BaFin's Banking Supervision Directorate was responsible for supervising 1,553 credit institutions at the end of 2017 (see Table 8 "Number of institutions by group of institutions"). They included 63 SIs, i.e. significant institutions or groups of institutions, that are directly supervised by the ECB and are monitored by the joint supervisory teams referred to above.¹ 1,490 institutions were subject to direct banking supervision by BaFin at the end of 2017 – including 1,455 LSIs, or less significant institutions.² The number of institutions under supervision has again fallen substantially since 2016. The reason for this is the continuing wave of mergers in the banking industry – in particular in the cooperative sector.

Division into groups

The Banking Supervision Directorate subdivides the banks into four groups of institutions on the basis of their business model or membership of a particular network: commercial banks, institutions belonging to the savings bank sector, institutions belonging to the cooperative sector and other institutions.

The commercial banks include the major German banks, subsidiaries of foreign banks and the private banks. The institutions belonging to the savings bank sector comprise the public-sector and independent savings banks together with the Landesbanks and DekaBank. The institutions belonging to the cooperative sector continue to form the largest group of institutions; they include the cooperative banks, DZ Bank and three other institutions. The other institutions, the smallest group of institutions, include, among others, Bausparkassen, guarantee banks and special-purpose credit institutions.

Table 8: Number of institutions by group of institutions

Number of institutions by group of institutions

Stand: 31.12.2017 BaFin

Risk classification

Together with the Deutsche Bundesbank, BaFin produces a risk profile for each of the less significant institutions, i.e. the credit institutions it supervises directly (see Table 9 "Risk classification results of LSIs in 2017"). BaFin updates the risk profile of each of these LSIs at least once a year.

It uses the risk profile of an individual LSI to determine how closely it supervises the institution. In addition to the findings of the audit report for the annual financial statements, current risk analyses and knowledge obtained from special audits and requests for information are also included in the assessment.

BaFin allocates each institution to a risk class on the basis of its risk profile. This risk classification is based on the categories "quality" of the institution and potential "impact" – namely the impact of a solvency or liquidity crisis of the institution on the stability of the financial sector. In comparison with 2016, there were only marginal changes in the allocations to the individual risk classes – while the quality of the institutions showed a slight downward trend, their impact increased slightly.

Table 9: Risk classification results of LSIs in 2017

Risk classification results of LSIs in 2017

BaFin

Special audits

In 2017, BaFin ordered 199 special audits pursuant to section 44 (1) sentence 2 of the Banking Act (see Table 10 "Breakdown of special audits of LSIs by areas of emphasis"). BaFin uses these audits as a supervisory tool if it identifies a greater need for information which is not satisfied by the regular sources of information, namely the reporting system, the direct exchange of information with the institutions and the audit reports for the annual financial statements.

An audit pursuant to section 44 of the Banking Act may be ordered for a specific reason or because too much time has elapsed since the last special audit. The Deutsche Bundesbank is appointed to carry out most of the special audits, but external auditors are also engaged.

Table 10: Breakdown of special audits of LSIs by areas of emphasis

Breakdown of special audits of LSIs by areas of emphasis

BaFin

As in the previous year, the audits mainly related to section 25a (1) of the Banking Act. Audits pursuant to section 25a (1) of the Banking Act enable BaFin to form an impression of whether an institution's risk management system is adequate. The minimum conditions that must be satisfied for a risk management system to be adequate are set out in detail in the MaRisk referred to above. 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.³

13 cover audits were carried out in 2017. In accordance with the statutory requirement in the German Pfandbrief Act (Pfandbriefgesetz), the cover for Pfandbriefe should normally be audited every two years.

BaFin also ordered five requested special audits in 2017, that is, audits initiated by institutions themselves. These related to recognition of the internal ratings-based approach (IRBA) for credit risk measurement.

Most of the special audits were carried out in the cooperative sector due to the fact that this group has the largest number of institutions (see Table 11 "Breakdown of special audits of LSIs in 2017 by groups of institutions").

Table 11: Breakdown of special audits of LSIs in 2017 by groups of institutions

Breakdown of special audits of LSIs initiated by BaFin in 2017 by risk classes

Stand: 31.12.2017 * Zahl der Prüfungen im Verhältnis zur Anzahl der Institute pro Institutsgruppe. Es handelt sich um die LSIs unter Aufsicht der BaFin-Bankenaufsicht. BaFin

BaFin conducted special audits for 12.5 percent of the LSIs under supervision. Table 12 "Breakdown of special audits of LSIs initiated by BaFin in 2017 by risk class" on page xy provides a detailed analysis of the special audits of LSIs on BaFin's initiative in 2017 for the individual risk classes.

Table 12: Breakdown of special audits of LSIs initiated by BaFin in 2017 by risk class

Supervisory law objections and measures under the Banking Act in 2017

Stand: 31.12.2017 * Anteil der Prüfungen an der Summe aller Institute der jeweiligen Qualitäts- bzw. Relevanzeinstufung. BaFin

Objections and measures

The Banking Supervision Directorate recorded a total of 974 objections and measures (see Table 13 "Supervisory law objections and measures under the Banking Act in 2017").⁴ This sharp increase compared with the previous year (415 objections and measures) was almost entirely the result of formal measures relating to own funds/liquidity measures. The supervisory measures in 2017 included 902 SREP notices issued.⁵

Table 13: Supervisory law objections and measures under the Banking Act in 2017

Supervisory law objections and measures under the Banking Act in 2017

BaFin

In general, the approach adopted by Banking Supervision is to make direct contact with the institutions concerned at the first indications of deficiencies. The objective is for the institutions to rectify the deficiencies as quickly as possible. In most cases BaFin is successful in motivating the institutions to do so, with the result that formal measures no longer become necessary. BaFin had to take formal measures against an institution's managers or members of its supervisory or administrative boards in 2017 only in isolated cases.

Discussions and letters

In addition to regular discussions with representatives of the institutions, BaFin uses letters as an important tool of preventive supervision. It uses them to inform the institutions how it evaluates the findings of the audit of the annual financial statements or how it assesses the findings of a special audit. In these letters, BaFin points out minor deficiencies before they develop into serious deficiencies and formal measures may have to be taken.

Situation of the institutions

Situation of the private commercial, regional and specialist banks

No group of institutions displays such a wide range of business models as the private commercial, regional and specialist banks. Their strong focus on specialisation allowed some of the institutions to achieve comfortable margins, especially if concentrating on individual niche markets or areas of activity generated competitive advantages.

Broader range of services

In order to tap sources of income that are independent of interest rates, a number of institutions – frequently those with strong regional ties – have broadened the range of services they offer beyond traditional banking services to include, for example, real estate development or building management. An increasing readiness to co-operate with other institutions – driven by the need to cut costs – is also noticeable and extends, for example, to securities settlement, setting up investment funds or payment services. Some of the banks – especially those with fintech expertise – have identified the provision of payment services as their market niche.

Institutions under pressure

Other institutions were under substantial pressure to develop new areas of business because their business models were not sustainable. This led them to engage in the cross-border purchasing of receivables or to specialise in individual loan portfolios, among other examples. However, because some of the smaller banks were unable to cope with the associated concentration and cluster risks due to inadequate governance and risk management systems, these institutions ran into financial difficulties which threatened their continued existence. This triggered supervisory measures which varied according to the specific circumstances of the individual case.

Cum/ex and cum/cum

A number of institutions in this group were affected by the reappraisal of cum/ex and cum/cum transactions by the tax prosecution authorities (in the wake of the Federal Ministry of Finance's letter dated 17 July 2017).⁶ Banks' business premises were searched and documentation was seized, including as the result of investigations relating to their clients and not to the relevant credit institutions themselves. Any institution that was itself suspected of tax evasion was confronted with notice of claims for recourse in respect of taxes not paid in the context of a client transaction.

Situation of the savings banks

The savings banks achieved a satisfactory overall result during the past financial year. The effects of the persistent low interest rate environment are clearly evident in the income statements of the affiliated institutions, however. For example, net interest income – the most important source of earnings for the savings banks – declined once again, as expected. However, the impact of the fall in earnings was lessened by rigorous cost-saving measures. As a result, the net profit for the year has returned to the level of previous years.

Lending business profitable

The savings banks benefited above all from lending to small and medium-sized companies, thanks to increased demand for loans for investments in view of the positive macroeconomic environment. The institutions also achieved growth in commercial and private real estate financing, helped by the historically low rates of interest on loans. Net commissions received continued the modest upward trend of recent years. In order to save costs, the savings banks cut staff numbers and further reduced the number of their branches (see Figure 2 "Number of savings banks"). Fewer and fewer institutions are offering free current accounts. Expenses for risk provisioning in the lending and securities business rose only slightly compared with the previous year and continue at a very low level. In anticipation of the higher capital requirements in the future, the savings banks once again added substantially to their reserves, but not by as much as in 2016.

Figure 2: Number of savings banks

Number of savings banks*

*This statistic does not include seven Landesbanks and DekaBank BaFin

Compliance with higher capital requirements

From a regulatory point of view, the increase in the minimum capital requirements was the main issue for the majority of the savings banks in the past financial year. BaFin set individual own funds requirements on the basis of the SREP⁷ for around three quarters of the affiliated institutions. The tighter requirements cover interest rate risk in the banking book in particular, but also other material risks not explicitly included in the Pillar I minimum requirements. All of the savings banks complied with the higher capital requirements in 2017. In fact, the aggregated total capital ratio of all savings banks was well above the minimum figure required on average from the individual institutions.

Decline in net profit for the year expected

The results of the 2017 low interest rate environment survey show that the savings banks are expecting a decline in net profit for the year in all scenarios due to their high degree of dependence on interest income.⁸ The institutions are intending to counter this development by improving their commission income, increasing fees received and further enhancing their efficiency. Overall, the savings banks coped well with the lower interest rate environment thanks to their high level of capital resources. Despite this, the survey results showed that many institutions in this group could envisage a merger with a neighbouring savings bank in the medium term.

Situation of the Bausparkassen

The continuing low interest rate environment again represented the central challenge for the Bausparkassen in 2017. The situation of the sector in 2017 was essentially the same as in the previous year: the proportion of Bauspar loans issued continued to decline. This demonstrates that, as before, few Bauspar customers are willing to take up the Bauspar loans made available by their Bausparkasse but not currently bearing a market rate of interest.

At the same time, the renewed increase in Bauspar deposits illustrates interest on the part of Bauspar customers in older Bauspar contracts, featuring a high deposit rate of interest which is also not in line with current market conditions.

Significant impact on results of operations

This is having a significant effect on earnings across the entire Bauspar sector, because the comparatively high expenses for Bauspar deposits paying a high rate of interest are not matched by any corresponding income from Bauspar loans issued. An additional factor is that the German Bausparkassen Act (Bausparkassengesetz) essentially restricts the Bausparkassen to the residential real estate lending business.

Emphasis on building loans

The Bausparkassen attempted to counter these negative effects on earnings in 2017 once again. They therefore placed greater emphasis on granting building loans, although by far the majority of the loans issued again consisted of pre-financing and bridging finance loans. The institutions also continued to reduce their personnel expenses and non-staff costs, improved their (IT) processes and – as in previous years – drove ahead with the introduction of tariffs at low rates of interest, in line with the market. Nevertheless, it will take some time before sales of these new tariffs reach a level at which the lower expense for interest on deposits will have a positive effect on the profitability of individual Bausparkassen.

Termination legally permitted

In 2017 once again, the Bausparkassen attempted to terminate Bauspar contracts in order to reduce the proportion of high-interest building savings contracts in their portfolios. The industry can rely on established case law with respect to the termination of over-saved Bauspar contracts, i.e. those contracts where a Bauspar loan can no longer be disbursed because the payments by the Bauspar customer have already reached the agreed savings target.

The Federal Court of Justice (Bundesgerichtshof) also clarified on 21 February 2017 that the termination rules in section 489 (1) no. 2 of the German Civil Code (Bürgerliches Gesetzbuch) can be applied to building savings contracts that have been eligible for allocation for over 10 years. As a result, Bausparkassen can now also terminate these Bauspar contracts in principle without incurring a legal risk.

Situation of the cooperative banks

The cooperative banks' performance was satisfactory in the 2017 financial year despite the difficult market environment. The reason for the slight decline in earnings for this group of institutions is also the low interest rate environment; net interest income is now noticeably below the long-term average. The substantial efforts over the past decade to control costs are helping to reduce the impact of the lower net interest income. Despite an expected increase in expenses for measurement losses, which are, however, still well below the long-term average, it is possible to make adequate provision for future risks in the form of reserves.

Figure 3: Number of primary cooperative institutions

Zahl der genossenschaftlichen Primärinstitute

BaFin

Mergers

The scope for consolidation in the sector was seen in 2017, for example, in the merger of the Rhineland-Palatinate cooperative association (Rheinisch-Westfälischer Genossenschaftsverband) with the Cooperative Association (Genossenschaftsverband) to form the largest German cooperative auditing association. There were also mergers of primary cooperative institutions – as in past years – with the result that the number of primary institutions fell from 972 in the previous year to 915 (see Figure 3 "Number of primary cooperative institutions").

IT audits

In 2017, BaFin audited the IT systems of two service providers in the cooperative sector. The reports on the audits are still being evaluated. Further IT audits are planned for 2018.

BaFin also investigated institutions in the cooperative sector as a result of their involvement in cum/cum transactions.⁹ Since the transactions investigated covered several financial years, some of the institutions concerned had to make substantial payments to the tax authorities, which has had a significant impact on their income statements. Whether the claims enforced by the tax authorities are actually valid is the subject of legal disputes.

Negative interest

Negative interest for retail customers has become a major topic in the cooperative sector. At the present time, this is normally only required for very large deposits. However, institutions are weighing up strategies for charging negative interest on a broader basis.

Situation of the foreign banks

Foreign banks again played a major role in the German financial market in 2017. The foreign banks located in Germany are concentrated on the deposit business and also on the lending business, private banking, investment banking, custodian bank operations as well as export finance and payment services.

Most of the foreign banking entities located in Germany again qualified as less significant institutions in 2017. The proportion of the less significant institutions treated as having high priority (high-priority less significant institutions – HP LSIs) was unchanged compared with the previous year.

Consequences of Brexit

It is currently assumed that a number of undertakings will relocate their business operations from the United Kingdom to Germany in the wake of the planned Brexit.¹⁰ This is expected to increase the volume of business of the institutions already located here, and BaFin and/or the SSM will have a large number of authorisation, qualifying holding and EU passporting procedures to process.

Consequences of the lifting of the Iran sanctions

Following the extensive lifting of sanctions against Iran in 2016, Iranian credit institutions located in Germany are once again able to conduct banking business. Three of the four Iranian credit institutions that had operations in Germany prior to the imposition of sanctions resumed their business activities in 2017. More Iranian credit institutions have expressed interest in starting operations in Germany.

Situation of the finance leasing and factoring institutions

The leasing and factoring sector once again recorded growth in new business in 2017. According to figures provided by the Federal Association of German Leasing Companies (Bundesverband Deutscher Leasing-Unternehmen)¹¹, the leasing industry's new business in equipment goods recorded growth of 7.5 percent in the first half of 2017 compared with the prior-year period. The factoring industry achieved revenue growth of 8.4 percent according to the German Factoring Association (Deutscher Factoring-Verband e.V.).¹²

The number of (pure) finance leasing institutions subject to ongoing supervision by BaFin fell to 318 in 2017 (previous year: 334), while the number of (pure) factoring institutions declined to 159 (previous year: 160). In addition, 32 institutions provided both finance leasing and factoring services (previous year: 26).

Authorisations

BaFin approved 11 new applications for authorisation pursuant to section 32 of the Banking Act. A total of 21 authorisations terminated in 2017, mainly as a result of waivers, more rarely due to mergers or because no use was made of an authorisation granted. In 2 cases the authorisation was revoked on the basis of section 35 (1) of the Banking Act, and in 1 further case pursuant to section 35 (2a) of the Banking Act.

BaFin initiated 161 qualifying holding procedures. In these cases, BaFin is required, among other things, to form an idea of the integrity and the objectives of the potential purchaser of a qualifying holding. It must also check the existence and origin of the funds used to make the purchase. Notifications were received of the intention to appoint 109 new members of management or commercial attorneys-in-fact, and notification was given that the appointments of 37 members of supervisory or advisory boards had been completed. It is BaFin's responsibility to review the fitness and propriety of these persons.

Measures and sanctions

Letters containing advice and caution letters were sent to 17 leasing and factoring institutions. In addition, eight administrative fine proceedings were initiated and two managers were given warnings in accordance with section 36 (2) of the Banking Act. One special commissioner was appointed pursuant to section 45c of the Banking Act and one liquidation order was issued in accordance with section 38 (1) of the Banking Act.¹³

Situation of the payment institutions and e-money institutions

In 2017, BaFin granted 6 authorisations to provide payment services and 1 authorisation to conduct e-money business under the German Payment Services Supervision Act (Zahlungsdiensteaufsichtsgesetz). Existing institutions were affected in particular by the amended version of the Payment Services Supervision Act which came into force on 13 January 2018, since it imposes additional requirements for authorisation. The Payment Services Supervision Act was amended by the German Act Implementing the Second Payment Services Directive (Gesetz zur Umsetzung der Zweiten Zahlungsdiensterichtlinie) of 17 July 2017.

Payment institutions and e-money institutions holding an authorisation from BaFin under the Payment Services Supervision Act in force until 12 January 2018 may continue to provide payment services up to 13 July 2018 at the latest, without having an authorisation in accordance with the requirements of the new Payment Services Supervision Act. BaFin therefore informed institutions authorised under the old Payment Services Supervision Act in good time about the additional requirements, to ensure smooth implementation of the notification procedure required under the transitional provisions.

Enquiries from fintech companies

BaFin is also receiving an increasing number of enquiries from fintech companies due to the amendments to the Payment Services Supervision Act and the new requirement for authorisation for payment initiation services and account information services. In anticipation of the amended Payment Services Supervision Act entering into force, BaFin held discussions with the new market participants beforehand to explain the upcoming authorisation procedures.

Pfandbrief business

The German Pfandbrief performed relatively well in 2017 in a difficult market environment. Despite the availability of alternative funding options and the persistently low level of interest rates, total sales of Pfandbriefe recorded modest growth. In total, Pfandbriefe with a volume of €48.8 billion were sold in the past financial year (see Table 14 "Gross Pfandbrief sales").

Measured by issue volume – €36.8 billion – sales of mortgage Pfandbriefe (including ship and aircraft Pfandbriefe, although these are niche products) were once again more than three times higher than those of public-sector Pfandbriefe. Issues of the latter in 2017 amounted to €11.9 billion.

Table 14: Gross Pfandbrief sales

Gross Pfandbrief sales

As at 31 December 2017 BaFin

Total volume of outstanding Pfandbriefe

With an outstanding volume of €362.2 billion, the steady decline in the total volume of outstanding Pfandbriefe in recent years was halted for the first time in 2017. While the outstanding volume of mortgage Pfandbriefe (including ship and aircraft Pfandbriefe) rose to €214.0 billion, the volume of public-sector Pfandbriefe outstanding amounted to €148.2 billion in 2017, representing another decrease (see Table 15 "Volumes of outstanding Pfandbriefe").

Table 15: Volumes of outstanding Pfandbriefe

Volumes of outstanding Pfandbriefe

BaFin

ECB investments

Although the volumes of the monthly purchases of the ECB as the largest investor in the covered bond market are declining, the ECB is likely to continue investing heavily in this market in the immediate future, if only to reinvest bonds maturing. As a result of the ECB's influence on the market, margins in the covered bond market are unlikely to increase significantly in the short term, which will probably continue to hold back sales to traditional investors. At the same time, the sector is aiming to broaden its investor base with modern product types – such as the "green Pfandbrief". The proportion of mortgage Pfandbriefe, currently benefiting from the healthy real estate market, is likely to increase in future. By contrast, there will be a further decline in the importance of the public-sector Pfandbrief, which is mainly still used for funding traditional local government financing requirements and state-backed export finance.

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