analysis of the balance sheet Analysis of the profit and loss situation Study internal memorandums and Databases Internal and external reports of the bank

Discussion with our colleagues from desk top supervision

06. June 2013 25

Evaluation of available information: Documents requested beforehand

Annual auditor’s report Analysis of the risk situation Analysis of the balance sheet Analysis of the profit and loss situation Study internal memorandums and Databases Internal and external reports of the bank

Discussion with our colleagues from desk top supervision

Examples for Requested Documents(e. g. Risk Controlling)

Strategy papers

Executive board decisions

Organization charts

Organization guidelines

Valuation libraries

IT system overviews

Daily, monthly reports

Limit book

Data flow pictures and descriptions

06. June 2013 26

Strategy papers

Executive board decisions

Organization charts

Organization guidelines

Valuation libraries

IT system overviews

Daily, monthly reports

Limit book

Data flow pictures and descriptions

Organisation and Processof an Examination

ContactwithBAFin




Start on-site


DraftingReport


Followup offindings

06. June 2013 27

ContactwithBAFin





Start on-site


DraftingReport


Followup offindings

Day 0

1 week3 monthsor longer

Qualityassurance


2 monthsafter finalmeeting

Running the Examination

Team size reaches from 3 to 13 examiners.

Teams go to head offices of the institutes and the largestlocations, domestic or abroad.

An examination can take from a week up to about six weeks,depending on size of the Institute and scope of the audit

06. June 2013 28

Team size reaches from 3 to 13 examiners.

Teams go to head offices of the institutes and the largestlocations, domestic or abroad.

An examination can take from a week up to about six weeks,depending on size of the Institute and scope of the audit

Internal Organisation of the Teams

Examiners work in sub teams of two on a specified task,e.g. partitioned along product lines or processes.

Sub teams draft their part of the examination report.

Relatively low specialization degree but specialists for themathematical models and IT.

06. June 2013 29

Examiners work in sub teams of two on a specified task,e.g. partitioned along product lines or processes.

Sub teams draft their part of the examination report.

Relatively low specialization degree but specialists for themathematical models and IT.

We evaluate

internal audit reports, policies and manuals

to see if they are in line with minimum requirements.

At the bank we do a lot of interviews with

trading, controlling, operations, IT, internal audit and other areasto understand the bank and assess the internal control system.

Conducting Examinations

06. June 2013 30

We evaluate

internal audit reports, policies and manuals

to see if they are in line with minimum requirements.

At the bank we do a lot of interviews with

trading, controlling, operations, IT, internal audit and other areasto understand the bank and assess the internal control system.

Reporting lines Systems for dealcapture,

position keeping, file keeping Interfaces to operations and

controlling Manpower Strategic goals Market limit system and its

monitoring

Portfolio structure Trading volumes Sources of revenues Illiquid markets Exotic instruments New products: frequency,

introduction process,volumes

Areas of interest

Organisation: Risk situation:

06. June 2013 31

Reporting lines Systems for dealcapture,

position keeping, file keeping Interfaces to operations and

controlling Manpower Strategic goals Market limit system and its

monitoring

Portfolio structure Trading volumes Sources of revenues Illiquid markets Exotic instruments New products: frequency,

introduction process,volumes

Documentation

Documentation of examiner‘s work(interview minutes, evaluation reports)

Documentation of examination results(examination report, findings list)

Documentation of Quality assurance

06. June 2013 32

Documentation of examiner‘s work(interview minutes, evaluation reports)

Documentation of examination results(examination report, findings list)

Documentation of Quality assurance

End of On Site Phase

In a final meeting our findings are discussed with themanagement of the bank.

Our report describes and assesses organization, processes andfindings. We use four categories for findings: F1 (light) to F4 (very severe).

The report goes to the BAFin and also to the examined bank.

The bank is asked for a statement and its plans about how todeal with the findings.

06. June 2013 33

In a final meeting our findings are discussed with themanagement of the bank.

Our report describes and assesses organization, processes andfindings. We use four categories for findings: F1 (light) to F4 (very severe).

The report goes to the BAFin and also to the examined bank.

The bank is asked for a statement and its plans about how todeal with the findings.

ExaminedBank

Report plus requestfor a statement

Last Steps

06. June 2013 34

Examination teamof the Bundesbank

BaFinFinal clarificationof facts

Report plus commentand proposals for actions

decisionabout measures

Basel III

06. June 2013 35

Basel III

❙Capital Requirement Directive IV & Capital RequirementRegulation accepted by❙European Parliament on 17th April❙Council on the 27th of March

❙Aim:❙Single Rule book❙Quantitative and qualitative enhancement in capital adequacy❙Harmonised liquidity requirements for EU

❙ Delayed start❙National implementation❙Target date of application 1st of January 2014

06. June 2013 36

❙Capital Requirement Directive IV & Capital RequirementRegulation accepted by❙European Parliament on 17th April❙Council on the 27th of March

❙Aim:❙Single Rule book❙Quantitative and qualitative enhancement in capital adequacy❙Harmonised liquidity requirements for EU

❙ Delayed start❙National implementation❙Target date of application 1st of January 2014

Banking Union

06. June 2013 37

Banking Union

❙Three main components:❙Single supervisory mechanism❙European recovery and resolution mechanism for systemicallyimportant banks❙European bank deposit insurance scheme

❙Three main challenges:❙conflicts of interest and complex decision-making processes❙clear hierarchy of liability and an orderly procedure❙distribution of “legacy risks”

06. June 2013 38

❙Three main components:❙Single supervisory mechanism❙European recovery and resolution mechanism for systemicallyimportant banks❙European bank deposit insurance scheme

❙Three main challenges:❙conflicts of interest and complex decision-making processes❙clear hierarchy of liability and an orderly procedure❙distribution of “legacy risks”