Work in the joint supervisory teams (JSTs)

With the launch of the Single Supervisory Mechanism (SSM) in November 2014, the ECB took over the direct supervision of the banking groups classified as significant¹ – of which 21 are currently German (see Table 31 "German institutions supervised by the ECB under the SSM", Appendix). A joint supervisory team (JST) is responsible for each of these significant institutions (SIs). Employees of BaFin and the Bundesbank are represented in these teams as well as employees of the ECB.

The number of members in each JST and its composition vary depending on the size and complexity of the banking group. The JSTs are headed up by the ECB's JST coordinators. The core JST in each of the 21 JSTs for German SIs consists of a JST coordinator together with one sub-coordinator from BaFin and one from the Bundesbank. More than 100 BaFin employees from Banking Supervision are directly involved in the collective work in the JSTs. Up to 20 BaFin supervisors work together in individual JSTs. When dealing with specialist questions, they are assisted additionally by BaFin experts on policy issues.

In 2016, on the basis of an annual supervisory examination programme (SEP) for each individual institution, the JSTs carried out a total of 32 on-site inspections, 17 examinations of banks' internal models and a number of benchmark comparisons (thematic reviews) across different institutions focusing on various areas of emphasis (for example the implementation of BCBS 239). In over 30 cases, the JSTs investigated risk areas that had become noticeable in individual institutions using targeted deep dives. They also held workshops on these topics with the employees responsible for the particular area at the institutions. In total, in 2016, each JST conducted up to as many as 300 supervisory consultations with representatives of the institutions in individual cases.

In 2016, in addition to these SEP-related activities, the JSTs, in which BaFin employees are represented, participated in around 130 decision-making procedures of the ECB's Supervisory Board, dealing among other things with decisions on appointments to executive bodies (fit and proper assessments) or SREP decisions. BaFin’s President, Felix Hufeld, is a member of the Supervisory Board.

The participants in the JSTs, which frequently have members from several different countries, work together on a firm foundation of mutual trust. In this context, BaFin is able to contribute its wealth of experience and expertise as a national supervisory authority. Despite this, there remains room for improvement, for example with respect to coordination and consultation between members. Further points are that the overall activities of the individual participants need to be more closely aligned, while the process of optimising information and decision-making channels must continue.

Merger of DZ Bank and WGZ Bank

On 1 August 2016, the assets of WGZ BANK AG were transferred to DZ BANK AG in the context of a merger by absorption. This completed the process of consolidation at the top level of the cooperative sector in 2016. The two data centre operators Fiducia and GAD had already merged to form a collective cooperative IT services provider in the previous year. The primary cooperatives located in the Rhineland/Westphalia area of operations of the former WGZ BANK AG are now also looked after by the combined central bank. The merger of the top cooperative institutions has created the third-largest banking group in Germany.

There were frequent discussions in previous years on the merger intentions of the two cooperative central banks. The merger is intended as a response to the growing challenges in the market and from a regulatory point of view.

Supervisory approvals

The proposed merger triggered a large number of supervisory approval processes. BaFin carried out a number of qualifying holding procedures, for example. The appointment of the new management board for the merged institution and the capital increase carried out in connection with the merger were also monitored from a supervisory point of view. Both of the cooperative central banks were exempted from the EBA's EU-wide stress test carried out in 2016 in order to free up the resources necessary to implement the complex merger project.

The merger is not only one of the largest between German banking groups but also the first merger between two significant groups of institutions in the SSM. In order to handle the numerous merger-related special activities, the JST has created a merger sub-team at BaFin's suggestion, consisting of employees of the Deutsche Bundesbank, the European Central Bank and BaFin. The sub-team brings together all the merger-related processes and decisions, which are discussed and coordinated internally. Since BaFin has supervised both of the institutions for many years, it has made a major contribution to the joint merger sub-team with its extensive expertise.

The merged central institution reached a milestone that had been planned for a long time with its entry in the commercial register on 29 July 2016. However, the effects of the merger will still be felt for a long time after 2016. For example, the institution has announced a process of transformation towards a new holding company structure by the end of 2020. The objective is to combine the strategic and management functions of the DZ BANK Group and bring the business activities of the former central bank alongside the other cooperative institutions on the same level.

Recovery and resolution plans: BaFin's experience

During the year under review, BaFin evaluated more than 30 group and individual recovery plans. The large majority of these related to recovery plans of significant institutions from Germany, although there were also some from other SSM member states. BaFin reviews, among other things, whether the plans submitted comply with the requirements of the Bank Recovery and Resolution Directive (BRRD), set out in detail by the European Banking Authority and the German Recovery and Resolution Act (Sanierungs- und Abwicklungsgesetz), and whether they are capable of achieving the objectives of recovery planning.² The aim of recovery planning is to prepare the institutions for potential crisis situations so that they are able to manage them using their own resources. The core elements of a recovery plan therefore include, among other things, options that the institution can take in a recovery situation in order to restore its financial viability on a sustainable basis. The institutions are also required to define indicators enabling them to take appropriate measures in good time in the event of a crisis. In addition, they must carry out a stress analysis as part of the recovery plan, which must include both serious idiosyncratic stress scenarios and those affecting the market as a whole, and take into consideration sudden developments as well as those arising over a longer period of time.

In order to continue improving the quality of the recovery plans and to ensure that consistent standards of evaluation are applied, BaFin – as in the previous year – carried out a benchmark comparison of the recovery plans submitted jointly with the Deutsche Bundesbank (see info box).

BaFin is involved in the consultations on resolution plans via the SSM and also through its representation in resolution colleges (see info box). The plans act as a template for the resolution authorities in the event that a financial institution cannot overcome its financial difficulties on its own and has to be resolved. During the year under review, the Single Resolution Board (SRB) prepared around 50 such plans for the largest significant institutions. When doing so, the SRB consults the ECB in its SSM supervisory function in order to identify potential conflicts between the suggested resolution measures or possible resolution preparations and the going-concern approach. BaFin assists the ECB with the evaluation of the resolution plans in the joint supervisory teams.

BaFin evaluated 15 resolution plans of German and foreign SSM institutions during the year under review. It also reviewed the results of evaluating a large number of other resolution plans of foreign institutions in preparation for meetings of the Supervisory Board. BaFin uses the knowledge gained in this process to continue developing its own evaluation procedures consistently and to contribute this knowledge to the SSM.

Its evaluation of the resolution plans is focused, among other things, on identifying the principal business activities and critical functions, which ideally match those in the recovery plan. In addition, from a going concern perspective, BaFin assesses the impediments to resolution identified by the resolution authority, the measures to deal with them and possible implications for supervisory activities. BaFin also assesses the particular institution's MREL ratio in the recovery plan. Since resolution plans have only been prepared since 2016 for the most part, more detailed analyses by the resolution and supervisory authorities are still needed.

EBA and ECB stress tests

In 2016, the EBA once again organised an EU-wide stress test for the 51 largest European banks following the test in 2014.³ The test was carried out by the competent supervisory authorities under the direction of the EBA. The SSM was responsible for the test in the eurozone. In total, 37 institutions supervised directly by the ECB participated in the EBA stress test. For 56 other institutions, the ECB carried out an internal stress test in parallel, the SREP stress test.

Of the 22 significant German institutions, 19 took part in one of the two stress tests. Two institutions were exempted from the supervisory stress tests in view of their forthcoming merger.⁴ One further institution was only included via consolidation by its parent company.

Both of the stress tests were based on the EBA methodology for stress tests. Bearing in mind the principle of proportionality, however, BaFin allowed the institutions in the SREP test to use simplified procedures, in particular with respect to the extent of the data requested.

The main focus of the stress tests was on the future development of the own funds items. The effects had to be determined assuming a static balance sheet in a baseline scenario and a stress scenario over a three-year period until 2018. While the baseline scenario reflected the expected development of the overall economy as assumed by the EU Commission, the stress scenario took into account various systemic risks defined by the European Systemic Risk Board (ESRB). These included a low rate of economic growth with the related effects on the institutions' earnings situation, and a sudden increase in bond yields, which are extremely low in some cases. For the purposes of market risk, the stress scenario was supplemented by two historically observable scenarios.

In contrast to the 2014 stress test, legal risks were included for the first time as a component of operational risk. A further material change compared with 2014 was the explicit inclusion of hedging relationships, which were given a new definition in the EBA methodology.

Both stress tests focused on the following five types of risk:

1. credit risk (including securitisations and sovereign exposure)
2. market risk (including sovereign exposure)
3. net interest income
4. operational risk (including legal risks)
5. other income and expenses

Unlike in 2014, this time the institutions were permitted to depart from the static balance sheet assumption to a limited extent. For example – with the approval of the supervisory authorities – they were allowed to adjust the year-end results for non-recurring items, if the latter would have distorted the results because of the static balance sheet assumption. Non-recurring items in this connection include, for example, the disposal of business divisions or material staff restructuring measures.

There were also new developments in the quality assurance process. Since the SSM took over responsibility for conducting the stress tests for the first time in 2016, quality assurance was effected in an SSM-wide process led by the ECB and with the involvement of staff from the national supervisory authorities. BaFin employees participated both in the context of their national supervisory work in Bonn and also as members of various teams at the ECB in Frankfurt.

The EBA and the ECB handled the results of the stress tests differently. While the EBA published the results of the EBA stress test in full, the ECB did not publish the results of the SREP stress test.

Risk data aggregation – Thematic review on Basel Committee principles

Risk data aggregation and risk reporting were among the supervisory priorities in the SSM in 2016. The ECB undertook a thematic review to assess the implementation of BCBS 239, which BaFin has incorporated in the amended MaRisk.⁵ At the same time, the intention was to determine benchmark standards to be used by banks and identify possible corrective measures for deficiencies. The findings of the thematic review will be included in the ECB's SREP decisions for the individual banks in 2017.

Phase 1

The thematic review consisted of two phases: in Phase 1, the JSTs evaluated the individual banks' documentation which they had specifically requested. They were assisted by a central SSM team, which provided guidance to help with the evaluations, in addition to training sessions and workshops. At the completion of Phase 1, the central team distributed a provisional, brief comparative report, which enabled the individual JSTs to identify the ranking of their own banks. The comparative report showed that the banks inspected were not yet able to satisfy the requirements of BCBS 239 in full and that further work is required.

There were difficulties in complying with almost all of the principles of BCBS 239. The institutions were particularly challenged by the requirements for data architecture and infrastructure, as well as the risk reports. Concluding talks were held with the banks, in which the JSTs discussed their assessments with the banks.

Phase 2

Phase 2 of the thematic review consisted of a fire drill and a data lineage exercise. For the data lineage exercise, the banks were required to provide evidence of the origin and aggregation of the data from the various data systems, legal entities and jurisdictions for selected data points in the supervisory reporting system. In the fire drill exercise, the banks had to demonstrate their capabilities for the rapid, accurate aggregation and reporting of credit risk and liquidity risk data. The JSTs required the data and reports to be submitted for this purpose. In addition, the banks' internal auditors had to assess the quality of the data and reports delivered on the basis of the criteria set by BaFin.

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