The pandemic, landmark rulings, catastrophic flooding: these are turbulent times for the banking sector. Chief Executive Director Raimund Röseler sat down with BaFinJournal to discuss how the measures to stop the spread of the coronavirus have impacted the banks' books, what additional burdens are expected to result from recent court decisions on cum/ex transactions, premium-aided savings agreements and changes to standard terms and conditions, as well as the extent to which recent catastrophic floods might affect institutions. He also talked about the outcome of the recent Europe-wide stress test.

Mr Röseler, with the delta variant spreading, the pandemic appears to be entering yet another new phase. How long do you want to maintain the supervisory exemptions for the institutions?

Although the pandemic isn't over yet, it hasn't had an inordinate impact on the banks' books so far. So we expect to let the exemptions relating to the liquidity coverage and leverage ratios expire at the end of the year. We will also be gradually withdrawing other exemptions, including administrative ones. However, we will of course continue to keep a close eye on events as they develop so as not to overburden the banks.

What are the plans for the countercyclical capital buffer?

We will discuss that within the Financial Stability Committee. I suspect that we won't raise the capital buffer until the economic situation permits it.

You've just said that the pandemic hasn't hit the banks' books as hard as originally feared. How are German banks faring, then?

They are well capitalised, as ever. The German institutions have surplus capital in excess of 150 billion euros, and the actual write-downs required have been significantly lower than projected. Germany's SIs budgeted for six billion euros in write-downs for this year, and only recognised a few hundred million in the first five months. And the situation has been similar for our LSIs . Most of them have thus far not reported any increased impairments or any significant rises in defaults. We expect that impairments might rise for LSIs and certain risk metrics might deteriorate in some instances. However, on the whole, we believe that Germany's banks remain sound.

What will happen when the various state support measures run out? We can assume that those measures are still distorting the actual picture somewhat at the moment.

State aid really has cushioned much of the blow to the German economy. Now that insolvency law applies again in its old form, insolvencies in certain sectors are on the rise. However, this has yet to directly hit the banks' books so far. While individual institutions are giving us cause for concern, it is mainly those which were on shaky ground already before the pandemic. Germany's banking sector as a whole has weathered the crisis well so far and we currently believe it will continue to do so.

How are the banks' loan portfolios looking? Do they hold many non-performing loans?

Those are currently at a low level. If NPL ratios were to rise, this would necessitate higher provisions and could weaken the German institutions' profitability further, thereby eroding their solvency. However, we do not anticipate any wide-scale problems as they are unlikely to rise so drastically.

There are also loans for which the banks have granted forbearance measures, which might also need to be taken into account. The NPL ratio for the SIs is currently 1.3 percent. If every loan in forbearance were to default, that ratio would climb above 2 percent. Now, that's a lot. But it's a worst-case scenario.

What should institutions do to keep the issue of non-performing loans in check?

Two things: Firstly, institutions need to keep an eye on their borrowers, and act early if need be. And secondly, they need to set aside enough capacities to deal with defaults – possibly more than in the past. That's because while they might not be dramatic, a number of defaults will undoubtedly occur.

The way banks handle credit risk is also a question of risk management. How are the banks doing on that front?

We believe there is room for improvement at a number of institutions at any rate. The pandemic has shown us that certain banks are experiencing greater problems than others as far as management and organisation are concerned. As for dealing with defaults: there have been extremely few in the past. Some institutions thus have only little experience in handling NPLs. It is important for banks to be prepared and to set aside capacities for risk management.

The ECB has decided to discontinue its dividend recommendation from October and you have expressed your view on the matter. In your opinion, has BaFin's case-by-case approach been proven effective?

Yes, I believe it has. It was not and is not possible for us to ban dividend distributions wholesale. We will therefore continue to examine each case on its own. However, we will rescind our announcement of December 2020 on the matter. We will no longer require institutions to notify us in advance of their dividend distribution plans. However, we continue of course to expect them to distribute dividends only if they can afford it.

So you don't expect a wave of distributions.

Correct. Many institutions have already distributed dividends over the course of the year, but at a very prudent level. I assume that this will remain the case. I don't expect that institutions will be trying to make up for lost time, as it were.

Will you be monitoring the institutions?

Yes, we will of course look at each one individually. Ongoing supervision provides us a window into how banks are approaching the issue. If we see that an institution isn't doing well and still pays out dividends or excessive distributions, we will intervene. We have already done so in the past.

Mr Röseler, what do you make of the German banks' results in the current EBA and ECB stress tests

The German banks have shown that they are sufficiently capitalised even in an adverse stress scenario. That's good news. Particularly as this scenario was no walk in the park, since it included a prolonged economic downturn resulting from persistent uncertainty due to the coronavirus crisis. Although some German institutions use up portions of their capital buffer in the stress scenario, these are mainly the capital conservation buffer and the buffer for global or other systemically important institutions. There are two things to keep in mind here: The institutions remained above the minimum capital requirements we supervisory authorities have imposed. This means they would still have more CET1 capital than we require. And these additional buffers are expressly intended to ensure that the banks have reserves which they can tap in a crisis in order to absorb shocks and continue to lend.

It was just like in the actual coronavirus crisis: the stress test once again showed us how important it is to have sufficient and sound capital resources. By that I'm referring to both the quality and the quantity of capital. The combination of Tier 1 capital and additional buffers for crises has proven itself. We require this combination as one of the lessons learnt after the 2007/2008 financial crisis.

What will the recent cum/ex ruling by the Federal Court of Justice mean for banks?

The cum/ex ruling did not come as a surprise. It would have been surprising had the Federal Court of Justice ruled differently. And I think the ruling was also in line with most banks' expectations. That's why the majority of banks likely also recognised sufficient risk provisions. Now we need to see whether there remains room for improvement here and there, including with respect to the provisions.

The Federal Court of Justice has also recently issued two other landmark decisions: one on premium-aided savings agreements and one on changes to standard terms and conditions. How are the banks coping?

The cum/ex ruling really only affects a relatively small number of institutions. The decisions on premium-aided savings agreements and standard terms and conditions are relevant to a large number of banks. I would even go so far as to say that the terms and conditions decision affects every bank, albeit to varying degrees since not all banks are active in the retail business to the same extent. The decision took many institutions by surprise. Quite in contrast to the cum/ex ruling. Nobody truly believed it was legal to pay taxes once and have them reimbursed twice.

Are the banks prepared to bear the burdens arising from the terms and conditions decision?

I don't think the costs of reimbursements will be as staggering as originally feared. What is more significant is the question as to how this will affect the future. What price level will the affected institutions return to in immediate reaction to the decision? The one from three years ago? Or the one in effect when the account was opened? And which price level do they hope to achieve in the long run? What options and processes will the banks have at their disposal for future price hikes?

You said the cost would not be staggeringly expensive. What scale are we talking about here?

Due to limitation rules, reimbursements are expected to be kept to a reasonable amount. However, we don't have any reliable estimates as of yet. We have surveyed 100 banks on the matter and are currently working with ten institutions to figure out how expensive this can get. We are also in close dialogue with the relevant industry associations.

Is BaFin considering issuing a general administrative act regarding changes to standard terms and conditions? Or have the discussions with the institutions and associations been so fruitful that this won't be necessary?

Let's see how the banks get on, first. We've got to bear in mind that the decision caught the institutions off guard. We will also take a close look the next time account management fees are charged at the end of the quarter. We expect the banks to reach valid agreements with their customers as soon as possible. If not, we have every option at our disposal, of course.

A quick look at the Federal Court of Justice's ruling on premium-aided savings agreements: So far, BaFin has received 1.100 objections to the general administrative act.

These objections are not surprising, and do not worry us. We will examine every one of them and every institution will receive a formal objection notice from us. Some banks will then no doubt turn to the administrative court. This is the usual procedure in a state governed by the rule of law, and that procedure cannot be rushed. I have utmost confidence that our general administrative act will become legally effective. We would not have proceeded in this manner had we not been confident of this.

The consumers are likely less sanguine in this regard.

Understandably. We want to require banks to inform their customers if their premium-aided savings agreements contain invalid interest rate adjustment clauses. And to let them know whether or not they short-changed them on interest on the basis of those clauses. If so, they have to irrevocably promise their customers an interest recalculation or offer them an amending agreement containing a valid interest rate adjustment clause. To the extent banks fail to approach customers on their own – as we intended – those customers will have to wait until our general administrative act becomes legally effective. Or they will have to dispute their interest calculations through the civil courts – potentially with assistance from consumer protection associations.

Mr Röseler, we'd like to close with a question regarding the devastation in certain regions of Germany in the wake of July's severe storms. How will this affect the banks?

Some local banks were badly hit by the storms. And in more than one respect: branch offices have been destroyed and employees have been affected. That has an immediate impact on institutions. And the banks' customers also suffered severe losses. The extent to which this will affect loan portfolios, for instance, will surely depend on the scope of state support measures. We will of course keep a close eye on developments. And we will of course exercise our supervisory responsibilities with a sense of proportion.

Mr Röseler, thank you for sitting down to talk with us.