At the end of 2016, BaFin's Banking Supervision Directorate was responsible for supervising 1,628 banks – including 66 significant institutions (SIs).¹ 1,562 less significant institutions (LSIs) were directly supervised by BaFin. The number has declined significantly compared with the previous year. This is partly due to a large number of mergers in the banking sector, for example the merger of WGZ Bank and DZ Bank.² Also, since 2016 a number of banks have been monitored by the Securities Supervision Directorate instead of the Banking Supervision Directorate as before.³

The Banking Supervision Directorate subdivides the banks into four different groups of institutions (see Table 8 "Number of institutions by group of institutions"). The largest group of institutions, as before, is represented by the cooperative sector (976 institutions); the savings banks are the second-largest group (412 institutions). The institutions within the cooperative sector include the cooperative banks, DZ Bank and three other institutions. The savings bank sector comprises public-sector and independent savings banks together with the Landesbanks and Deka Bank.

The commercial banks, the third-largest group, comprise 171 institutions. They include the major banks, subsidiaries of foreign banks and the private banks. The smallest group with 69 banks is known as the group of other institutions. They include, among others, Bausparkassen, guarantee banks and special-purpose credit institutions.

Table 8 Number of institutions by group of institutions*

*As at 31 December 2016

Number of institutions by group of institutions*

Source: BaFin

Risk classification

The 1,562 LSIs are supervised by BaFin directly. It is assisted in this task by the Deutsche Bundesbank, which is responsible for ongoing monitoring. The risk profile of each LSI is an important supervisory tool and is updated by the supervisors at least once a year.

The risk profile of an institution affects how closely it is supervised. Each profile is based on the relevant audit report for the annual financial statements which is evaluated by the Bundesbank (see info box "Online submission of auditors' reports"). The risk profiles also incorporate up-to-date risk analyses, the findings of special audits and information from other sources.

The risk classification of an institution is based on its risk profile. The decisive factors are the quality of the institution and its potential impact in the event of a solvency or liquidity crisis on the stability of the financial sector or financial market. In 2016, the risk matrix was expanded to a 4x4 matrix. Previously it had used a 3x4 matrix. The quality criterion still has four different categories (1 to 4). The impact criterion has now been expanded from three to four categories by splitting the "low" impact category into "low" and "medium-low" (see Table 9 "Risk classification results of LSIs in 2016").

A glance at the distribution of the LSIs supervised by the Banking Supervision Directorate between the different fields in the 4x4 risk matrix shows that, compared with 2015, a higher percentage of the institutions have fallen into the "high" impact category. The reason for this is that in 2016 a number of high-priority LSIs were allocated to the highest impact category. High-priority LSIs are institutions subject to particularly close supervision on the basis of various indicators, such as their size, intrinsic risks or influence on the national economy.

Table 9 Results of risk classification of LSIs 2016*

Risk classification results of LSIs in 2016

Source: BaFin

Special audits

BaFin ordered 183 special audits in accordance with section 44 (1) sentence 2 of the Banking Act during the past financial year. It appointed the Deutsche Bundesbank to carry out the majority of these special audits. In comparison with 2015, however, BaFin made greater use of the option of awarding audits to external auditors.

Table 10 shows the breakdown of special audits of LSIs in 2016 by areas of emphasis. Most of the audit work related to special audits initiated by BaFin, which include impairment-related special audits and audits pursuant to section 25a (1) of the Banking Act (MaRisk).

Table 10 Breakdown of special audits of LSIs in 2016 by areas of emphasis*

As at 31 December 2016

Breakdown of special audits of LSIs in 2016 by areas of emphasis*

* This table relates to LSIs under the supervision of the Banking Supervision Directorate. IRBA stands for internal ratings-based approach and AMA stands for advanced measurement approach. Source: BaFin

As a general rule, the impairment-related special audits are conducted by auditors on BaFin's instructions. The impairment analysis relates to loan collateral and the adequacy of the provision for credit risks.

Audits in accordance with section 25a (1) of the Banking Act are intended to examine the adequacy of an institution's risk management systems. The minimum conditions that must be satisfied for a risk management system to be adequate are set out in detail in the MaRisk. Among other things, they include provisions affecting the design of an institution's internal control systems, its organisational and operational structure and, in particular, its risk management processes.⁵

In addition to the knowledge acquired in the course of its supervisory activities, the audit reports for annual financial statements are an important source of information for BaFin. If the information available is not sufficient to clarify a particular issue, BaFin orders a special audit. As well as for the purpose of clarifying particular issues, it also orders audits on a routine basis if the most recent audit of an institution was some time ago. Institutions may also request special audits.

In 2016, BaFin carried out five special audits on the initiative of the institutions. Four of these requested audits related to approval of the credit risk measurement procedure under the internal ratings-based approach (IRBA), while one was an audit of an institution's market risk model.

Of the total of 183 special audits in 2016, 10 were concerned with the cover for Pfandbriefe. In accordance with the German Pfandbrief Act (Pfandbriefgesetz), cover audits should generally take place every two years.

The breakdown of special audits of LSIs by the individual groups of institutions is shown in Table 11. The majority of the special audits were carried out in the cooperative sector, since this group of institutions has by far the greatest number of institutions. The audit ratio in the cooperative sector – i.e. the ratio of the number of special audits to the total number of institutions within a group – amounted to 10.5%. In total, BaFin carried out audits initiated by itself for 11% of the LSIs under supervision.

Table 11 Breakdown of special audits of LSIs in 2016 by groups of institutions

As at 31 December 2016

Breakdown of special audits of LSIs in 2016 by groups of institutions

* Number of audits as a proportion of the number of institutions in each group of institutions. This relates to LSIs supervised by BaFin's Banking Supervision Directorate. Source: BaFin

Table 12 shows the breakdown of special audits of LSIs initiated by BaFin in 2016 by risk class. In accordance with the principle of risk-based supervision, BaFin conducted the highest proportion of special audits, 55.6%, in the group of institutions where a solvency or liquidity crisis would potentially have a high impact on the stability of the financial sector.

Table 12 Breakdown of special audits of LSIs initiated by BaFin in 2016 by risk class

As at 31 December 2016

Breakdown of special audits of LSIs initiated by BaFin in 2016 by risk class

*Percentage of the total number of institutions in the respective quality/impact category accounted for by the audits. Source: BaFin

Objections and measures

BaFin recorded a total of 415 objections and measures across all four groups of institutions in 2016 (see Table 13 “Supervisory law objections and measures in 2016”).⁶ Institutions in the cooperative sector were the most affected as they represent by far the largest group of institutions.

Formal supervisory action not always necessary

In general, the approach adopted by BaFin is to make direct contact with the institutions concerned at the first sign of deficiencies. Its objective is to rectify the emerging deficiencies at the earliest possible stage. In most cases, the institutions are highly cooperative and remedy the deficiencies immediately. As a consequence, BaFin had to take formal measures against managers or members of the supervisory or administrative boards of an institution only in isolated cases during the past year.

The main formal measures taken in 2016 related to the SREP notices, which dealt with own funds and liquidity measures. These are notices issued on the basis of the guidelines on common procedures and methods for the supervisory review and evaluation process (SREP) published by the EBA on 19 December 2014. BaFin sent out a total of 303 SREP notices in 2016.⁷

Table 13 Supervisory law objections and measures under the Banking Act in 2016*

As at 31 December 2016

Supervisory law objections and measures under the Banking Act in 2016*

* This relates only to LSIs supervised by BaFin's Banking Supervision Directorate. ** Measures to improve own funds and liquidity (section 45 of the Banking Act), in the case of organisational deficiencies (section 45b of the Banking Act) and in the case of specific danger (section 46 of the Banking Act). *** These figures comprise formal and informal measures and dismissal requests from third parties. On sanctions under the Banking Act, see Administrative fine proceedings initiated by BaFin. Source: BaFin

Situation of the private commercial, regional and specialist banks

For many of the private commercial, regional and specialist banks, 2016 was characterised by rising capital requirements from a regulatory point of view. For example, BaFin sent SREP notices⁸ on the subject of higher own funds requirements to about half of the institutions in this group. The tighter requirements cover interest rate risk in the banking book in particular, but also other material risks not already dealt with in Pillar I of the framework, i.e. under the Capital Requirements Regulation (CRR) or the Solvency Regulation. The increased requirements create different challenges for the institutions due to their very different levels of capital resources. The group of institutions which did not receive a SREP notice are subject to BaFin's general administrative act dated 23 December 2016, which stipulates additional own funds requirements relating to interest rate risk in the banking book.

Low level of interest rates

The low interest rate environment which again prevailed in 2016 was the major factor affecting the business environment of the private commercial, regional and specialist institutions, even if its economic impact differed due to the wide range of business models. However, more or less all of the institutions are facing pressure to reduce costs. As a result, they too are becoming ever more interested in financial technologies, or fintech for short.⁹ The private commercial, regional and specialist institutions are making increased use of financial technologies to cut costs and offer customers up-to-date and timely services by employing IT processes.

Digitalisation

In addition, the market is experiencing a surge of innovative providers from the fintech sector with new business models. Specific business models, for example, are based on mobile banking transactions conducted using a smartphone, the establishment of online trading and brokerage platforms, the use of automated investment strategies (robo-advisors) or are aimed at project financing for renewable energies. In addition to simplifying processes, these undertakings are also aiming to use the increasing digitalisation of the banking business to collect user data for the purpose of offering future products and services that match the customer's profile, as is already normal practice in other areas of the economy. To date, fintech companies have mainly offered their technology to established institutions or have entered the market in their own name only in cooperation with authorised institutions. In 2016, BaFin granted a banking licence to two subsidiaries of fintech companies.

Situation of the savings banks

The business environment of the savings banks was also mainly affected by the historically low level of interest rates together with regulatory changes. Nevertheless, the affiliated institutions once again succeeded during the past financial year in achieving an overall result that was satisfactory. As expected, net interest income – by far the most important source of earnings for the savings banks – declined once again. By contrast, net commissions received recorded a modest upward trend. The increase was not sufficient to offset the decline in net interest income, however. Risk provisioning expenses continued to be extremely low, in both the lending and the securities business. Reserves were once again significantly increased, if not by as much as in the past, so that overall the reported net profit for the year matched the level of previous years.

Low level of interest rates

The reason for the decline in net interest income was the persisting low interest rate environment which is presenting increasing earnings problems for the savings banks. Many affiliated institutions earn a portion of their interest income from maturity transformation, i.e. exploiting the gap between short-term and long-term interest rates on the capital market. However, because the yield curve has become flatter and flatter in recent times, the income from maturity transformation has steadily receded. At the same time, maturity transformation involves an increased interest rate risk for the institutions. In order to take this risk and other material risks into account from a supervisory point of view, BaFin carried out an individual capital quantification (SREP¹⁰) for around 20% of the savings banks during the past year. It then increased the minimum capital requirements for the large majority of the institutions inspected by an average of around 1.6 percentage points, which is roughly equivalent to the capital add-on for the other groups of banks. As a transitional measure, BaFin used a general administrative act to order the capital add-on for the remaining savings banks that were not individually inspected. An individual SREP capital quantification is expected to be carried out for all of the savings banks by the end of 2017.

Mortgage Credit Directive

As the affiliated institutions have a relatively strong presence in residential building lending, they are affected to a greater extent by the European Mortgage Credit Directive,¹¹ which was transposed into German law in March 2016. The legislation imposes numerous new obligations on the credit institutions in order to protect consumers. For example, the Directive requires the institutions to carry out an even stricter review of their customers' creditworthiness in future for the purpose of residential building loans. The consequence for the banks and savings banks is that granting real estate loans is now more labour-intensive and requires more time.

Digitalisation

Since the behaviour of customers has changed in response to the increasing digitalisation of the banking business and their visits to the branches are becoming less and less frequent, the savings banks reduced their branch network again in 2016 in order to save costs (see Figure 2 "Number of savings banks"). The institutions will face additional expenses with the expansion of their online presence and the modernisation of their IT systems. The savings banks are responding to the growing pressure on costs by combining to form larger entities and merging with neighbouring savings banks. The rate at which these mergers are taking place is expected to accelerate in 2017. The savings banks' average total assets has now risen to around €1.2 billion as a result of the mergers completed in recent years.

Figure 2 Number of savings banks*

Number of savings banks*

*This statistic does not include eight Landesbanks and Deka Bank. Source: BaFin

Situation of the Bausparkassen

The continuing low interest rate environment represented a challenge for the Bauspar sector in 2016 as well. Loans granted for residential building purposes increased once again, although modestly, with the growth mainly attributable to pre-financing and bridging finance loans. The proportion of Bauspar loans, on the other hand, continued to decline. This was reflected in a further reduction in the share of total assets of the individual Bausparkassen represented by Bauspar loans. However, savings targets continued at a high level in 2016 as well.¹²

The declining proportion of Bauspar loans once again contrasted with a further increase in Bauspar deposits across the sector in 2016.¹³ One reason for this is the lack of interest on the part of Bauspar customers in taking up Bauspar loans that are ready to be disbursed but bear a high rate of interest in comparison with the current interest rate environment. At the same time, older Bauspar contracts also feature a comparatively high rate of deposit interest, which explains the low level of interest on the part of many Bauspar customers in terminating their contracts.

Impact on results of operations

This is having a significant impact on the results of operations of the Bausparkassen throughout the sector. The reason is that there is no corresponding interest income from Bauspar loans to offset the interest expenses for Bauspar deposits paying a comparatively high rate of interest. Furthermore, the business activities of the Bausparkassen are mainly restricted to residential real estate financing and their investment options to low-risk investments. However, an amended Bausparkassen Act (Bausparkassengesetz) came into effect at the end of 2015. While the new provisions it contains do not eliminate the impact of the low interest rate environment on the Bausparkassen, the requirements aimed at strengthening earnings power are nevertheless helping to lessen the consequences in the long term.¹⁴

Reactions to the low level of interest rates

The Bausparkassen themselves also endeavoured to deal with the consequences of the low interest rate environment during the financial year. They pushed further ahead with the introduction and distribution of new lower-interest tariffs, they created leaner processes and reduced their costs.

Terminations

But the Bausparkassen are also continuing their efforts to reduce the proportion of high-interest contracts in their portfolio. This was made clear by the large number of terminations again announced by Bausparkassen in 2016, relating to Bauspar contracts that are over-saved or have been eligible for allocation for more than 10 years, which were reported in the media. Over-saved Bauspar contracts are those contracts where the Bauspar loan can no longer be disbursed because the payments by the Bauspar customer have already reached the agreed savings target. The courts consistently regard the termination of such Bauspar contracts as permissible.

The Federal Court of Justice (Bundesgerichtshof) ruled in principle on 21 February 2017 that Bausparkassen may terminate Bauspar contracts that have the conditions for granting a loan for more than 10 years without the savers having taken out the allocated loan. Allowing a Bauspar contract to run for more than 10 years simply as a savings account was in conflict with the meaning and purpose of building savings, according to the Court's decision.

Situation of the cooperative banks

The cooperative banks performed well in the 2016 financial year despite the difficult market environment. However, the institutions in 2016 once again failed to achieve the level of success enjoyed from 2009 to 2014. The reason for this in their case as well is the low interest rate environment, which has had a noticeable impact on net interest income. The considerable efforts to control costs over the past 10 years are having a clearly visible effect over the long term and are offsetting the decline in net interest income to a significant extent. The ratio of the sector's operating result to total assets was only just below the long-term average. As the expected measurement losses were below the long-term average, the institutions in the cooperative sector were again able to make adequate provision for future risks by adding to reserves in 2016.

However, due to an excess of liquidity at low interest rates, the banks will generate lower income than in the past for the foreseeable future. The cooperative sector is endeavouring to counteract this with further cost reductions.

The mergers of Fiducia and GAD (computer centres) and of DZ Bank and WGZ Bank (central banks)¹⁵ have generally lifted the potential for consolidation at sector level. It is now up to the primary institutions to reduce costs. The renewed increase in the number of mergers is evidence of the endeavour to transfer regulatory costs to larger entities. While in 2015 the number of primary institutions declined by 2.6% to 1,022, the rate of mergers doubled in 2016. The number of primary cooperatives shrank from 1,022 to 972, equivalent to a fall of 4.9% (see Figure 3 "Number of primary cooperative institutions").

Figure 3 Number of primary cooperative institutions

Number of primary cooperative institutions

Source: BaFin

When asked about their results of operations in the low interest rate environment in discussions with BaFin, the management boards of primary institutions reported that they were planning additional measures to cut costs. Accordingly, topics such as branch closures and focusing on core regions – together with reductions in staff numbers – grew in importance in 2016. The primary cooperatives have made efforts to compensate their customers for the reductions in the branch network by expanding their online banking services. In addition, they have shown an increasing tendency to reduce dividend payments to their members in order to strengthen their financial position.

End of free current accounts

Another observable trend is that primary institutions are increasingly charging prices for their services that reflect the use made of them. Most noticeably: fewer and fewer institutions are offering free current accounts. Given the persistent low level of interest rates, many institutions can no longer subsidise this service out of interest income. In doing so, they are following a trend that has already been observed in other areas of the banking industry for some time.
Negative interest for retail customers has become a major topic in the cooperative sector in 2016. Some institutions adopted a policy of demanding penalty interest from their customers this year, even if the majority of primary institutions continued to indicate that they would not follow suit. It remains to be seen whether this trend will spread throughout the cooperative sector during 2017.

Situation of the foreign banks

As in the past, foreign banks continue to play a major role in the German financial market. Foreign banks' customer deposits remained at a high level in 2016 despite the general decline in the level of interest rates. In addition to the deposit business, the business activities of these banks are concentrated primarily on the lending business, private banking, investment banking and custodian bank operations. Export finance and payment transactions also play a significant role in the business activities of these institutions.

The establishment of the Single Supervisory Mechanism (SSM) also affects foreign banks with operations in Germany. BaFin is currently represented in a total of 15 joint supervisory teams (JSTs),¹⁶ which also supervise banks from other countries with operations in Germany in the context of group supervision.

Most of the foreign banking entities operating in Germany qualify as less significant institutions (LSIs). Recently, however, a number of foreign banks that were classified in principle as less significant were identified separately in the light of their importance. These banks are referred to as high-priority less significant institutions and are supervised more closely by BaFin.

Third-country branches

Since the ECB does not have supervisory powers for monitoring branches of banks from third countries, BaFin remains solely responsible for this group of institutions. They are deemed to be credit institutions pursuant to section 53 of the Banking Act and are therefore subject for the most part to the same supervisory standards as legally independent credit institutions. As before, the supervision of third-country branches has not been harmonised across Europe, with the result that there are national differences in the regulatory framework.

It was already noticeable in the past that non-European foreign banks in particular were pushing ahead with the centralisation of their European activities. Based on a European headquarters, they are able to use European passporting rights to service the remaining markets through legally dependent EU branches or in the context of cross-border services.

Brexit

International groups of banks are weighing up similar strategic reorganisations – also as a result of Brexit. The institutions have to assume that, in the event of the United Kingdom leaving the European Union, the ability to use EU passporting rights would no longer be available. In order to maintain their existing relationships with European customers and gain new customers from the EU in addition, the banks could find it necessary in future to continue their business activities conducted to date in the United Kingdom via a different entity located in the European Economic Area.

BaFin is also actively approaching interested undertakings, for example with the offer of workshops or individual consultations. As the German supervisory authority, its aim is to provide the undertakings with clarity and support, as well as a reliable framework. Acting on the initiative of BaFin's President Felix Hufeld, for example, BaFin invited around 50 representatives of foreign banks to a workshop in Frankfurt am Main on 30 January 2017, for the purpose of an exchange of views on supervisory issues relating to Brexit.¹⁷

Iranian banks

Following the widespread lifting of sanctions against Iran in 2016, Iranian credit institutions located in Germany are once again permitted to provide banking services.

Situation of the finance leasing and factoring institutions

Finance leasing and factoring institutions (see info box) are generally benefiting from the growing readiness across the economy as a whole to make capital investments. The ifo Institut forecast growth in investments for the German economy as a whole of around 2.9% for 2016,¹⁸ after they had already risen by around 3% to €341.8 billion in the previous year. As in previous years, the leasing and factoring institutions accounted for an above-average share of this increase.

According to the Federal Association of German Leasing Companies (Bundesverband Deutscher Leasing-Unternehmen e.V.), the leasing industry achieved growth of 9% in its new equipment goods business in 2016 compared with the previous year.¹⁹ Factoring revenues in the first half of 2016 also recorded an above-average increase of 4% compared with the prior-year period to €104.51 billion, according to a survey by the German Factoring Association (Deutsche Factoring-Verband).²⁰ As in previous years, therefore, the Group V institutions continued to grow in importance as a source of financing for German companies in comparison with other forms of finance.

Irrespective of the growth in revenue of the two sectors, the number of Group V institutions under supervision at 31 December 2016 changed as follows: there were 334 pure finance leasing institutions (64%; previous year 352), 160 pure factoring institutions (31%; previous year: 163) and 26 institutions engaged both in finance leasing and in factoring (5%; previous year: 25; see Figure 4 "Breakdown of the Group V institutions"). This shows a small decline in the number of Group V institutions – in keeping with the general trend towards consolidation in the financial sector.

Figure 4: Breakdown of the Group V institutions

As at 31 December 2016

Breakdown of the Group V institutions

As of 31.12.2016 Source: BaFin

New authorisations

The number of new authorisations in 2016 rose compared with the prior year, while the number of authorisations terminated recorded a negligible decline. The year saw a continuation of the easing with respect to changes in authorisations observed for a number of years. During the year under review, BaFin approved 21 new applications for authorisation pursuant to section 32 of the Banking Act. A total of 36 authorisations ended in 2016, 20 of them as the result of waivers, including cases where the intention was to pre-empt a formal suspension of the authorisation by BaFin. In 14 cases the authorisation ended following a merger with another institution. In 1 case the authorisation was revoked on the basis of section 35 (2a) of the Banking Act. In addition, 1 authorisation expired for statutory reasons pursuant to section 35 (1) of the Banking Act. BaFin also commenced formal proceedings to revoke an authorisation in 1 case in December 2016.

Qualifying holding proceedings

BaFin initiated qualifying holding proceedings pursuant to section 2c of the Banking Act in conjunction with the German Holder Control Regulation (Inhaberkontrollverordnung) in a total of 103 cases in 2016 due to the proposed acquisition of a significant shareholding in a Group V institution. In these proceedings, which have to be completed by a certain deadline, BaFin is required, among other things, to build up a comprehensive picture of the integrity and aims of the potential purchaser of a qualifying holding. It must also verify the existence and origin of the funds used to make the purchase. In one case BaFin initiated formal proceedings to prohibit the sale of a holding and the exercise of the associated voting rights on the basis of section 2c (2) of the Banking Act.

Personnel changes

BaFin again received numerous notifications of changes in personnel at Group V institutions in 2016. Notifications were received of the intention to appoint 94 new members of management or commercial attorneys-in-fact, and notification was given that the appointments of 41 members of supervisory or advisory boards had been completed. It is BaFin's responsibility to review the fitness and propriety of these persons. In eight cases, it issued warnings or letters of disapproval to managers of Group V institutions or expressed its disapproval in writing with respect to members of supervisory or advisory boards.

Tighter supervision of money laundering

In addition to their obligations under the Banking Act, Group V institutions are also subject to the requirements of the German Money Laundering Act (Geldwäschegesetz). In 2016, BaFin stepped up its monitoring activities to prevent money laundering, terrorist financing and other punishable offences at Group V and other financial services institutions. BaFin has been inspecting the institutions' internal measures for the prevention of money laundering more closely since 2016, using systematic samples selected on the basis of a risk-oriented approach. The assessment of the samples revealed significant deficiencies in some cases – firstly with respect to the implementation of the statutory requirements, and secondly with regard to the audit reports for annual financial statements. The latter were not sufficiently informative, with the result that BaFin required additional information and evaluations from the auditors. Additionally, in many cases the institutions' own documentation was inadequate and/or the AML risk analysis, which has to be updated annually, was incomplete.

Review of intrinsic value calculations

The balance sheet and profit and loss account give an incomplete view of the actual position of leasing institutions, since their presentation of the economic profitability of leasing transactions is often inadequate. In order to show their future profitability and manage their risks, leasing institutions generally prepare an intrinsic value calculation. The intrinsic value calculations, which are submitted to funding partners, investors, shareholders and BaFin, are presented in a format which is largely standardised and issued by the Federal Association of German Leasing Companies. Nearly all the institutions now use this format.

Nevertheless, a variety of items provide scope for flexibility and different valuation methods. BaFin has set itself the objective of investigating this scope more closely to enable it to identify differences in the valuation approaches used in the intrinsic value calculations of the leasing institutions more easily, and to ask critical questions where necessary. BaFin laid the foundations for this in 2016 by electronically recording the intrinsic value calculations submitted for the first time, using a systematic procedure and with the assistance of the Deutsche Bundesbank. This – now expanding – database is intended to help BaFin distinguish between riskier and more conservative valuation approaches, which may have consequences, for example, for the supervisory assessment of the institutions' calculations of risk-bearing capacity and the going concern assumption. This is the assumption that an entity will be able to continue its business activities in accordance with section 252 (1) no. 2 of the Commercial Code (Handelsgesetzbuch) and constitutes a fundamental assumption underlying accounting in accordance with commercial law.

Audit emphasis on IT security

In times of increasing digitalisation and networking, IT security and cybercriminality are becoming ever more important topics for financial services providers as well.²¹ The invoices and end customer data of factoring customers have been passed on to the factoring institution for a long time, in most cases electronically. The same applies to dealer-based leasing. In the latter case, the authorised dealer (for example the car dealership) enters the customer data on site into an electronic mask and transmits them to the leasing institution in digital form. The institution then carries out the credit check, as a rule primarily also electronically, for example by assessing the customer's creditworthiness and the value of the item. The result is then relayed back to the dealer electronically. The ongoing processing of the contract is also usually based mainly on IT applications, and in addition customers frequently use access portals via the Internet. The increasing number of interfaces and the growing extent of digitalisation represent potential gateways for hackers, but also entail dangers with respect to the validity and availability of data. Due to the considerable negative consequences that malfunctioning IT systems can have for institutions and their customers, and in view of the increasing threat posed by cybercriminality, BaFin has decided in its supervisory strategy for 2017 to make the IT security of Group V institutions an area of emphasis for supervision, and to monitor the larger institutions within this group more closely for that purpose.

Situation of the payment institutions and e-money institutions

In 2016, BaFin granted three new authorisations and two authorisations to existing institutions under the Payment Services Supervision Act. As before, applications for authorisation and authorisation proceedings represent a focal area for supervisory activities pursuant to the Payment Services Supervision Act. Applicants frequently describe the great potential they envisage for their payment services offered online or via mobile devices. Following the entry into force of the Second Payment Services Directive (PSD2), there has been increased interest in authorisations for the provision of payment services. The application proceedings during the year under review, however, still complied with the existing version of the Payment Services Supervision Act. The implementation of PSD2 is due in 2017 and must be completed by 13 January 2018.

As before, several new notifications for payment or e-money institutions from other EU member states are received on a weekly basis. The extent of the payment services actually provided by these institutions in Germany is unknown due to the lack of statistical information. The same applies to the agents notified for providers of remittance services.

Pfandbrief business

The Pfandbrief business performed relatively well again in 2016 despite a difficult market environment. Current global economic and political uncertainties – such as Brexit and the developments in Turkey – had little effect in the end on demand for Pfandbriefe as a conservative investment product with a high standard of quality. A trend towards benchmark issues can be discerned in the Pfandbrief market; for the first time since the sovereign debt crisis, a few institutions are also accepting peripheral countries in their cover pool again. Whether new product types – such as the "green Pfandbrief" marketed as a sustainable investment – will survive in the long term remains to be seen. The ECB has become by far the largest investor in the Pfandbrief market and the covered bond market as a whole in the context of its third covered bond purchase programme (CBPP3), while traditional investors such as insurers, pension institutions and asset managers are holding back from Pfandbriefe as a result of the low returns, which can even amount to a negative rate of interest.

Decline in volume of Pfandbrief sales

2016 recorded a lower sales volume of Pfandbriefe in comparison with the previous year. Following an increase in 2015 for the first time since the start of the financial crisis, sales have now returned to the level of 2014. The main factors responsible for the decline in sales were alternative funding options in the form of the ECB's targeted longer-term refinancing operations (TLTRO II) and the continuing low interest rate environment. In total in 2016, Pfandbriefe with a volume of €45.5 billion were sold. Measured by issue volume, sales of mortgage Pfandbriefe (including ship and aircraft Pfandbriefe, although as before these were relatively insignificant) amounting to €35.1 billion (previous year: €42.6 billion) were more than three times higher than those of public-sector Pfandbriefe with an issue volume of €10.4 billion during the past year (previous year: €15.5 billion) (see Table 14 "Gross Pfandbrief sales").

Table 14 Gross Pfandbrief sales

Gross Pfandbrief sales

Source: BaFin

The continued decline in the total volume of outstanding Pfandbriefe was due as in the past to a high level of maturities and relatively lower new issuance activity. More mortgage Pfandbriefe than public-sector Pfandbriefe were outstanding for the first time in 2015. This trend continued in 2016. The volume of public-sector Pfandbriefe outstanding at the end of 2016 recorded an above-average decline to €155.2 billion (previous year: €180.5 billion). By contrast, the volume of mortgage Pfandbriefe outstanding at the end of 2016 (including ship and aircraft Pfandbriefe) remained almost unchanged at €203.7 billion (previous year: €203.9 billion), giving a total volume of Pfandbriefe outstanding of €358.9 billion (previous year: €384.4 billion) (see Table 15 "Volumes of outstanding Pfandbriefe").

Table 15 Volumes of outstanding Pfandbriefe

Volumes of outstanding Pfandbriefe

Source: BaFin

Since there is a favourable environment for real estate financing, the level of demand for real estate loans, which can be refinanced using mortgage Pfandbriefe, remains high. The proportion of mortgage Pfandbriefe will also continue to increase in the future. Public-sector Pfandbriefe, whose main uses currently are still the refinancing of traditional local government funding and of state-backed export finance, will only play a minor role in comparison.

Situation of the securities trading banks

At the start of 2016, BaFin reorganised the operating supervision of securities trading banks and stock exchange brokers and brought them together in the Securities Supervision Directorate. The background to the change is that the focus of their activities is on securities trading and they are classified as investment firms within the meaning of the EU Capital Requirements Regulation (CRR).

The business environment also presented challenges to securities trading banks and exchange brokers during the past year. Stock exchange turnover figures recorded only modest growth as retail investors continued to hold back – despite the positive developments on the DAX and the extremely low interest rates. In addition, the bond market remained at a low level following the ECB's purchase programme.

Difficult earnings situation

The earnings situation in stock exchange trading therefore remains difficult, with the consequence that the institutions are continuing to look for new business areas and sources of income. Only a few institutions were able to benefit from the market for corporate finance activities, in particular for small and medium-sized entities. Moreover, once again in 2016, no undertaking took advantage of the option of applying for authorisation to engage in high-frequency trading within the meaning of section 1 (1a) sentence 2 no. 4d of the Banking Act. Traders operating in Germany are either already authorised by BaFin to engage in proprietary trading or able to engage in cross-border trading using the EU passport because they hold corresponding authorisation from an EU member state. The restructuring measures implemented by major energy groups triggered various processes of reorganisation in energy derivatives trading at securities trading banks and exchange brokers. BaFin monitored these processes in particular from the point of view of qualifying holding procedures.

Alternative trading platforms

The development of alternative trading platforms continues to make progress. None of the securities trading banks or stock exchange brokers took advantage of the option of operating a multilateral trading facility (MTF).

Consolidation process

Against the background of competitive pressure and the difficult environment, the process of consolidation continued during the past year. One institution surrendered its authorisation as a securities trading bank entirely. Another institution reduced the scope of its activities and will conduct its business in future as a financial services institution. A further institution split off its corporate finance activities which will be continued in a new financial services institution.

In 2016, BaFin applied to the competent insolvency court to initiate insolvency proceedings in relation to the assets of a securities trading bank. The bank's senior management had previously notified BaFin that the bank was insolvent. Only BaFin itself can apply to open insolvency proceedings relating to the assets of an institution under its supervision. The securities trading bank in question was the lead broker responsible for order books on a number of German stock exchanges.

When the securities trading bank was able to demonstrate to BaFin that it was once again able to meet its payment obligations, BaFin withdrew its application to initiate insolvency proceedings since the grounds for the proceedings were no longer valid.

Organisational weaknesses

In the course of its ongoing supervisory activities during the past year, BaFin once again identified weaknesses in the organisation of some institutions, particularly in risk management and controlling, risk-bearing capacity concepts and the documentation of transactions. The institutions rectified these deficiencies after BaFin had requested them to do so.

In one case, BaFin ordered a special audit to examine the adequacy of the risk management system and the system of governance. The institution had previously entered a critical situation as a result of settlement problems relating to the execution of stock exchange transactions. The special audit found that the institution's risk management system (limit system and limit authorisation) was inadequate for the type, size, complexity and riskiness of the transactions examined. BaFin is currently considering appropriate supervisory actions for similar breaches of the obligation to maintain a proper system of governance, which could range from ordering specific organisational measures to warning or removing senior managers or to revoking the authorisation.

In one case, BaFin required a securities trading bank, following an earlier hearing, to comply with its own funds requirements on the basis of the consolidated situation of the financial holding company. A combination of own funds and the principal risk positions is intended to ensure that the concentration of risk in the group is adequately covered.

Brexit

In the second half of the year, BaFin held many discussions with banks and financial services providers who were considering relocating their activities as broker-dealers to Germany and applying to BaFin for authorisation as securities trading banks, following the referendum in the United Kingdom on leaving the European Union.²²

Financial services institutions

At the end of 2016, BaFin’s Securities Supervision/Asset Management Directorate had 708 financial services institutions under its supervision (previous year: 674). It was also responsible for supervising 94 German branches of foreign institutions (previous year: 86).

32 undertakings applied for authorisation to provide financial services in 2016 (previous year: 25). 8 financial services institutions applied to extend their authorisation to cover the provision of additional financial services (previous year: 13). The number of tied agents at the end of 2016 was approximately 34,900 (previous year: approximately 38,500).

In the course of 2016, BaFin participated in 39 audits at financial services institutions (previous year: 41) and conducted 97 supervisory interviews with institutions (previous year: 135).

Authorisations

A total of 27 authorisations held by financial services institutions ended (previous year: 28), in most cases because they were returned. BaFin revoked one institution's authorisation to provide financial services. At the same time, BaFin required the institution to provide evidence to it within four weeks of the cessation and winding-up of all transactions subject to authorisation. One member of the institution's management board had previously made unauthorised use of his power of disposal over customers' assets entrusted to the institution, and used them for improper financial transactions. In consequence, the institution was faced with substantial claims for damages, which necessitated a massive increase in its reported contingency provisions (see info box).

The institution was not even close to being able to meet the additional capital requirements that would have been necessary to comply with the capital ratios for banking supervisory purposes. After no improvement in the institution's capital adequacy could be discerned, despite repeated requests by BaFin, and given that there was also no prospect of any such improvement in the medium term, BaFin revoked the authorisation.

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