On the morning of the event, Felix Hufeld did not pin a Sheriff’s badge to the lapel of his black suit. The golden badge worn by US police officers is something BaFin’s President has only seen in films. “This is not the Wild West, but a state governed by the rule of law,” said Hufeld in his speech to open the annual press conference of the Federal Financial Supervisory Authority.

With this, Hufeld hopes to put paid to false expectations towards the supervisor. One cannot simply ride off wearing a Sheriff’s badge to arrest anyone suspected of being involved in money laundering, said Hufeld. The supervisor passes on evidence of criminal offences to the police and the public prosecutor’s office. If the public prosecuting authorities then conduct an investigation, this does not mean that BaFin has been sleeping on the job – quite the reverse. “Setting ourselves up as an authority with an all-encompassing field of competence for the sake of supposed success, or accepting such a role, would be questionable with regard to the principles of the rule of law,” explained BaFin’s President.

One number in particular reveals the extent of public interest in BaFin: more than 60 journalists in the field of finance and economics, representing both national and international newspapers and broadcasters, accepted an invitation to BaFin’s annual press conference in Frankfurt at the beginning of May. For these journalists, the opportunity to hear BaFin’s President, Felix Hufeld, and the other Chief Executive Directors offer their insights and observations once a year is an event not to be missed.

Lasting nearly three hours, it was also the longest press conference in BaFin’s history. The reason: the journalists had plenty of questions for BaFin’s Executive Board.

These questions focussed on the failed merger between Deutsche Bank and Commerzbank, the alleged failings by the supervisory authorities in Estonia and Denmark in connection with money laundering activities by Dankse Bank, the investigations into the payment service provider Wirecard, and the financial situation as regards Pensionskassen (occupational pension funds). BaFin’s new division, a kind of intensive care unit for struggling banks, also caught the journalists’ attention.

How can the current state of Germany’s financial system be described? “All in all, the financial sector is more stable and more resilient today than before the outbreak of the sub-prime crisis,” said Hufeld. He explained that banks are holding more capital and have built up liquidity buffers. “But even the unprecedented regulatory effort following the outbreak of the crisis was unable to completely eliminate old risks or pre-empt all new challenges,” said Hufeld.

“Even the best regulation cannot eliminate the possibility of a financial crisis”

According to Hufeld, constant vigilance is therefore paramount for financial supervisors. Otherwise, they could once again be overwhelmed by risks, just as they were almost ten years ago when the sub-prime crisis broke out. Since then, supervisors have gained new tools and, thanks to tailored resolution plans, they are now in a position to resolve banks in an orderly manner, he explained. Nonetheless, Hufeld openly admits that even the best regulation cannot eliminate the possibility of a financial crisis.

BaFin’s President currently has a number of concerns. These include banks’ lack of profitability and minimal efforts to cut costs. “We are lacking the necessary drive, which is simply essential in this context in Germany,” said Hufeld. Since the subprime crisis, the total costs of the German banking industry have risen further. This affects savings banks and cooperative banks (Sparkassen and Volksbanken), in addition to major private banks. “This shows me that the pressure still isn’t high enough,” said Hufeld.

Although institutions do have savings plans, they are not rigorous enough and institutions lack the willingness to implement them. “The management boards of banks must make this issue a top priority,” warned BaFin’s President. “We would fail in our duty as supervisors if we did not alert institutions to this problem.”

Most senior banking supervisor believes financial stability is at risk

Raimund Röseler, Executive Director of Banking Supervision at BaFin, is also cracking down on the banks. At the beginning of the year, he established a division with the specific task of closely supervising struggling institutions. “These are banks in the intensive care unit,” said Röseler. The number of institutions currently under special supervision is in the single-digit range. “We want to take precautions while the economic situation is still good so that we can be prepared in the event of a real downturn,” explained BaFin’s most senior banking supervisor.

At the same time, he believes financial stability is at risk because a “potential erosion of credit standards combined with a reduction in risk provisioning” is possible. “There is a lot of liquidity in the market, and at the same time limited demand for credit. In such an environment, many banks may be tempted to aggressively market loans and to offer them at very favourable conditions,” said Röseler.

BaFin is therefore currently concerned that institutions may relax their requirements regarding the creditworthiness of their borrowers or the quality of collateral, and at the same time neglect to make sufficient risk provisions, he explained. Together with the Bundesbank, BaFin conducted a survey on credit standards of around 100 institutions operating in Germany (see April 2019 edition of BaFinJournal – only available in German). The results are not yet available.

Röseler’s warnings come after a decade of almost constant economic growth in Germany during which the ratio of non-performing loans has fallen considerably. He pointed out that both the Federal Government and the five leading German economic research institutions recently significantly reduced their growth forecasts.

Röseler defended BaFin against the accusation that the authority, as a member of the decision-making body of the European Banking Authority (EBA) and together with other European banking supervisors, had voted against the recommendation of an investigation committee. To put this in context: the Estonian and Danish supervisory authorities were accused of breaching Union law in relation to the Danske Bank money laundering scandal. The two authorities reportedly did not exchange sufficient information to resolve the case.

Röseler explained that, as Executive Director, he was a member of the committee that issued the critical recommendation but that new facts were presented later during the key EBA meeting: the accusation of a breach of Union law could no longer be maintained and he therefore retracted his judgement for good reason. Nonetheless, the decision of the EBA’s board does not mean the authorities are beyond criticism. Mistakes were made in supervisory processes which are currently being reviewed, according to Röseler.

Money laundering is best combated at the international level

Dr Thorsten Pötzsch, Chief Executive Director for Resolution, who is also responsible for money laundering prevention at BaFin, drew the following conclusion in light of the various money laundering scandals in Europe: “While law-breakers have proved time and again how successfully they are working together internationally, the competences of the police, courts and supervisors in the fight against money laundering have, in most cases, ended at national borders.” The supervisory authorities of individual EU states must therefore work together with greater efficiency in the fight against money laundering, warned Pötzsch.

The different EU member states implement the European Money Laundering Directive differently. “One group in particular has benefited from the lack of consistent regulation in Europe up to now: law-breakers,“ said Pötzsch. He considers the fact that politicians are now taking regulatory action to be a good thing. In particular the Council of the European Union’s action plan and the European Commission’s roadmap are set to create supervisory convergence in Europe, meaning Europe-wide consistent provisions.

Pötzsch also welcomes the fact that the EBA will in future be able to demand investigations be carried out at the national level and, where necessary, take supervisory action itself. However, the EBA must not become a “supervisor of supervisors,” he warned.

MiFID II – a mixed impression

One and a half years after its entry into force, the Second European Markets in Financial Instruments Directive (MiFID II) is still the subject of controversial discussion. “However, BaFin’s market surveys have shown that, in the vast majority of companies, processes have been integrated with considerably less disturbance than was to be anticipated given the scope of the directive,” said Roegele, BaFin’s Deputy President and Chief Executive Director of Securities Supervision.

Roegele believes that further action must be taken with regard to the key conduct of business rules to be followed by companies towards investors. Although institutions have made progress in the area of cost estimates, referred to as ex ante cost information (see expert article on the BaFin website dated 1 October 2018 ), particularly in relation to the quality of forecasts, there are still considerable differences in the cost information provided to clients, according to Roegele. “This makes it impossible to really compare costs,” said Roegele. With respect to common standards, there is a need for further adjustments at EU level and for efforts to be made to reach compromises.

As regards the statement on suitability (see expert article on the BaFin website dated 17 October 2018 ), which is a written statement provided to clients following investment advice in which the financial advisor explains why their recommendation to buy a specific financial product is suitable for the respective client, too many institutions have not yet implemented all of the requirements. “We cannot accept this,” said Roegele.

According to Roegele, bank employees have implemented the process of taping telephone investment consultations that could lead to securities transactions largely without errors (see expert article on the BaFin website dated 4 October 2018). She reported that she is satisfied with how the institutions have implemented taping requirements.

Solvency II needs improvement

“Bloated, number-obsessed and bureaucratic” – Dr Frank Grund has heard such criticism of the European supervisory regime for insurers time and again. But the Chief Executive Director for Insurance and Pension Funds Supervision does not entirely agree with this view. “Solvency II has proven its worth as a system based on market-consistent valuation and has improved risk management.”

As provided for under EU law, Solvency II is currently being reviewed. By mid-2020, the supervisory authorities of the member states, together with the European Insurance and Occupational Pensions Authority (EIOPA), must reach an agreement on the technical advice to provide to the European Commission. Grund believes that, with this review, Solvency II can even be improved, particularly with respect to the standard formula, long-term business and reporting.

In Grund’s view, the standard formula, which is used by insurers to calculate their solvency capital requirement, must take negative interest rates into consideration, as is already the case for internal models. According to Grund, the standard model currently assumes that there are no negative interest rates.

“The Solvency II review also needs to adequately reflect the needs of long-term business,” said Grund. In life insurance, the dates of the payouts for obligations insurance undertakings have to clients can sometimes lie a long time in the future, according to Grund. “Life insurers are able to ride out fluctuations in investments,” he explained. This must be reflected in the capital requirements.

Grund spoke in favour of improving proportionality (see expert article on the BaFin website dated 15 March 2019), which means that smaller, lower-risk insurers are to be treated differently to large, higher-risk undertakings. Regulation and supervision need to be aligned with the nature, scale and complexity of undertakings’ risks, according to Grund.

He reported that the number of Pensionskassen under intensified supervision has fallen from 45 to 31 within one year, which he regards as a success on the part of the supervisor.

Increasing digitalisation of BaFin

Considerable changes can be seen within BaFin, too. “BaFin is in the midst of a digital transformation,” explained Béatrice Freiwald. BaFin’s Chief Executive Director of Internal Administration and Legal Affairs is pushing forward the digitalisation of the financial supervisor. She also sees potential gains in efficiency.

“The internal digitalisation of our authority is one of the cornerstones of BaFin’s digitalisation strategy¹,” said Freiwald. She explained that, in future, a Chief Digital Officer will focus BaFin’s digitalisation activities in one place and, together with their colleagues from the Digital Office, will see that processes are continually improved.

“Communication with supervised institutions must also be made more digital,“ said Freiwald. BaFin has already digitalised a large portion of its supervisory and supporting processes, according to Freiwald. It is already possible for companies to make use of various notification procedures to submit information to BaFin electronically, she explained, adding that BaFin intends to further develop these possibilities.

In response to a question on the topic, BaFin’s Chief Executive Director of Internal Administration and Legal Affairs explained why BaFin’s budget has risen in recent years. When looking at the costs, one must bear in mind that BaFin has recently been assigned numerous new tasks, according to Freiwald. For example, with the national resolution authority, an entire authority was integrated into BaFin, she explained.

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