Both in terms of the general stability situation – in this respect, the IMF assessed stress tests and considered risks including the low interest rate environment – and of structural issues such as crisis management, supervisory regime, macro-prudential tools, resolution and recovery, the IMF paints a picture of a financial system in Germany that is stable and robust overall despite the existing vulnerabilities. The conclusions arrived at by the IMF are broadly consistent with the assessments of all relevant German and European authorities: the Federal Ministry of Finance, the Federal Financial Supervisory Authority (BaFin), the Deutsche Bundesbank, the Financial Market Stabilisation Agency (FMSA), the European Resolution Board, and the European Central Bank. However, there are significant differences of opinion regarding some of the individual issues.

As part of the stability report, the IMF also assessed and rated the observance of international supervisory standards by banks and financial market infrastructures. Germany generally did well in this respect, despite the fact that some assessments made by the IMF are not shared by the German side, in particular with respect to the observance of banking supervision standards. In addition, the IMF has published six Technical Notes.

Overall stability situation

In its report, the IMF highlights the importance of the German financial sector for the financial stability of Europe as a whole. Germany is home to three global systemically important financial institutions: Deutsche Bank, the insurance group Allianz and clearing services provider Eurex Clearing. Germany is also the third-largest securities market in the EU. Moreover, in the IMF's view, Germany's sovereign bond market is a safe haven and benchmark globally.

According to the IMF, the German financial sector is very heterogeneous due to the large number of banks and insurers, and the range of business models. The report also states that the German financial sector is, overall, resilient, thanks to major reforms driven by EU-wide and global developments, in particular due to solvency and liquidity requirements set out in the EU Capital Requirements Directive IV (CRD IV) and Regulation (CRR), and the introduction of macro-prudential tools. The establishment of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) and the European Recovery and Resolution Directive have strengthened banking supervision, the IMF says. The globally valid Principles for Financial Market Infrastructures, prepared jointly by the Committee on Payment and Settlement Systems (CPSS¹) and the International Organization of Securities Commissions (IOSCO) have also contributed to the European, and, by extension, German, financial market becoming stronger, the report says.

Risks and stress testing

According to the IMF, risks may originate with domestic, European and global financial architecture. The European supervisory architecture is still being established, the IMF argues, which results in risks to cooperation between individual authorities and thus to efficient decision-making processes. The report points out that the low interest rate environment poses risks to the profitability of banks and insurers, particularly if they maintain traditional business models and allow riskier search-for-yield strategies. A global growth shock, sharp downturn in emerging markets or renewed tensions in the euro area could, due to the high level of interconnectedness, lead to a rapid hike in global risk premia and asset price volatility; this may give rise to financial risks in Germany and risks of cross-border contagion, the IMF says.

The IMF regards the German banking system as having very high regulatory capital ratios when compared with other European countries. The institutions did well both in the baseline scenario and in liquidity testing in the course of an IMF solvency stress test involving all banks operating in Germany.

The IMF also subjected German life insurers to stress testing. The IMF took as a basis a security level significantly higher than that required by Solvency II and assumed an extreme stress scenario. The stress test showed that the majority of German life insurers would meet the solvency capital requirements under Solvency II even in the event of a severe shock.²

Macro-prudential supervision

The IMF regards the German macro-prudential framework, which includes the Financial Stability Act (Finanzstabilitätsgesetz, only available in German) and is integrated into the EU-wide macro-prudential policies, as broadly appropriate for effective macro-prudential supervision.

Even though the mandate, accountability and tasks are clear, it believes there is scope for improvements as overseeing a market requires readily available, comprehensive and granular data, however.

Banking regulation and supervision

Overall, the IMF's assessment of the regulation and supervision of banks in Germany is positive. Despite the fact that this area received lower marks as compared with the previous assessment of 2011, the downgrades were down to new weightings and the Core Principles for Effective Banking Supervision by the Basel Committee on Banking Supervision being tightened. Also, Germany decided to be judged on the harshest assessment basis, which included additional criteria. The supervisory authorities will use the four years until the next assessment intensively to remedy the weaknesses found regarding the meeting of stricter requirements as fully as possible.

In addition, the downgrades are linked to the IMF assessors criticising the German two-tier system, where the management board and supervisory board are two different entities, even though Basel III regards this as equally valid as the one-tier system where one body performs both functions.

Moreover, Germany is the first country to have been assessed under the new European banking supervision regime, the SSM.

Financial market infrastructure

The observance of supervisory standards for central counterparties (CCPs) – limited to Eurex Clearing AG as a global systemically important CCP – was looked into, with a very satisfactory outcome.

With just one exception, the IMF saw the CPSS/IOSCO Principles for Financial Market Infrastructures as fully met both on the part of Eurex Clearing and German authorities.

Insurance regulation and supervision

The IMF also reached positive conclusions with regard to the insurance sector. It states that the introduction of Solvency II enhanced the regulatory and supervisory regime for insurers, leading to a more risk-based approach. However, the report states that the low profitability of business models is exacerbated by the low interest rates, which hampers life insurers' ability to pay guaranteed yields to policyholders. Notwithstanding severe challenges and Solvency II implementation, life insurers generally retain significant loss absorption capacity, the report states.

In the IMF's view, improvements in the intensity of insurance supervision are evident. It points out that BaFin contributes to system-wide oversight by adopting analytical tools. The observance of selected supervisory standards in the insurance sector was looked into, with a very satisfactory outcome.

Regulation and supervision of investment funds

The IMF assesses BaFin's supervision of investment funds as firm but fair. It highlights the good cooperation between BaFin, which enjoys a good standing with market participants, and the market participants it supervises. The IMF also stresses that BaFin and the Bundesbank together have access to high-quality underlying data to be able to identify individual risks quickly and with precision.

In terms of liquidity management, the IMF concludes that additional protective measures have been implemented since the last assessment. Still, it recommends further tools for liquidity management. The current legal regime allows German asset managers only two options: to suspend redemptions and – according to BaFin's administrative opinion – to redemption in kind, meaning a redemption for securities rather than cash. A change in the law would be necessary for additional liquidity tools to be allowed.

Combating money laundering and terrorist financing

As part of the FSAP, the IMF also looked into selected aspects of the German system to combat money laundering and terrorist financing. In particular, the IMF gave credit to the significant progress made with regard to the definition of money laundering as a criminal offence according to section 261 of the Criminal Code (Strafgesetzbuch – StGB, only available in German). By extending the range of predicate offences to include so-called "self-laundering", which involves bringing into circulation the proceeds from an illegal act without revealing their illicit origins, the definition of the criminal offence now largely corresponds with international standards. In addition, the IMF sees the automated account information access procedure as a highly effective tool that allows BaFin and law enforcement agencies, among others, quick access to the data of bank customers and their beneficial owners under certain conditions.

The IMF also praises the group compliance regime in force in Germany. Financial institutions in the country are required to ensure that their subsidiaries and branch offices abroad comply with at least the key standards in anti-money laundering and combating the financing of terrorism that apply in Germany.

Bank resolution and crisis management

The crisis management framework was significantly strengthened by the transposition of the EU Bank Recovery and Resolution Directive in Germany, the IMF says. It acknowledged major progress made in Germany with regard to recovery and resolution planning.

The IMF also praises Germany's progress in enhancing deposit insurance schemes made by transposing the European directive in the Deposit Guarantee Act (Einlagensicherungsgesetz). This ensured that the IMF's recommendation made in the previous FSAP to set a uniform, EUR 100,000 guarantee per depositor and to provide adequate pre-funding to the deposit insurance schemes was met. The EU Deposit Guarantee Schemes Directive includes harmonised rules governing guarantee limits and fund level.

Footnotes:

¹ Now renamed Committee on Payments and Market Infrastructures (CPMI).

² BaFin has published the details on the stress test of life insurers on its website.