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Stand:updated on 24.01.2014 Banking Supervision

In order for a national economy to be able to function properly, it needs a reliable banking system. Banking supervision helps to ensure that this system is efficient and stable. The most important objectives of banking supervision and the most important rules for credit institutions are laid down in the Banking Act (Kreditwesengesetz - KWG).

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Banking Supervision in Germany

Only a stable financial system can fulfil its macro-economic function - the cost-effective transformation and provision of financial resources. A properly functioning banking system is indispensable for the performance potential of a country's economy and an efficient banking supervision system is therefore essential for the whole economy.

The primary legal basis for the supervision of banks is the Banking Act (Kreditwesengesetz – KWG), which has by now been amended fairly extensively on a number of occasions since it was signed in 1961. There are also a number of special Acts, such as the Pfandbrief Act (Pfandbriefgesetz - PfandBG), the Safe Custody Act (Depotgesetz - DepotG), the Building and Loan Associations Act (Bausparkassengesetz - BauSparkG) and the Savings Banks Acts (Sparkassengesetz - SpkG) of the Federal States.

Objectives of banking supervision

The primary objectives of banking supervision are summarised in section 6 (2) of the Banking Act. These are to work to prevent irregularities in the banking system which

  • endanger the safety of the assets entrusted to institutions;
  • adversely affect the orderly execution of banking transactions; or
  • may substantially prejudice the economy as a whole.

The Banking Act lays down rules for banks which they have to observe when they are being established and when they are carrying on their business. These rules are designed to prevent undesirable developments which might disrupt the smooth functioning of the banking system. How closely banks are supervised depends above all on the nature and scale of the business they carry on. As a matter of principle the regulator concentrates most closely on whether institutions have adequate capital and liquidity and have installed appropriate risk control mechanisms.

The laws on which banking supervision is based are consistent with the principles of the free market economy. The banks' senior management alone is responsible for the banks' business policies. But institutions do have to meet basic qualitative and quantitative conditions and are under a statutory obligation to open their books to the regulator. If BaFin identifies significant deficiencies in an institution when carrying out its solvency supervision and if the ascertained facts correspond to the circumstances defined by law, BaFin may take supervisory measures intervening in the institution's business policies.

Banking supervision cannot - nor should it be expected to - prevent insolvency in every case. That is why for the protection of customers there is statutory deposit protection. It covers an investor's deposits to a maximum compensation limit of 100,000 euros (section 4 (2) of the Deposit Guarantee and Investor Compensation Act (Einlagensicherungs- und Anlegerentschädigungsgesetz – EAEG). But alongside the statutory scheme there are also private protection schemes run by the banking associations which offer protection in excess of the statutorily prescribed degree of protection.

Division of responsibilities between BaFin and the Deutsche Bundesbank

BaFin and the Deutsche Bundesbank share banking supervision. Pursuant to section 6 (1) of the Banking Act, BaFin is the administrative authority responsible for the supervision of institutions under the Banking Act. The cooperation of BaFin and the Deutsche Bundesbank in the institutions' ongoing supervision is governed by section 7 (1) of the Banking Act, which stipulates that, among other things, the Deutsche Bundesbank shall, as part of the ongoing supervision process, analyse the reports and returns that institutions have to submit on a regular basis and assess whether their capital and their risk management procedures are adequate. In consultation with the Deutsche Bundesbank BaFin has also issued a "Guideline on the execution and quality assurance of the ongoing supervision of credit and financial services institutions by the Deutsche Bundesbank" (Supervision Guideline).

Authorisation and ongoing supervision

Before an institution can actually be supervised on an ongoing basis, it must first be granted authorisation.

Authorisation and the conditions that have to be met

Any party wishing to conduct banking business in Germany requires written authorisation from BaFin (sections 32 and 33 of the Banking Act). To this end, certain conditions must be met - here are some examples:

  • When an institution is being established, it has to prove that it is endowed with a particular minimum amount of initial capital. For investment banks, for example, the initial capital required is at least 730,000 euros, while for deposit-taking credit institutions it is at least 5 million euros.
  • The institution must have at least two senior managers (executive directors). Both must be "fit and proper persons". Being a "fit" person means that the persons concerned have during their professional careers to date acquired sufficient theoretical knowledge and practical experience to enable them to carry out their new jobs properly. BaFin consults the Federal Central Register (Bundeszentralregister) for criminal offences and the Central Commercial Register (Gewerbezentralregister) for business offences in order to verify whether they are reliable (i.e. "proper") persons.
  • The applicant must declare any holders of significant participating interests (section 1 (9) of the Banking Act) in the proposed institution and the size of any such participating interests. Any such persons must also be "proper" persons. If they are not, or if they fail to meet the standards required in the interests of sound and prudent management of the institution for any other reasons, BaFin may refuse to grant authorisation.
  • In addition, the application for authorisation must contain a viable business plan indicating the nature of the proposed business, the organisational structure and the proposed internal control systems. BaFin checks whether the applicant is ready and able to take the necessary organisational measures in order to be able to carry on its business in a proper manner.

Ongoing supervision

Once institutions have been established, the banking supervisor monitors them on an ongoing basis. In so doing, it pays particular attention to the following points:

  • Credit institutions must have adequate own funds (section 10 of the Banking Act in conjunction with Articles 92 to 386 of Regulation (EU) No 575/2013 on prudential requirements for credit institutions and investment firms (Capital Requirements Regulation – CRR). Banks must at all times satisfy the requirements of a Common Equity Tier 1 capital ratio of 4.5%, a Tier 1 capital ratio of 6% and a total capital ratio of 8%. As part of their ongoing supervision, banking supervision staff also monitor whether institutions have adequate capital to cover risks incurred in respect of on-balance-sheet assets and off-balance-sheet transactions - such as lendings, securities, derivatives or participating interests. In addition to default and market risks, operational risks must also have adequate capital backing.
  • The institutions must also set aside funds for the capital conservation buffer, the countercyclical buffer and, if so ordered, also for the capital buffer for systemic risks, the capital buffer for global systemically important financial institutions and the capital buffer for otherwise systemically important financial institutions (sections 10c to 10i of the Banking Act).
  • In addition, banking supervision also checks whether institutions have adequate liquidity, i.e. whether they invest their funds in such a way as to ensure that adequate liquidity for payment purposes is guaranteed at all times (section 11 of the Banking Act).
  • Under the Supervisory Review Process (SRP) BaFin also supervises those risks which do not require capital backing under the CRR (section 6b of the Banking Act). Key elements of the SRP are the establishment of adequate risk management systems and the supervision thereof by BaFin. For instance, institutions must establish the so-called Internal Capital Adequacy Assessment Process (ICAAP), which ensures that they have adequate internal capital to cover all material risks. In addition, they must also have appropriate management, monitoring and control processes (“robust governance arrangements”). Consequently, a credit institution's organisation must be structured in a manner appropriate to the nature and scale of the business that it carries on. In addition, institutions have to meet the Minimum Requirements for Risk Management (Mindestanforderungen an das Risikomanagement – MaRisk). They must be able to identify, measure and control risks. Since banking business is becoming increasingly more complex, institutions must take appropriate measures to manage and monitor their different risks. It is therefore an important function of BaFin to verify whether the banks' own risk control and management systems are up to this task.

In addition to institutions' annual financial statements, the banking supervisors' main sources of information include the audit reports which external auditors or audit associations produce as part of their auditing of the annual financial statements. In addition, every month institutions have to file abbreviated balance sheets, known as monthly returns, from which the major balance sheet items and risk positions and changes therein can be identified. Institutions must also report major changes - for example, emergent net losses or changes in senior management, in their domestic and foreign branch network or in participating interests of more than 10 per cent. Large exposures and "Millionenkredite" (loans to one borrower totalling 1.5 million euros or more) also have to be reported. BaFin can also gain deeper insights into a bank's financial situation by way of special on-site inspections. BaFin can give prior notice of such inspections, but it can also pay the bank a "surprise" visit.

For its solvency supervision purposes, BaFin has all regulatory decision-making powers. Measures to avert threats range from written warnings - known as serious objections - through fines to withdrawal of a bank's authorisation to conduct banking business and closure of its business premises. If senior management lack the necessary qualifications, BaFin may require of the Supervisory Board that they be removed from office and may replace them with a special commissioner. BaFin may also transfer supervisory board powers to a special commissioner.

History of Banking Supervision

The banking crisis of 1931 was the prime motive behind the establishment of comprehensive state supervision of all banks operating in Germany. This crisis had been fuelled by the Great Depression, which had begun with the Wall Street Crash in America ("Black Friday"). Reeling from the shock of this crisis, the German Reich government issued a large number of emergency decrees, including the "Decree relating to Stock Corporation Law, Banking Supervision and Tax Amnesty" (Verordnung über Aktienrecht, Bankenaufsicht und über Steueramnestie) of 19 September 1931. This legislation became the foundation-stone for a uniform system of state supervision of all banks. Previously, only particular groups of institutions (public savings banks in Prussia since 1838 and mortgage banks since 1899) or particular types of banking business (e.g. those covered by the Safe Custody Act and the Stock Exchanges Act of 1896) had been subject to supervisory rules. Apart from that, up to the early 1930s the principle of freedom of trade (the core principle of the Trade Regulation Code of 1869 (Gewerbeordnung)) had generally prevailed in the banking sector as well.

The banking crisis swept into Germany following the failure of Österreichische Creditanstalt (an Austrian bank) in May 1931, which also triggered a run on German banks and savings banks. The situation was exacerbated when, following the failure of the "Nordwolle" textile group, the Darmstädter und Nationalbank ("Danatbank") suffered large losses on its lending and had to close its doors on 13 July. Investors' confidence in other banks also visibly waned – the main victim being Dresdner Bank, which had a close contractual relationship with Danatbank. When things eventually came to a head, as all Berlin-based banks could only pay out one fifth of the funds depositors were seeking to withdraw, the Reich government finally intervened: it closed all bank counters for two days, guaranteed customers' deposits with Danatbank, provided Dresdner Bank with 300 million Reichsmarks to strengthen its capital base and finally, nine months later, ordered the merger of Dresdner Bank and Danatbank. All told, the German Reich had to spend 1.3 billion Reichsmarks to shore up the country's banks.

The emergency decree of September 1931, which had been issued with a view to stabilising the financial sector, resulted in banks being supervised on a monitoring basis. A more comprehensive legislative framework for banking supervision was established by the Banking Act of the German Reich (Reichs-Kreditwesengesetz – KWG) of 5 December 1934. The Act marked the beginning of a general, codified system of banking supervision, the basic principles of which have in some respects survived to this very day. These include, for example, the involvement of the central bank in banking supervision (section 7 of the Act), the obligation to obtain an official licence in order to be able to conduct banking business, principles governing the amount of liquidity that banks must hold as well as reporting requirements for all banks. The Banking Act of 1934 also established a new Banking Supervisory Office (Aufsichtsamt für das Kreditwesen) within the Reichsbank. The Supervisory Office included representatives from all relevant government agencies. In addition, as an executive body, the Act also provided for an executive organ in the form of a Banking "Reich Commissioner" (Reichskommissar), a government official reporting directly to the Reich Minister of Economics. The Reich Commissioner was responsible for implementing the Banking Act within the regulatory framework laid down by the Supervisory Office.

The Banking Act of 1934 was amended and supplemented by implementing regulations on a number of occasions. When the Reichsbank lost its independence in 1939, the supervisory duties and powers were transferred to the Reich Banking Supervisory Office (Reichsaufsichtsamt für das Kreditwesen), which was answerable to the Reich Ministry of Economics. By a decree of September 1944 the Reich Banking Supervisory Office was also wound up.

After the end of World War II the military governments of the Western Allies decentralised the banking supervision system in the three western occupation zones and transferred regulatory powers to the newly created Federal States. The Federal State governments created a "Special Banking Supervision Committee" (Sonderausschuss Bankenaufsicht) in order to coordinate their activities. Its members included representatives of all banking supervisory authorities and of the Bank deutscher Länder – which was later to become the Deutsche Bundesbank – and, from 1949 onwards, representatives of the competent Federal ministries.

Shortly after the end of the war efforts began to be made to comprehensively revise the Banking Act. Problems over what powers were required to implement framework regulations, ambiguities regarding allocations of responsibilities and proposals put forward by the Occupying Powers gave rise to a large number of proposed amendments, which were the subject of discussion from 1950 onwards.

Following several years of preparations, the Banking Act of 10 July 1961 (Gesetz über das Kreditwesen – KWG) entered into force on 1 January 1962, thus creating Germany's central prudential supervision system, the Federal Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen – BAKred). The headquarters for the new authority was located in Berlin for political reasons.

The centralisation of banking supervision under a higher federal authority led some Länder to reject the new Banking Act in the Bundesrat. They first appealed to the conciliation committee – unsuccessfully – and then filed for judicial review with the Federal Constitutional Court. On 24 June 1962, the Court ruled that the Banking Act was compatible with Germany's Basic Law, thus putting an end to years of dispute surrounding the centralisation of banking supervision.

When it commenced its activities in 1962, BAKred supervised approximately 13,000 credit institutions with some 18,000 branches. By the time BAKred became an integral part of the Federal Financial Supervisory Authority (BaFin) on 1 May 2002, the number of institutions it supervised had fallen to roughly 2,600, while the number of supervised branches had risen to approximately 51,000. These figures reflected the consolidation process in the banking sector, as well as the expansion of the banks' branch networks that had taken place over the course of 40 years.

In the time between its inception in 1961 and today, the Banking Act has been extensively revised on several occasions. These amendments were made in order to enable banking supervision to evolve in response to developments on national and – in recent decades, increasingly – on international financial markets.

While the first round of amendments to the Act contained only isolated changes, all further amendments brought about the expansion and sophistication of regulatory requirements imposed on banks: the scope of supervision was further expanded to include ever more types of undertaking, as were the powers of supervisory intervention.

For example, the second round of amendments, which entered into force on 1 May 1976, authorised the banking supervisor to impose a temporary moratorium on distressed banks (section 46a of the Banking Act) and to conduct special inspections without special reason (section 44 (1) of the Banking Act). The amendments also included a stricter provision relating to large exposures (section 13 of the Banking Act) and introduced the principle of dual control among senior management (section 33 of the Banking Act). However, the purpose of these "stop-gap" amendments was merely confined to closing the gaps in banking supervision which had become evident upon the collapse of the Cologne-based bank, Herstatt, in 1974.

The Banking Act was extensively revised in the course of the third round of amendments, which entered into force in 1985. These amendments were based on the findings of the study commission on "Fundamental issues concerning the banking industry" (Grundsatzfragen der Kreditwirtschaft), which was convened just months after Herstatt's failure. In particular, the amendments seized on the commission's proposals concerning a new method for calculating liable capital and on the consolidation of banking supervision, thereby preventing the occurrence of "credit pyramids".

The legislator implemented further rounds of amendments to gradually transpose the Directives of the European Union into German law. Those Directives are intended to lay the foundations for the free movement of financial services in Europe's internal market. This is based on the principle of home country control and is predicated on the mutual recognition of supervision while ensuring compliance with agreed minimum supervisory standards (introduction of the "European Passport"). The fourth round of amendments, introduced at the end of 1992, transposed into German law the Second Banking Directive and the Own Funds Directive. An amendment to the principles concerning own funds served to transpose the Solvency Directive into national law. The amendments to the Banking Act also considerably expanded the definition of own funds, introduced shareholder control and imposed limitations on non-bank shareholdings. Just under two years later, in September 1994, the fifth round of amendments transposed into German law the Large Exposures Directive and the Second Consolidation Directive.

The sixth round of amendments entered into effect in January 1998; these amendments served primarily to transpose into German law the Capital Adequacy Directive (CAD) and the Investment Services Directive (ISD). The primarily impact of the two Directives was to harmonise the supervision of investment firms and banks. For the first time, the financial services institutions in Germany defined in section 1 (1a) of the Banking Act were subject to government supervision. In addition, the transposition of the CAD and ISD also included the underwriting business in the catalogue of banking business subject to an authorisation requirement (section 1 (1) of the Banking Act). At the same time, the new section 44c of the Banking Act provided the Federal Banking Supervisory Office with the necessary tools to successfully combat unauthorised banking business and financial services under its expanded competence.

The CAD supplemented the four Directives already concerning banks (Own Funds, Solvency, Consolidation and Large Exposures) and was aimed at defining own funds requirements, particularly for risks arising from securities trading and foreign exchange transactions. In the summer of 2002, the Fourth Financial Market Promotion Act again expanded the powers to obtain information and powers of intervention of banking supervisors merged under the Federal Financial Supervisory Authority in May of that year. For instance, it was now possible to submit requests for information from, and conduct inspections pursuant to section 44 of the Banking Act on, undertakings to which a credit institution has outsourced portions of its business. Finally, the Electronic Money Directive was transposed into law, thus closing existing gaps in the anti-money laundering system.

In 2007, strong turbulence erupted on the financial markets once again, posing a serious risk to financial stability. The bursting of the US housing bubble triggered worldwide losses and insolvencies among companies from the financial sector, including the major American bank Lehman Brothers Inc. in September 2008. It was only possible to prevent other collapses by means of state interventions. Some credit institutions in Germany ran into serious difficulties too. The financial sector worldwide suffered from the effects of the crisis. Dangerous gaps in the international regulatory system became apparent and needed to be closed, so regulation was significantly tightened at both a global and European level.

The fi­nan­cial cri­sis and its con­se­quences

Stronger capital requirements and supervision of systemically important financial institutions: How has regulation changed as a result of the financial crisis?

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Systemgefährdende Institute (refer to: The financial crisis and its consequences)

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As a result of the crisis major structural reforms took place as well, including the setting up of a European supervisory system at the beginning of 2011. The European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA) started work. They form the European System of Financial Supervision together with the European Systemic Risk Board (ESRB), which monitors macroeconomic developments and, in case of emergency, warns of systemic risks to the financial stability of the EU.

Another fundamental reform was undertaken in 2014: in November of that year, the Single Supervisory Mechanism (SSM) was launched as part of the European banking union, which is regarded as one of the most important European reforms since the introduction of the euro. Since then, the largest banking groups of the eurozone – currently 125 of them – have come under the supervision of an alliance led by the ECB. These banking groups, including 21 from Germany, are supervised directly by the SSM. There are now Joint Supervisory Teams for them, in which BaFin staff work side by side with supervisors from throughout the eurozone. The introduction of the SSM was, first and foremost, a reaction to the sovereign debt crisis, which escalated in 2011 and became the main risk to financial stability.

Sin­gle Su­per­vi­so­ry Mech­a­nism

How do the ECB and national supervisory authorities cooperate? Which institutions are supervised by the SSM?

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Internationales - Europäische Aufsicht (refer to: Single Supervisory Mechanism)

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The SSM has represented a historic paradigm shift for European banking supervision and has raised many questions and areas of uncertainty. BaFin participated intensively in the design of the framework for the cooperation of the ECB with national supervisory authorities and contributed to the development of a joint SSM Supervisory Manual.

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